Covered bond trading halt not to be repeated: EMF

By Richard Barley

LONDON (Reuters) - Last year's halt in interbank market-making in the 1.7 trillion euro ($2.5 trillion) covered bond market is unlikely to be repeated, the secretary general of the European Mortgage Federation said on Wednesday.

"It was done once, I don't think it's going to be done twice," Annik Lambert told the Reuters Housing Summit, as those parts of the market that have performed well seek to avoid being seen as problematic.

Credit market participants were shocked in November last year as the European Covered Bond Council, part of the EMF, recommended that traders suspend interbank market-making in covered bonds -- a key source of mortgage funding -- due to extreme volatility.

Covered bonds -- backed by pools of assets that remain on the borrower's balance sheet -- are typically rated triple-A by credit ratings agencies and had been viewed as highly liquid securities.

One problem was that the pressure on covered bonds was only being felt severely in certain sectors of the market.

Analysts said that investors were discriminating between those markets with a long track record and strong legislative support for covered bonds -- such as Germany and France -- and those seen as having less support, such as from the UK.

As a result, spreads on covered bonds from the UK widened sharply while those on German Pfandbriefe actually tightened on the year.

Lambert said the across-the-board suspension of market-making had reflected badly on those covered bonds that had not experienced problems, and that therefore it was unlikely to be repeated.

"I don't think it's going to happen again," she said.

As a result, the market is still operating on a two-tier system, whereby bonds trading at wider spreads have less stringent market-making requirements than those trading at tighter spreads.

Lambert said the market was aiming at getting back to normal in terms of market-making commitments, but it was not clear whether this could happen in 2008.

However, the covered bond market could yet see benefits from the credit crisis as it is a key funding route for mortgages. With the European securitization market remaining shut, the relative simplicity of covered bonds could find favor.

However, some issuers which had been showing interest -- among them U.S. banks -- may not rush to market.

Lambert said that the ECBC had seen interest from U.S. banks but that contacts had lapsed as the credit crisis deepened.

The EMF is a key trade body which advises the European Central Bank, European Commission, and the Basel Committee on mortgage lending issues. The ECBC, set up in 2004, is part of the EMF and has over 80 members, representing 85 percent of all covered bond issuers in the European Union.  Continued...