Covered bond framework may land on the president's desk
A proposal by Rep. Scott Garrett (R-N.J.) to create a regulatory framework for fostering a U.S. covered bond market holds bipartisan support, prompting ratings firm DBRS to suggest the plan could actually make it to the president's desk. In March, Garrett and Rep. Carolyn Maloney (D-N.Y.) introduced the United States Covered Bond Act of 2011, reviving past efforts to create a regulatory framework for what lawmakers see as a investment tool to help the economic recovery. Like asset-backed securities, covered bonds are debt securities. The difference is issuers are on the hook against losses with covered bonds. Payment to investors is via swap agreements, which is meant to cover the scheduled payments should the issuer become insolvent or there is a discrepancy in timing, where the interest being paid on the loans doesn't line up with payments due to investors. A third party trustee is also appointed to represent covered bondholders. Adding the layers of additional recourse, as it compares to securitization, makes it pricier by comparison. As it stands, the Covered Bond Act would allow U.S. covered bond market to pool traditional assets, including residential and commercial mortgages, into debt securities. But, unlike in the established multi-trillion dollar European arena, the U.S. version would also include auto loans, credit-card receivables, student loans and government-guaranteed small business loans. "Congress is continuing to consider if other asset classes should be eligible with some supporters seeking to have equipment and aircraft leases added," DBRS said. The Federal Deposit Insurance Corp. issues policy on the best practices in covered bonds, but a regulatory framework is seen as a necessary step toward earning the confidence of investors. On July 28, 2008 then Secretary of the Treasury Henry Paulson announced the publication of a Best Practices guide, as a complement to the FDIC, which was intended to promote issuance. At the time, several large banks indicated support. However, none have brought a covered bond platform to market. While lawmakers see covered bonds as a one tool to restart the economy by wooing investors back to riskier assets, the Garrett and Maloney's bill remains controversial among analysts and community banks who believe such a market will favor big banks, chasing out smaller competition. "The covered bond legislation now pending before the Garrett subcommittee in the House is all about Wall Street and does nothing to increase the availability of housing credit," said market analyst Christopher Whalen with Institutional Risk Analytics. "The bill lacks basic protections for investors in bonds and for the FDIC, which would be fully exposed to losses from covered bonds under the Garrett proposal," he said. "Most banks today have more funding than can be employed. (Covered bonds) do not add any new, non-bank funding leverage to the system, which is the key objective if we are to avoid a catastrophe in housing." Write to: Kerri Panchuk.