A fight is brewing between regulators and Congress over how to develop a covered bond market, with the latest salvo expected to be fired as soon as Tuesday, when the House Financial Services Committee could begin voting on a bill tackling the issue.
The legislation by Rep. Scott Garrett, R-N.J., would establish a regulatory framework for covered bonds, including a regime to handle the failure of a bond issuer. The bill is expected to pass and has already attracted the support of key Democrats, including House Financial Services Committee Chairman Barney Frank and Rep. Paul Kanjorski, the panel's chairman of the capital markets subcommittee.
But the details of the legislation have raised problems with the Federal Deposit Insurance Corp. (FDIC), which fears a new secured-asset class could hurt federal reserves and wants a greater say in covered bonds' regulation.
"The FDIC has issues," Garrett said in an interview Monday. "They want to be in charge of the whole program. … We are not sure that would be the best avenue to take."
Covered bonds have been popular in Europe, but have failed to take off in the U.S. Regulators have touted them as a possible alternative to securitization.
Unlike securitization, in which a bank sells off its loans to be packaged into securities, covered bonds are issued by the bank to fund assets that remain on the balance sheet, and they require collateral to be refreshed with new loans if the original assets stop performing.
The FDIC said it supports expanding the covered bond market, but is concerned that details of the bill could potentially make failures more expensive. They are also seeking to regulate such bonds, which in the latest version of the Garrett bill would fall to the Office of the Comptroller of the Currency (OCC).
"The FDIC's primary jobs are to protect insured depositors, conserve the deposit insurance fund, and resolve failed banks," said Michael Krimminger, deputy to the chairman for policy. "While other banking regulators play a vital role, protection of depositors is not their principal responsibility."
In the event of an issuer failure under the bill, the OCC could appoint an administrator to continue servicing the bond pool, which the FDIC fears could establish an implied government guarantee.
Ironically, the FDIC has long pushed for an expanded covered bond market. It issued a policy statement in July 2008 that said investors could claim their assets as early as 10 days into a receivership, reversing a previous policy that forced creditors to wait 90 days after a bank failure to seize their collateral.
The statement was intended to make investors more comfortable with covered bonds, but they never took off, in part because of the financial crisis, which worsened dramatically in August of 2008. Only two deals have been completed in the U.S., and both were before the policy change.
Garrett called the FDIC's worries overblown. He said that the FDIC is concerned that a covered bond deal will be overcollateralized, and then the agency "would not necessarily be able to claim all the assets of a failed bank that they normally would have."
But he said that could be addressed in other ways.
"That's a problem with the regulator of the bank that they allowed overcollateralization of the bond pool," he said. "I wouldn't be moving this legislation as aggressively as I have been for the last two years if I thought this would be a true threat to the DIF."
The issue was unexpectedly interjected into the regulatory reform debate in June during the conference committee's deliberations of that bill. Garrett, with Frank's approval, succeeded in adding a draft of his bill to the reform legislation, only to see opposition to it build momentum in the Senate.
Senate Banking Committee Chairman Chris Dodd said at the time that while he supported a market for covered bonds, the FDIC's problems with the bill raised concerns. As a result, he successfully eliminated it from the final bill.
The Senate Banking Committee may hold a hearing on the issue next week at the behest of Sen. Bob Corker, R-Tenn., who is interested in the Garrett bill.
"We think it's another tool as it relates to residential finance down the road," Corker said in an interview.
He said he hoped the hearing would cast more light on objections raised by the FDIC and the Treasury Department, which objected to Garrett's bill because it originally would have put the Treasury in charge of covered bond regulation.
"Hopefully, it will be a hearing where we can sound out some of the concerns that Treasury and FDIC raised in the past," he said. "I think the FDIC was concerned when they come in to resolve a firm that fails, the covered bond issue complicates things because certain assets are segregated out from the bank when the covered bond transaction takes place."
The Garrett bill has changed since the conference committee process, including appointing the OCC as covered bond regulator, and a provision that would require a covered bond be stripped from the FDIC's receivership if the agency could not sell it after 180 days.
The FDIC is seeking other changes, including appointing the agency or a consortium of federal and state regulators to set covered bond standards.
Bankers said the bill, if it is passed, could have an impact.
"We think that the appetite is significant," said Tim Skeet, a managing director and head of covered bonds at Bank of America in London. "There is a tremendous pent up demand for high-quality assets. If we would be able to produce U.S. domestic issues, which would have the benefit of being out of familiar credits with many banks, that would be something that we know the investors would like."
