In a Federal Deposit Insurance Corp. (FDIC) statement released today on the legislative proposals to create a U.S. covered bond market, the agency said that it has "significant concerns" regarding the United States Covered Bond Act of 2011 (H.R. 290).

The statement was released for the Congressional hearing today on H.R. 290 held with the subcommittee on capital markets and GSEs that featured securitization experts including Natixis Managing Director Ralph Daloisio. who represented the American Securitization Forum.

This week Rep. Scott Garrett (R-N.J.) and Rep. Carolyn Maloney (D-N.Y.) introduced H.R. 290 that will provide a legal framework for U.S. covered bonds, the third time a bill like this has been introduced in Congress.

The FDIC thinks that the legislation has failed to maintain the important balance between investor demands and government exposure and offers investors with "lopsided benefits at the direct expense of the Deposit Insurance Fund [DIF]," the FDIC stated.

It added that the bill would expose the DIF to added losses by restricting the FDIC's ability to maximize recoveries on failed bank operations and assets. It restricts the agency's existing receivership authorities used to maximize the value of the failed bank's covered bonds.

The bill, the agency said, creates an implied subsidy to financial institutions and investors that is not there for any other privately issued security. It provides, in short, for a new class of investments that is "risk free," the agency said.

"This structure will skew the market, limit the demand for long-term, stable securted debt, and will thwart the nascent efforts to enhance matrket dsicipline in the wake of the financial crisis," the FDIC said in the statement. "At a time when the government is carefully removing its extraordinary support of the financial system, we should not create a new permanent government subsidy of the financial markets."

The FDIC added that the legislation does not recognize that U.S. financial institutions already have access to covered bonds, citing the fact that these bonds were successfully issued before the 2008 financial crisis.

For a full copy of the statement, please click this link.

In an emailed note, Patrick Dolan, a partner in Dechert said: "The changes proposed by the FDIC in its statement in response to the introduction of the 2011 covered bond bill will likely eliminate the covered bond market that the bill intends to create because investors would be uncomfortable with the uncertainty that the proposed changes would create."

He added that initial research has showed that losses to be incurred by the DIF resulting from the proposed covered bond programs would be marginal at best, particularly given the new deposit insurance premiums that are set to take effect April 1.

Dolan also noted his thoughts on this morning's committee meeting, which ended with the committee indicating that the record would stay open for 30 days to permit submission of added statements and comments.

At the meeting, Dolan said it was made clear that community banks could participate in covered bond programs via pooling mechanisms.

However, there were some concerns regarding whether community banks would be able to have meaningful participation in the covered bond program or whether they would effectively be priced out of participation in these programs. It was noted, however, that small European banks have participated in covered bond programs previously.

A distinction between GSEs and the proposed covered bond programs, Dolan reported, is that there are considerably more asset classes that are covered by the latter. "The proposed covered bond program is intended to increase liquidity and encourage banks to distribute loan funds once the economy fully recovers," Dolan stated. 

 

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