FDIC Controlling Covered-Bond Legislation

The FDIC is working with lawmakers to draft a new covered-bond bill, just days after the agency blocked efforts to include such a measure in Congress' financial-market reforms.

Those in on the talks include Rep. Scott Garrett (R-N.J.), a strong proponent of legislation that would facilitate the creation of a covered-bond market in the U.S. A new measure could be ready in the next few months.

While Garrett and others were eager to make covered-bond regulations part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, FDIC officials were able to shoot down that component just hours before a final version of the package emerged June 25. The reason: The insurer felt the proposed measure would have come too close to placing it in the role of a bond guarantor.

It's not that the FDIC would have to take over investor payments if an insured bank were to fail. Rather, the worry stems from how covered-bond terms require issuers to replace poorly performing collateral with stronger assets - meaning that in a seized-bank scenario, the FDIC would essentially have to absorb bad accounts while surrendering better ones. "The FDIC as receiver shouldn't bear the risk that should appropriately go to bondholders," said Michael Krimminger, the FDIC's special advisor for policy.

Nonetheless, the FDIC does want to see a U.S. covered-bond market emerge. Its discussions will revolve in part around how to ensure asset-replacement requirements don't hamper bank liquidity. Of particular concern is that another credit crisis could see banks encounter trouble acquiring replacement assets while taking swaths of bad accounts onto their books - potentially increasing the government's burden.

The FDIC also wants to renegotiate how it might access covered-bond collateral in the event of a bank insolvency. Specifically, the insurer wants to assess the underlying loans - usually mortgages - and immediately take control of assets acting as over-collateralization. The previously proposed bill would have given it a certificate that could be exchanged for any remaining over-collateralization after 10 years. Additionally in contention is the timeframe to find a buyer for a failed bank's covered bond program. The proposed measure would have given the FDIC 15 days from the institution's seizure, at which point the issuing entity would be removed from the receivership estate. The insurer feels that isn't long enough.

If lawmakers address the FDIC's concerns, Krimminger said, the two sides could reach an agreement quickly.

Covered bonds are debt instruments secured by revolving pools of assets. Unlike asset-backed securities, however, the creditworthiness of the issuers is also at play. The instruments are generally considered safe, and sell at low yields. But they have been uncommon in the U.S.

Garrett and other lawmakers have been trying in recent years to come up with a bill that would support a robust covered-bond market in the States, in part as an alternative to issuing mortgage-backed securities. The American Securitization Forum was disappointed to see the measure pulled from the financial-reform package, but is still holding out hope. "We are encouraged that members of Congress have expressed a willingness to revisit covered-bond legislation in 2010," ASF executive director Tom Deutsch said.

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