Shortly after, the US Treasury announced its best practices guide for US covered bonds, mirroring the FDIC’s guidelines and making a few additions. The main ones are the limit on eligible mortgages to include only performing, first-lien mortgages with a maximum LTV of 80%, and the restriction of geographic concentration in a single metro area to 20%. Citi, Bank of America, JPMorgan, and Wells Fargo issued a joint statement of support, fuelling optimism for the successful establishment of a US covered bond market.
The proposed framework might be a good thing, giving beleaguered mortgage lenders an alternative and relatively cheap funding source, provided action follows words.
Bankers are hopeful that the clarification of the FDIC’s treatment of covered bond holders will aid issuers and attract investors to the product. However, things might not be so easy. US investors have little or no experience with covered bonds, with only two US institutions having issued so far. And the potential issuers themselves have also shown little understanding of the product. When the FDIC invited suggestions after it released its preliminary covered bond statement in April, many banks were hopeful that the eligible criteria for cover pool assets would be expanded to include, among other things, student loans and credit card receivables. One can only speculate on how such a suggestion would be received among traditional Pfandbrief bankers in Germany.
And there are other problems. The 4% limit on covered bond issuance, as a percentage of total liabilities, limits the potential size of the market and is something that Tim Skeet, head of covered bonds at Merrill Lynch, admits "everyone fundamentally disagrees with". It might be that the FDIC is thinking more in terms of protecting itself than promoting a vibrant covered bond market. It acts to ensure that depositors are protected when a bank fails. By limiting covered bond issuance to 4% of assets, FDIC is ensuring banks have sufficient unencumbered assets in the event of insolvency. "I think they’d be much happier if the covered bond market didn’t evolve," suggests a covered bond analyst. "It complicates their job, so they’re putting a brake on potential amounts early on."
The US will not be looking to Europe for investors. Plans are centred on a domestic market, and with good reason. The US investor base is massive and diverse, and deals would involve only one currency. European covered bond markets are numerous, fragmented and have many products to choose from, with mortgage and public sector backed issues as well as legislated covered bonds and those structured without reference to a specific legal framework. Success lies in the US’s ability to adapt the European model to work at home, rather than to imitate it. Skeet affirms this, referring to the recent activity at the FDIC and the Treasury. "This is an attempt by the US authorities to explain how covered bonds will work in the US, rather than just bringing a European product into this market."
The outlook for Fannie Mae and Freddie Mac, the traditional supporters of US mortgages, is grim – with their equity trading at rock bottom. Thus hopes are high that covered bonds will at least partly step into the void left from the closure of mortgage securitization markets. Whether this will happen, and how soon, is uncertain but there is now an optimism surrounding US covered bonds not seen since before the credit crunch. "There’s an extremely good chance that there will be an issue in the near future," says Richard Kemmish, head of covered bonds at Credit Suisse. "The Treasury will have spoken to the main likely issuers, and encouraged them to issue. The authorities will make it happen."