Washington Mutual's Covered Bonds

Topics: Bond, Mortgage, Washington Mutual Pages: 73 (5997 words) Published: March 19, 2014
9-209-093
REV: OCTOBER 22, 2009

DANIEL B. BERGSTRESSER
ROBIN GREENWOOD
JAMES QUINN

Wa
ashingt Mu
ton utual's C
Covered Bond
ds
September of 20 was not a calm time fo the world’s capital mark 008
or
s
kets. On Sept
tember 7 fede
erallybacke mortgage loan compani Freddie M and Fann Mae were placed into c ed
l
ies
Mac
nie
conservatorsh by
hip
the U.S. governme a move de
ent,
esigned to sta
abilize the em
mbattled lenders. On Mond
day, Septemb 15,
ber
global investment bank Lehma Brothers filed for Cha
an
apter 11 bank
kruptcy protection. Broa US
ad
equity market inde
y
exes dropped by as much as 5 percent as rumors s
d
h
t
spread about potential liqu
uidity
crises at other majo financial in
or
nstitutions. A slight marke recovery th following d was attrib et
he
day
buted
to rum
mors that the Federal Reserve was wo
e
orking on a ba
ailout for the insurance co
e
ompany Ame
erican
Intern
national Grou (AIG).1
up
Ea
arly on the morning of Sep
m
ptember 16, W
Washington M
Mutual’s cove
ered bonds tr
raded down to 75,
from 83.05 the pre
evious day (see Exhibit 1 Washingto Mutual (W
1).
on
WaMu) was one of the la
argest
saving and loans in the Unite States. Its covered bon program, i gs
ed
nd
initiated two years earlier just
r,
before the housing market had begun a precipitous slid consisted of €6 billion in covered b e
g
d
de,
bonds
outsta
anding. Like many large ba
m
anks, WaMu was now in c
considerable d
distress.
Th situation at WaMu had deteriorated in recent mo
he
t
onths, with th bank repor
he
rting $6 billion loss
n
for ye
ear-to-date June 2008. By e
early Septemb WaMu’s covered bond had dropp by around 13%
ber,
ds
ped
d
from January, as investors fore
i
ecast a possib distressed acquisition or seizure o the bank b the ble
d
of
by
Feder Deposit Insurance Co
ral
I
orporation (F
FDIC). With the chaos of September 15-16, the b
f
bonds
appea
ared to have dropped fur
rther. Yet, ev
ven at these prices, the b
bonds were s
still at a prem
mium
relativ to the bank unsecured debt, which was trading as low as 30 c ve
k’s
d
cents on the d
dollar.
Co
overed bonds were new instruments in the Unite States, hav
s
ed
ving been iss
sued by only two
y
dome
estic banks to date (Bank of America and WaMu) Could the low prices o these bonds be o
k
).
of
justifi by the poor fundamen outlook a WaMu? An even if the bonds were cheap, might they ied
ntal
at
nd
e
t
drop f
further? Thes questions w
se
were on the m
minds of many analysts stu
y
udying the situ
uation at WaM
Mu.

Covered Bonds
Co
overed bonds were fixed i
s
income obligations issued by a financi institution and secured by a d
ial
n
d
pool o mortgages or other asse They diffe
of
ets.
ered from mo
ortgage backe securities (
ed
(MBS), in whi an
ich
issuer would pool mortgages, p
r
pass them thr
rough to a sp
pecial-purpos vehicle, and then allocate the
se
d
return from that vehicle to inv
ns
v
vestors. In the case of cove
e
ered bonds, t underlyin mortgages were
the
ng
kept o the balance sheet of the issuer. The m
on
e
mortgages ser
rved as collat
teral for the covered bonds In a
s.
standard mortgage
e-backed secu
urity, the inve
estor in the se
ecurity had re
ecourse only t the mortgag in
to
ges
_______
_______________
_______________
_______________
________________
_______________
_______________
________________
______
Professo Daniel B. Bergs
ors
stresser and Robin Greenwood and R
Research Associate J
James Quinn prepa
ared this case. This case was develop from
s
ped
publishe sources. HBS ca
ed
ases are developed solely as the basis for class discussio Cases are not in s
on.
ntended to serve as endorsements, so
s
ources of
primary data, or illustratio of effective or in
y
ons
neffective managem
ment.
ght
nt
Harvard College. T order copies or request...
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