In an effort to provide more certainty to the market and to restore consumer confidence, Representative Scott Garrett (R-NJ) introduced a bill entitled “Equal Treatment for Covered Bonds Act of 2008” (H.R.6659) on July 30, 2008. The proposed legislation follows shortly after both the FDIC and the U.S. Treasury Department released guidance on the use of residential mortgage loan covered bonds as a source of liquidity for the U.S. housing market. Specifically, the proposed legislation seeks to amend the Federal Deposit Insurance Act (Act) to: 

  • provide covered bonds the same treatment as other qualified financial contracts (QFCs); 
  • include a definition of covered bonds in the Act to mean a non-deposit recourse debt obligation of an insured depository institution requiring a minimum maturity term of at least one year; 
  • include safeguards to ensure the value of a covered bond if a insured depository institution goes into receivership or conservatorship; and 
  • confer joint regulatory rulemaking authority to the secretary of Treasury, the Federal Reserve Board, the OCC, the OTS and the FDIC.

The Act currently provides protection for QFCs entered into before the appointment of a conservator or receiver. The proposed legislation would extend similar protections to covered bonds by ensuring that actual direct compensatory damages as of the date of receivership or conservatorship will be equal to the sum of (i) the outstanding principal amount of the covered bond; (ii) all unpaid interest accrued on the covered bond; (iii) the cost of any instrument that would provide for scheduled payments to be made on the covered bond until the original date of maturity and (iv) the cost incurred that would arise from or relate to the exercise of any right, power, or remedy under the covered bond or related transaction document. These protections go beyond what had already been proposed by the FDIC and Treasury, whose guidance on compensatory damages had been limited to outstanding principal plus accrued interest. Rep. Garrett articulated his hope that providing a statutory framework for these protections would imbue investors with additional confidence regarding a covered bond’s value in the event of an institution’s failure and thereby promote the much needed development of the U.S. covered bond market.

The proposed implementation of joint rulemaking authority adds an interesting twist to the covered bond story that has been playing out over the past several months. In particular, the heaviest criticism levied against the various proposals to date relates to the requirement set forth by the FDIC and seconded by the Treasury that the total covered bonds outstanding at issuance must not exceed four percent of such institution’s total liabilities. This four percent cap is deemed by many to be exceedingly conservative, providing minimal entry into the covered bond market by many mid-market and even larger institutions and not likely to provide the liquidity needed by the market. Joint rulemaking authority by the Federal Reserve and the other banking regulators would provide more influence, which could potentially force an increase to this cap.

Rep. Garrett emphasized that the intent behind the proposed legislation is not to nullify the FDIC and Treasury guidance, but to take them one step further. Rep. Garrett anticipates that codification in a federal statute will provide covered bonds with a permanent place in the U.S. market. Given that statutory authority provides more assurances than regulatory rules and regulations, supporters of the legislation believe that this will yield lower transactional costs as investors and issuers will no longer have to account for the uncertainty in the covered bond market. With Congress about to adjourn for August recess and returning only briefly before the election cycle, it remains to be seen what level of attention this proposed legislation will be given during the remaining session and whether the Senate will even weigh in. If the House does not decide on the bill prior to adjournment, it will expire and will need to be reintroduced when Congress reassembles for the next session.