Bank of America sponsors one of only two covered bond programs in the U.S. to date, established in July 2007. The cover pool contains more than $10 billion of mortgage loans. (A cover pool is a pool of collateral that a covered bond sponsor keeps legally separate to pay bondholders in the event of the sponsor’s insolvency.)

The U.S. lacks a statute setting up standards and procedures for covered bonds, so the BofA program is 100% structured, under the terms of issuance documents. (This is very different from the standardization found in countries where covered bonds have long been a principal funding source, such as Germany.)

At a time of continuing stress in the real estate financing arena, Moody’s Investors Service became concerned that certain provisions in the particular setup used by BofA could require a sell-off of mortgage assets at fire sale prices if BofA were to become insolvent—raising doubts as to whether the cover pool would be sufficient to assure full payment.

As a result, Moody’s Friday (July 10) downgraded BofA’s covered bond program from Aaa to Aa1, on review with direction uncertain. For a fuller explanation of that action, click here.

Resurgence of Covered Bond Mortgage Funding in Europe

Meanwhile, the covered bond market in Europe is continuing its resurgence while private securitization—both there and in the U.S.—continues to languish. Those covered bonds are a major source of funding for residential and commercial real estate.

Although the covered bond market froze up to a large degree during the turmoil following Lehman’s collapse, it was already showing new signs of life when the European Central Bank announced (in May) a plan to purchase a relatively modest €60 billion (USD $83.8 billion) as a liquidity measure.

The strength of this funding source was underscored by the fact that new issuances of covered bonds grew dramatically in the days and weeks after the ECB announcement—and spreads tightened—even though the ECB had not yet even announced the details, much less bought a single euro’s worth!

Last week, the ECB finally started its purchases , on a micro scale. As of Monday (July 13), the reported total was still only €60 million (USD $83.8 million).

So funding via covered bonds for mortgages and public-sector projects is rolling along nicely.

Wouldn’t it be great if we had a source of funding in the U.S. that could be jump-started so easily, and with such a small government investment?