Covered bonds provide highly efficient funding for lenders to provide residential mortgages, while increasing borrower protections and providing investors with new supply of triple-A rated debt, supporters say. And the time is nigh to create a regulatory framework for U.S. financial institutions that issue the bonds, which have long held a strong following in Europe. Two mortgage market participants are set to testify as much Friday before the House subcommittee on capital markets and government-sponsored enterprises. Rep. Scott Garrett (R-N.J.), who chairs the subcommittee, introduced a bill Tuesday that he hopes will establish a clear regulatory framework for the structured finance product. Critics say the dual recourse and on-balance sheet treatment makes covered bonds unfeasible. Further, the typical bullet repayment may not carry well with private investors. Also, there is the question of regulation. The Federal Deposit Insurance Corp. indicates it wishes to oversee covered bonds, as it will be responsible in case the bank itself fails. Supporters say the Treasury Department is a better candidate for this role. Bert Ely, a longtime financial services consultant, will testify in support of covered bonds. He plans to say that covered bonds are, by nature, over-collateralized and provide a safe investment because of the cover pool that includes multiple assets securing multiple bonds, rather than the single-asset structure of most residential mortgage-backed securities. He said some $20.58 trillion of debt could potentially be financeable by covered bonds. “While covered bonds will not come close to providing 100% of this funding, even a 10% share would be enormous – over $2 trillion, which begins to approach the size of well-established European covered-bonds market,” Ely said. Scott Stengel, a partner at King & Spalding in Washington, will testify Friday on behalf of the Securities Industry and Financial Markets Association. Stengel is a member of the U.S. Covered Bond Council. He said covered bonds are “an untapped but proven resource” that could help sate investor appetite for highly rated, secure bonds and give lenders cost-effective funding. “Equally important, covered bonds deliver funding from the private-sector capital markets without any reliance on U.S. taxpayers for support,” Stengel plans to tell the congressman. “Covered bonds, which have demonstrated resilience even in distressed market conditions, can serve as an important bridge from an economy that is limping along on government support to one that is able to stand and thrive on its own.” Ely said covered bonds won’t be backed by the government, either explicitly or implicitly, and the push to regulate the debt-financing instruments “is merely to ensure” they will be “at all times purely private-sector credit instruments of the highest possible credit quality.” Ely recommends only the Treasury oversee covered bonds, if they are regulated, to ensure consistent application of the rules governing the bonds. SIFMA wants a legislative framework for U.S. covered bonds that “stays true to the distinctive features of traditional covered bonds and provides investors with the certainty they need to support the market.” Covered bonds have the potential to enhance lenders ability to offer 30-year, fixed-rate mortgages, according to Ely, because the bonds can be issued at medium- and long-term maturities with a fixed rate of interest. In addition to providing an optimal way to fund owner-occupied housing, covered bonds also are ideal in funding multi-family rental housing because of the long-term fixed rates associated with the bonds, according to Ely. SIFMA said it has long supported the development of a covered bonds market in the United States. “U.S. covered bonds…could be invaluable in meeting the need for long-term and cost-effective funding that is sourced from diverse parts of the private-sector capital markets and that can be translated into meaningful credit for households, small businesses, and the public sector,” according to SIFMA. The trade group wants to see covered bonds become available to U.S. investors as soon as possible. “While the balance sheets of financial institutions cannot replace the multi-trillion dollar securitization market, covered bonds can bridge funding gaps in the short term and can supply a much needed source of complementary liquidity in the long term,” SIFMA said. “Similarly, while covered bonds are no panacea for the difficult policy issues that have been raised in the context of GSE reform, a robust covered-bond market would inject private capital where none exists today and would contribute ultimately to a more stable system of mortgage finance. With the success of a fragile economic recovery hanging in the balance, we simply cannot afford to wait any longer,” according to SIFMA. Write to Jason Philyaw.