Yesterday, key members of the House Financial Services Committee, Ranking Member of the Capital Markets Subcommittee, Scott Garrett, (R-NJ), Chairman Paul Kanjorski, (D-PA) and Ranking Member Spencer Bachus (R-AL), introduced the United States Covered Bond Act, that “aims to help facilitate a robust covered bonds market in the U.S. to add liquidity and certainty to our nation's capital markets.” A section-by-section summary of the legislation has also been made available.

Covered bonds are debt securities with 2-10 year maturities traditionally backed by cash flows originating from mortgage and public sector loans. Covered bonds typically receive high credit ratings and are retained on the issuer’s balance sheet. The covered bond market has been used primarily in Europe to help provide additional sources of funding for issuers and serves as a primary source of liquidity for the European mortgage industry. The regulatory framework set forth in the Garrett-Kanjorski-Bachus legislation seeks to provide similar benefits in the U.S. market. Last December, the House Financial Services Committee held a hearing on covered bonds and discussed the potential for a U.S. covered bonds market to provide stable, long term liquidity to the financial system. Congressman Garret stated in connection with the proposed legislation that “[a]s the U.S. continues to recover from the financial crisis, it is essential that Congress examines new and innovative ways to unthaw our locked credit markets and encourage private capital to confidently re-engage by turning cash now on the sidelines into active investments in our country’s future,” He also emphasized that “a robust U.S. covered bond market would offer numerous benefits to investors, consumers, and the broader financial sector, ensuring longer term liquidity that is more stable for U.S. credit markets.”

The framework of the proposed legislation establishes regulatory oversight of covered bond programs, includes broad provisions for default and insolvency of covered bond issuers and subjects covered bonds to applicable securities regulations by federal regulators. Further, the proposed legislation directs the U.S. Securities and Exchange Commission to “develop a streamlined registration scheme for other covered bonds that are not otherwise exempt securities.”

Under the proposed legislation eligible asset classes include the following classes of assets:

  • residential mortgage;
  • home equity;
  • commercial mortgage;
  • public sector;
  • auto;
  • student loans;
  • credit or charge card;
  • small business; and
  • such other asset classes designated by the covered bond regulator.

The proposed legislation is a follow-up to Congressman Garrett’s original legislation, The Equal Treatment for Covered Bonds Act that was introduced in 2008. Also in 2008, the U.S. Treasury Department and the FDIC published a list of Best Practices and a final policy statement respectively which addresses the issues of creating and regulating a covered bond market in the United states.

Many industry participants have welcomed the proposed legislation. In particular the Commercial Mortgage Securities Association which issued a press release yesterday that noted that creating a U.S. covered bond framework “should ensure that U.S. financial institutions, consumers and borrowers have a level playing field and equal credit opportunities.” The CMSA was invited as a select witness to provide testimony at the December House Financial Services hearing.