As Covered Bonds Move Forward, Questions Remain on Costs

Legislation to establish a regulatory framework for a US covered bond market was approved by a House of Representatives panel late Wednesday. The move represents the fourth attempt to promote the product by establishing a binding framework in the United States. Representatives Paul Kanjorski (D-PA) and Scott Garrett (R-NJ) are sponsoring the bill, which passed the House Financial Services Committee. And with the latest mark-up, questions are arising on how the costs will affect the structure finance platform’s ultimate attractiveness to issuers. With covered bonds, the issuer is on the hook for losses and the assets remain on balance sheet and they tend to be more expensive compared to securitization investments because of this dual recourse protection. But as Anna Pinedo, a partner at the capital markets group of Morrison & Foerster and co-author of the soon-released Covered Bond Handbook puts it, the once non-entity in the secondary market may still have a good chance this time around. “Covered bonds are a comparatively different cost analysis, but considering growing costs associated with securitization — due to FAS 166, 167, the Dodd-Frank 5% risk retention and Basel III guidelines — covered bonds create an alternative where an alternative wasn’t necessary before,” she said. According to a HousingWire source, a recent note from Bank of America Merrill Lynch finds that covered bonds actually may not be more cost-effective for issuing banks relative to RMBS. The report said that even with the price of RMBS going up, covered bonds are also facing a more expensive operational environment once all of the factors are summed. On top of this, the regulatory structure also looks to be burdensome. “In the House markup it’s suggested that there will be a multi-agency regulation oversight to covered bonds,” said Pineda. This could include the FDIC, SEC, FINRA and other regulators. Nonetheless, there are some positives to creating alternative origination funding that is not based on Ginnie Mae, GSE or a Federal Home Loan Bank. In a covered bond, the vehicle can substitute assets in and out of the dynamic cover pool and overcollateralization is already at least 5%. According to Pineda’s book, the integrity of covered bonds is further protected by provisions in the swap agreement that require the swap provider continue to make covered bond coupon payments in the absence of interest from the mortgage bonds for up to 90 days after the appointment of the FDIC as receiver or conservator. This provides a window of opportunity for the FDIC to arrange a transfer of the cover pool and mortgage bond liabilities to a successor institution and to avoid mortgage bond acceleration. Write to Jacob Gaffney.

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