Bill Pushes for Government Hand in Covered Bonds

Rep. Scott Garrett (R-NJ) and Rep. Paul Kanjorski (D-PA) on Tuesday introduced the Equal Treatment for Covered Bonds Act, which urges the same legal protections and considerations for covered bonds as for other financial products. The legislation aims to make greater stability and permanence for covered bonds as a liquidity-providing investment tool. Covered bonds are distinct from securitization in many ways. The dual recourse feature, where issuers cover loses on the bonds, is more expensive and the use of bullet redemptions are not historically to the taste of American investors. That may be changing as covered bonds are considered a safer bet than investing in securitization. The rating of covered bonds is pegged to the bank, therefore, as long as the banks are ‘good for it,’ the covered bonds will not be downgraded. “Covered bonds have the potential to aid in returning liquidity to the mortgage market and reduce borrowing costs for homeowners by providing an alternative to securitization,” Garret said in a media statement Tuesday. “If we want to truly level the playing field and foster the growth of covered bonds in the US, we need to develop a legislative structure for covered bonds.” Kanjorski agreed, adding the bill may open a new structured finance market in the US, where there are currently only two dollar-denominated covered bond platforms. One of which, it must be noted, is being book-runned at one of JP Morgan’s City of London offices. “As a result of the financial crisis, the private securitization markets have dried up, and we must explore new ways to oil the gears and get consumer credit flowing again,” he said. The bill amends the Federal Deposit Insurance Act to provide the same treatment for covered bonds as other qualified financial contracts, defines a covered bond as a non-deposit recourse debt obligation of an insured depository institution and allows a minimum one-year maturation term for a covered bond and sets no maximum term. The bill also allows for a wide variety of asset classes to be eligible as collateral in the cover pool, adds a clause ensuring a bank failure will not impair the covered bonds’ value and provides for joint rule-making authority to major regulators  for any new regulations affecting covered bonds. Government regulation of covered bonds would not be a situation unique to the US. Covered bonds are hot in Europe. In fact, the European Central Bank developed a plan to buy up as much as €60bn (US$83.19bn) of covered bonds, in a deal that is proving successful, sources say. Write to Diana Golobay. Disclosure: The author held no relevant investment positions when this story was published. Indirect holdings may exist via mutual fund investments.