Towards the promised land

US covered bond legislation is creeping ever closer, despite not having universal support. Its backers hope President Obama will sign the act into law before the end of the year. Bill Thornhill reports.

  • 28 Mar 2011
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The long, at times torturous journey to US covered bond legislation edged closer to completion on March 8 when Republican Scott Garrett introduced the Covered Bond Act 2011 to the House of Representatives. A few days later, on Friday March 11, a hearing took place on the legislative proposals in front of the Subcommittee on Capital Markets and Government Sponsored Enterprises.

Jerry Marlatt, senior counsel at Morrison Foerster in New York, said the bill was much the same as that in circulation weeks earlier.

Five people delivered testimonials to the subcommittee hearing, four in support of legislation and one against.

Those advocating the product included Scott Stengel, a partner at law firm King & Spalding who spoke on behalf of the US Covered Bond Council; Bert Ely from Ely & Co; Tim Skeet, ICMA’s chairman of the Committee of Regional Representatives and Ralph Daloisio, a Natixis managing director who spoke on behalf of the American Securitisation Forum.

"The time for US covered bonds is now," Stengel said in his testimony. "While the balance sheets of financial institutions cannot replace the multi-trillion dollar securitisation 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."

Skeet put the European case. "In the European Union covered bonds did not contribute to fuelling the mortgage or other bubbles and indeed have been consistently regarded as part of the solution to resolving market imbalances, not a cause," he said.

Dalosio also supported US legislation. "It would create a new and disciplined market structure around which free market forces can organise to better balance the flow of money, capital, and credit in our highly sophisticated financial system," he said.

Ely runs a consultancy which aims to "work with clients and others in eliminating government policies which cause mis-priced credit," according to his company’s website. He believes that covered bonds will not be explicitly or implicitly backed by the federal government. "There is no explicit federal guarantee of covered bonds issued under the provisions of this bill," he said.

Surprisingly the dissenting voice came from a small bank that the covered bond market could serve well. Stephen Andrews, president and chief executive of Bank of Alameda, said: "I am pleased to present testimony raising several serious concerns and objections about the possible development of a covered bond market in the US."

However, a source at the hearing said Andrews’ critique was misconceived. The source added that there were concerns among Federal Home Loan Banks that covered bond legislation would be a threat. It is early days and the FHLB’s support is not essential to getting legislation approved.

Marlatt says: "It was heartening to see that the committee was responsive, they kept bringing the focus back to benefits of a covered bond law. They didn’t get lost in concerns raised."

He adds: "It’s a fractured process but overall it was a good hearing and has strong support from both Garrett and [Democrat] Carolyn Maloney — my assessment for prospects of bill has not changed: it’s moving forward."

Garrett said legislation would "provide the necessary framework for a covered bond market in the US to flourish and grow, while ensuring that US financial institutions are no longer at a competitive disadvantage to their foreign counterparts."

Garrett co-introduced the bill with Maloney who said covered bonds presented a big opportunity for US financial markets.

That the bill was co-introduced is considered important. "This is not a partisan bill, there is lots of division on how to wind down the GSEs, but not with respect to the covered bond bill, it had good Democratic support in House Financial Services Committee last year," Ely tells EuroWeek.

Despite the high hopes, doubts linger over Democratic support. Virginia senator Mark Warner recently expressed reservations about the extent of government guarantees and state backing. But that could be simply a perception problem as covered bonds would not intrinsically require governmental support.

FDIC roadblock

Despite all the euphoria and hope for full passage of US covered bond legislation this year, Marlatt and other proponents are under no illusion that the bill has a long way to go, not least in securing the support of the Federal Deposit Insurance Corp which has long held reservations.

The FDIC stance will be particularly important. It has two specific concerns: firstly, its fundamental responsibility in protecting depositors could be compromised, given that covered bondholders would have first priority claim against the secured interest. Secondly, the FDIC has several options in the event of a borrower’s insolvency and these will have repercussions for covered bond investors.

Investors will therefore want clarity on what the FDIC’s role is at the point of insolvency. They will want to know precisely what will happen to the pledged collateral and whether the cover pool will be assigned to them without fear of repudiation or whether there is a risk it will be turned over to the FDIC and sold.

The FDIC "object to covered bond investors having a right to control assets in the cover pool in excess of the outstanding balance of the covered bonds. They are also focused on maintaining control over the liquidation of the cover pool," said Lawton Camp, a partner at Allen & Overy in New York.

FDIC deputy chair, Michael Krimminger, said in a September 2010 statement that covered bond investors would have "rights that no other creditors have in a bank receivership". As a result: "Legislation could lead to increased losses in failed banks that have issued covered bonds."

Despite FDIC concerns, Ely says it is notable that FDIC’s recently updated assessment base for deposit insurance is effectively based on total liabilities as opposed to total domestic deposits as it had previously been. As a result of this change to the assessment base, the FDIC will be able to collect revenues on outstanding covered bonds. "That will more than cover any additional losses the FDIC may have," Ely says.

The FDIC will also need to take into account the fact that covered bonds provide liquidity that wasn’t there before. "It would be good if the committee hears from small community bank organisations — it would be a big plus in terms of political support," said Marlatt. "One of the greatest benefits of the covered bond market is the smaller banks’ access to liquidity, and we have a lot of them."

Long road ahead

Observers say the FDIC’s opposition may improve once the incumbent chair, Sheila Bair, comes to the end of her five year tenure in June. Hopes are that the incoming chair might take a more sanguine view on covered bond legislation.

People involved in the legal process say March 11’s hearing is only the beginning, and there is a good chance that there will be another subcommittee hearing, in particular if Federal Home Loan Banks testifies.

But, a lot of these smaller banks have been working through bank capital requirements and Basel III, so covered bond legislation might not be top of their agenda. While they support the bill, there is concern that they are not working to get it passed.

After the bill’s hearing with the subcommittee it will proceed to the full financial services committee. By April the bill should be sent to the House floor. However, it is possible this may be delayed, as amendments proposed last July come back again.

Garrett’s version of the bill includes a wide array of asset types such as auto loans, student loans and home equity loans. Such assets would likely prove anathema to European investors.

With this wider array of eligible assets it ‘s likely that covered bond purists would view the prospective US product as somehow tainted. Perhaps fearing this, last year’s failed bill saw an amendment in which these assets were removed.

Passage in the House, where the Republicans are in majority, is likely to be straightforward. The bill will then be introduced in the Senate, where approval is more uncertain. It is not expected to have the same momentum as in the House but, at last September’s hearing, Republican senator Bob Corker was a strong supporter and two other senators could also take a lead — suggesting prospects have improved.

Both House and Senate versions will then need to be reconciled in a joint committee — which will report on final form. This will then be sent to the President for his signature which proponents say could happen before the end of the year.

Europeans are coming

Policy makers are likely to take into account the fact that European banks have been selling covered bonds to US investors for some time amid widespread expectations that supply will increase. "This puts US banks at a competitive [funding] disadvantage and increases the pressure on policymakers to level the playing field," says Marlatt.

"There is a great opportunity for covered bond issuers to develop their presence in this market as US investors are very keen on the triple-A product," says Paul Dudouit, managing director and head of medium and long term funding at Compagnie de Financement Foncier.

CFF has a 20% market share of the US dollar covered bond market and is therefore a key European player in this market. It was the first to issue a US dollar denominated, 144A fixed rate covered bond from a European borrower this year. The fundraising, that took place in March, was particularly notable for how many real money US accounts were attracted to such a deal for the first time, a point not lost on other European issuers anxious to diversify their investor base.

The $1.5bn 2.25% deal due March 2014, issued through joint leads Barclays Capital, BNP Paribas, Citi, JP Morgan and Natixis, was priced in line with mid-swaps plus 85bp area guidance, at mid-swaps plus 85bp, equating to a 111.2bp pick up over the US Treasury curve. After four hours of bookbuilding $1.8bn orders were taken from 60 global accounts, the vast majority of which were US real money buy and hold. US accounts bought 60%, 27% went to Europe and 10% to Asia. Asset managers and insurers took 52%, central banks and official institutions took 34%, leaving just 14% for banks.

"This is a key market for us regarding investor diversification" says Dudouit. One third of the accounts, or about 20 investors, were new to the borrower. "It’s gratifying to see more tier two investors and it pays testimony to the intensive marketing we have undertaken over the last year," he adds.

And with good prospects that a US covered bond law will come into effect this year, other European issuers believe they are in a win-win situation. "If the law comes into play it will definitely help develop the covered bond market for other jurisdictions as US investor appetite will increase," says Dudouit.

  • 28 Mar 2011

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 30,363.50 109 7.56%
2 JPMorgan 27,423.07 94 6.82%
3 Goldman Sachs 27,365.68 53 6.81%
4 Barclays 25,009.79 63 6.22%
5 Deutsche Bank 22,679.02 69 5.64%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
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1 Mizuho 299.85 1 21.73%
1 ING 299.85 1 21.73%
1 Commerzbank Group 299.85 1 21.73%
1 BNP Paribas 299.85 1 21.73%
5 UBS 60.22 1 4.36%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
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1 Goldman Sachs 1,607.28 5 22.59%
2 Credit Suisse 1,301.65 4 18.30%
3 UBS 970.80 3 13.65%
4 BNP Paribas 522.35 4 7.34%
5 SG Corporate & Investment Banking 444.17 3 6.24%