The House Financial Services Committee has approved draft Covered Bond legislation:
The committee voted 44-7 today to approve the bill, which would provide a regulatory framework for covered bonds by giving the Treasury Department oversight of the market and creating a separate resolution process in order to bolster investor interest.
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“The FDIC’s concerns, I believe, continue to be legitimate,” said Representative Barney Frank, the senior Democrat on the committee, who unsuccessfully offered two amendments drafted with the agency to change the measure. “The FDIC believes, I think correctly, there will be problems in some of these cases and the FDIC will not be fully protected.”In an effort to alleviate some of the agency’s concerns, Representative Carolyn Maloney, a New York Democrat, offered a successful amendment that extended to one year, from 180 days, the amount of time the FDIC would have in event of a bank failure to hold the exclusive right to transfer the covered pool to another eligible issuer.
The panel also agreed, by voice vote, to a requirement that the Treasury write rules to cap the maximum amount outstanding, as a percentage of total assets, that any one issuer can hold.
Andrew Gray, the FDIC’s spokesman, said in an e-mailed statement that the bill would subsidize covered bond investors with the deposit insurance fund and “will add to the funding advantage” of large banks.
The FDIC’s Deputy Chairman, Michael H. Krimminger, testified in September 2010 regarding FDIC concerns regarding super-priority:
Unfortunately, H.R. 5823 would restrict the FDIC’s current receivership authorities used to maximize the value of the failed bank’s covered bonds. The bill leaves the FDIC with only two options: continue to perform until the covered bond program is transferred to another institution within a certain timeframe; or hand over the collateral to a separate trustee for the covered bond estate, in return for a residual certificate of questionable value. The FDIC would not have the authority – which it can use for any other asset class – to repudiate covered bonds, pay repudiation damages and take control of the collateral. This restriction would impair the FDIC’s ability to accomplish the “least costly” resolution and could increase losses to the DIF by providing covered bond investors with a super-priority that exceeds that provided to other secured creditors. These increased losses to the DIF would be borne by all of the more than 8,000 FDIC-insured institutions, whether or not they issued covered bonds.
Limiting the time in which the FDIC could market a covered bond program to other banks will constrain the FDIC’s ability to achieve maximum value for a program through such a transfer. Similarly, preventing the FDIC from using its normal repudiation power will prevent the FDIC from recapturing the over-collateralization in the covered bond program. The ‘residual certificate’ proposed in H.R. 5823 is likely to be virtually valueless. More importantly, the legislation would provide the investors with control over the collateral until the term of the program ends, even though the FDIC (and any party obligated on a secured debt) normally has the ability to recover over-collateralization by paying the amount of the claims and recovering the collateral free of all liens. Providing the FDIC a residual certificate instead of the ability to liquidate the collateral itself would reduce the value to the receivership estate and would not result in the least costly resolution.
So long as investors are paid the full principal amount of the covered bonds and interest to the date of payment, there is no policy reason to protect investment returns of covered bond investors through an indirect subsidy from the DIF
The FDIC issued a Covered Bond Policy Statement in 2008.
There is an excellent discussion of the legislation available by Barton Winokur, Chairman and Chief Executive Officer of Dechert LLP, and is based on a Dechert publication by Patrick D. Dolan, Robert H. Ledig, Gordon L. Miller and Kira N. Brereton, titled Reform for the Covered Bond Industry on the Horizon.
US Covered Bond legislation was last mentioned on PrefBlog when it passed the Capital Markets Subcommittee. Consultations in Canada are taking place behind closed doors, as is only right and decent.
Update, 2011-6-24: I note from Chart 3.15 of the BoE June 2011 Financial Stability Report that covered bonds comprise 5% of 2011-13 maturities, but 16% of planned 2011-13 issuance in the UK.