Washington Mutual's Covered Bonds

Washington Mutual's Covered Bonds

Group members - A. Singh (61310825), F. Eucalipto (61319002), H. van den Heever (61319039), R. Chatterjee (61310003)

2008 had been a turbulent year experiencing the crash of Lehman Brothers, broad equity market index drop and Freddie Mac and Fannie Mae being placed into conservatorship. Washington Mutuals covered bonds also fell to 75 per 100 of face value. Earlier in 2006, Washington Mutual had issued 6 billion euros of Covered bonds. However in 2008 it was facing a crisis due to increasing losses in its mortgage portfolio. Here we evaluate the collateral portfolio in the event of liquidation, since the Covered bonds were over collateralized.

Covered bonds have certain distinct characteristics and benefits. They have double recourse to the issuer and cover pool, a higher rating than unsecured debt, favourable treatment under Solvency II and usually better liquidity through larger issuance size. These characteristic benefit the invertors. The regulators see an advantage due to lesser risk associated with these bonds compared to securitization. Greater due diligence is performed on these bonds as they are on-balance sheet. For the issuer, covered bonds increase diversification of the investor base both in terms of geography and investor type.

Covered Bonds differ from Mortgage backed securities (MBS) in a few ways. Although both have the purpose of raising liquidity, Covered bonds are on-balance sheet as compared to securitization which is off-balance sheet. In Covered bonds, the borrower absorbs both default risk and prepayment risk. However in securitization, the prepayment risk is transferred to the investors and the originator does not absorb default risk. Covered bonds have a dynamic asset pool where the borrower can manage the pool if the cover is ensured. In securitization the pool is static with the exception of master trusts where the investors make investment in an identifiable pool of assets.

Asset quality valuation is undertaken below -

* Delinquency is good with 98.8% payment received 30 days prior and 1.2% due past 30 - 59 days. The assets are not declared substandard until payment is not received for more than 90 days.

* The Fair Isaac credit score is 2.77% sub prime. Even at a score of 640-659 the component of subprime in the asset pool is less than 3%.

* Asset coverage is good from 24% to 47%. Greater asset coverage would imply more cushion.

* Loan to value is good at 14.11% which is between LTV ratio of 60% to 65%. This implies that 35% depreciation in the market value of the collateral will reduce the impact only 14.11% of the assets.

* Housing price index is average with CA-San Diego at 175.37 and