Yesterday, the Senate Committee on Banking, Housing, and Urban Affairs held a hearing entitled “Covered Bonds: Potential Uses and Regulatory Issues.” According to Committee Chairman Christopher Dodd (D-CT), the hearing was held “to learn more about this alternative and whether it will contribute to safe, stable and sustained economic growth.”

Testifying before the subcommittee were the following witnesses:

Panel 1:

Panel 2:

  • Julie L. Williams, First Senior Deputy Comptroller and Chief Counsel, Office of the Comptroller of the Currency (OCC)
  • Michael H. Krimminger, Deputy to the Chairman, Federal Deposit Insurance Corporation (FDIC)
  • Scott A. Stengel, Partner, Orrick, Herrington & Sutcliffe LLP, on behalf of the U.S. Covered Bond Council, Securities Industry and Financial Markets Association (SIFMA)
  • Kenneth A. Snowden, Professor, University of North Carolina at Greensboro
  • Ric Campo, CEO, Camden Property Trust, on behalf of National Multi-Housing Council

Chairman Dodd opened by posing several questions regarding covered bonds: “(i) is legislation needed, (ii) what entities would be eligible to issue covered bonds, (iii) what agencies should regulate covered bonds, (iv) what assets would be eligible for covered bonds, (v) what standards should apply to issuance, (vi) what are the consequences of a failure of a covered bond and (vii) what securities disclosures would apply?”

Congressman Garrett expressed his support for covered bonds, noting that he had recently helped introduce the U.S. Covered Bond Act of 2010 in the House. According to Mr. Garrett, a covered bond market in the U.S. would further the dual goals of “encourag[ing] the return of private investment to our capital markets” and “enabl[ing] the private sector to provide additional consumer, commercial, public sector and other types of credit.” He also noted that “[c]overed bonds will ensure more stable and longer term liquidity in the credit markets, which reduces financing risks as well as exposure to sudden changes in interest rates and investor confidence.”

Ms. Williams noted that covered bonds are “a promising funding option for financial institutions,” but also acknowledged that “a complex combination of factors will determine the relative attraction of covered bonds compared to alternative funding sources.” According to Ms. Williams, “capital requirements” and the “legal framework” could affect the attractiveness of covered bonds. With respect to the regulation of covered bonds, she would support “a framework where federal financial regulators operating under a single uniform set of standards would be designated as the covered bond regulators for their respective regulated entity.”

Mr. Krimminger stated that the FDIC would support “balanced legislation” related to covered bonds and stressed the importance of three key principals in developing such legislation: “[f]irst, the rights and responsibilities of investors, issuers, and regulators should be clearly defined. Second, the investment risks to covered bond investors should not be transferred to the public sector or to the DIF. Third, the legislative framework should be consistent with long-standing U.S. law and policy, and not unduly impair the interests of depositors and other creditors.” He pointed out that the FDIC had already developed a Statement of Policy that addressed the treatment of covered bonds of failed banks and stated that “[a]t a minimum, the FDIC suggests that its Statement of Policy should be considered as a framework for any legislation….”

Mr. Stengel, on behalf of the Steering Committee for the U.S. Covered Bond Council, also expressed support for a U.S. covered bonds market, stating that “U.S. covered bonds are an untapped but proven resource that could be invaluable in meeting this need.” Amongst other proposed benefits, Mr. Stengel noted that covered bonds (i) “are an effective vehicle for infusing long-term liquidity into the financial system,” (ii) have a “separate and distinct investor base” and (iii) “deliver funding from the private-sector capital markets without any reliance on U.S. taxpayers for support.” While Mr. Stengel acknowledged the FDIC’s Statement of Policy on covered bonds, he also noted that “it has become apparent that regulatory guidance alone will not suffice.” According to Mr. Stengel, “a well-functioning market for U.S. covered bonds cannot develop without a legislative framework that stays true to the distinctive features of traditional covered bonds.”

Professor Snowden provided a historical perspective on the covered bond market in the U.S., noting that “covered mortgage bond systems actually had been introduced several times between 1870 and 1935.” He identified “a combination of bad timing, poor implementation, and ineffective regulation” as causes for past failures of covered bonds in the U.S. and also cautioned that “a common failure in past attempts was to transplant elements of European covered mortgage bond systems without tailoring them to fit U.S. institutions.”

Mr. Campo discussed covered bonds as they would relate to the apartment sector. He supported the idea of covered bonds, noting that “covered bonds could indeed provide some degree of additional liquidity to U.S. multifamily finance,” but also cautioned that “it is quite unlikely that covered bonds could provide the capacity, flexibility or pricing superiority necessary to adequately replace any of the U.S.’s traditional sources of multifamily mortgage credit.”

During the hearing, the panelists discussed many benefits of covered bonds, but also identified possible consequences, such as maintaining higher capital levels and the potential for increased assessments. In support of establishing a covered bond market in the U.S., some panelists expressed concern over current international competition. According to Congressman Garret, “[s]o far, in 2010, there have been a dozen covered bond deals issued by foreign banks to U.S. investors totaling close to $18 billion.” Mr. Stengel also referenced this figure, stating that “[w]ith governments in Europe providing the requisite legal certainty for covered bonds issued by their domestic institutions, we fear that the playing field could grow increasingly uneven in the fierce competition among banks for less expensive and more stable sources of funding.”