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CAPITAL MARKETS

Uncovering US covered bonds

The Federal Deposit Insurance Corporation recently issued a statement laying the foundations for the regulation of a US covered bond market, specifically concerning the preferred treatment of bondholders in the event of an issuer default.

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.