02/20/2009

Card Lenders See Covered-Bond Salvation

Credit-card lenders are hopping on the covered-bond bandwagon.

Capital One, Citigroup and Discover are among several U.S. credit-card shops mulling such deals, as they seek alternatives to funding themselves in the downtrodden asset-backed bond market. Underwriter RBS Greenwich is also in on the act, as it works with a number of card companies to set up issuing platforms.

Elizabeth Padova Hanson, who heads RBS' covered-bond unit and sits on SIFMA's covered-bond council, is spearheading the bank's efforts.

Covered bonds, which combine aspects of asset-backed securities and corporate debt, have drawn considerable attention since early 2008 as a potential way for U.S. mortgage lenders to fund themselves in the face of anemic demand for traditional securitizations. But the on-balance-sheet deals haven't been seen as a possibility outside the home-loan sector until now.

The motivations of credit-card lenders are largely the same as those of mortgage companies. That is, the yields they must pay to asset-backed bond buyers have often swollen to uneconomical levels amid the credit crisis, effectively erasing a once-dependable source of funding.

Even after tightening by several hundred basis points, for instance, 2-year senior card bonds are trading around 300 bp over Libor - compared to flat to Libor before the debt market bombed in 2007. Covered bonds, meanwhile, promise to offer lower funding costs in part by appealing to a broader investment community that favors more conservative products.

Card lenders also want to expand their options as they lose faith in government efforts to stimulate securitization activity, and thus boost consumer lending. For instance, doubts are springing up about the effectiveness of the Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF).

That program is designed to stoke demand for asset-backed bonds by allowing buyers to post those instruments as collateral for low-cost government loans. But details have been slow to emerge, and some prospective issuers of TALF-eligible deals are grumbling about discounts the Fed plans to apply to the values of their deals. They also complain that TALF will prove unappealing to so-called hard-money buyers that don't use leverage, and worry that the arrangement could make them answerable to the government. "It's hard for us to justify using [TALF] from a pure cost-of-funding standpoint," Capital One securitization chief Richard Johns said while speaking on a panel at the American Securitization Forum's conference in Las Vegas last week. He added that covered bonds could present a more attractive alternative in the months ahead.

Still, much of the talk about covered bonds has been theoretical. While the deals have long been popular among mortgage lenders in Europe, it has been years since a U.S. home-loan shop has been in the market - and persistently weak debt-market conditions will probably prevent any planned deals from materializing for at least a few months.

Hopes for a surge of mortgage-related offerings remain high though. Industry players have kept a close eye on Bank of America, Citi, J.P. Morgan and Wells Fargo as the banks worked together in recent months to draft a blueprint for mortgage-related covered-bond sales in the States. Meanwhile, the FDIC and U.S. Treasury Department have expressed support for the development of the market.

Greenwich's Padova Hanson has even been working on ways to apply government guarantees to covered bonds, and may carry over those efforts to offerings from card lenders.

Investors are interested as well. That's largely because covered-bond ratings are linked to the strength of the issuers, creating an added layer of recourse for buyers while giving issuers an incentive to support their deals. A big complaint about traditional mortgage bonds has been that it was too easy for lenders to put together the bankruptcy-remote transactions and distribute them without keeping any skin in the game.

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