Yesterday, the House Financial Services Committee held a hearing entitled "Covered Bonds: Prospects for a U.S. Market Going Forward," discussing covered bonds and the potential for a U.S. covered bonds market to provide stable, long term liquidity to the financial system. Testifying before the committee were:
- Alan Boyce, Chief Executive Officer, Absalon
- Scott A. Stengel, Partner, Orrick, Herrington & Sutcliffe LLP on behalf of U.S. Covered Bond Council
- Bert Ely, Ely & Company Inc.
- Wesley Phoa, Senior Vice President, Capital International Research, Inc.
- J. Christopher Hoeffel, Managing Director, Investcorp International Inc., on behalf of Commercial Mortgage Securities Association
The panelists first provided a basic overview of covered bonds, explaining that a covered bond is a form of high-grade senior debt that is issued by a financial institution and is secured by a cover pool of financial assets that is continually replenished. The panelists explained that the distinguishing characteristic of a covered bond versus other types of secured debt is that a covered bond utilizes a legislatively prescribed process for managing the cover pool upon the issuer’s default or insolvency, instead of immediately liquidating the pool. The cover pools used in covered bonds may include many types of loans, such as small business loans, student loans, residential and commercial mortgage loans, and automobile loans.
Mr. Boyce discussed four primary advantages to covered bonds:
1) The use of covered bonds requires the financial institution to maintain the loans on their balance sheet;
2) Covered bonds are relatively transparent;
3) Covered bonds can be used to manage interest rate risks efficiently; and
4) Covered bonds provide low-cost private financing.
Mr. Stengel also noted that a covered bond generally has a term of 2 to 10 years or more, providing longer term liquidity, and that use of covered bonds adds funding from separate investor bases that would not otherwise be tapped to provide liquidity.
Panelists noted the continuing success of European use of covered bonds, and attributed the overall success of European covered bond market to the European market’s consistently conservative approach. Many committee members and panelists suggested that any U.S. covered bond market should adopt a similar approach.