U.S. House Panel Approves Measure to Boost Covered Bond Market

A bill aimed at establishing a viable U.S. covered bond market was among six measures advanced by the House Financial Services Committee.

The committee voted 44-7 today to approve the bill, which would provide a regulatory framework for covered bonds by giving the Treasury Department oversight of the market and creating a separate resolution process in order to bolster investor interest. The bill, if signed into law, could provide a boost to issuers including Bank of America Corp. and JPMorgan Chase & Co.

“This was a strong, bipartisan vote out of committee, so I think that should bode well on the House floor and bode well in the Senate where I think there is growing support over there as well,” Representative Scott Garrett of New Jersey, the Republican sponsor of the bill, said today in an interview.

The House panel also approved two bills that would make changes to the Dodd-Frank financial overhaul enacted last year. Representative Spencer Bachus, an Alabama Republican who heads the committee, said the measures were designed to free up capital that has largely been sitting on the sidelines in the wake of the worst recession since World War II.

“These bills will remove government barriers to private-sector job growth and help our economy to create badly needed jobs,” Bachus said.

House and Senate lawmakers, led by Garrett, have been drafting legislation for much of the last two years to create a market in the U.S. for covered bonds. Supporters say that they can serve as an alternative funding mechanism for banks and a way to provide liquidity in the mortgage market without relying on the federal government to securitize or insure mortgages.

Prussian Invention

Covered bonds are financial instruments backed by a pool of assets like mortgages or public-sector loans as well as by the issuer’s credit. Pioneered in 18th-century Prussia, they get higher credit ratings than other bank notes and pay less in interest because they augment the issuer’s repayment pledge with assets that can be sold in case of default.

In the U.S., legal uncertainty surrounds what happens if the issuer fails and bondholders and depositors both claim the bank’s assets.

The Federal Deposit Insurance Corp. has voiced concerns about the priority of covered bonds in the event of a bank failure, as well as whether the FDIC would become the de facto guarantor of the instruments. The agency, which runs the Deposit Insurance Fund and is responsible for resolving failed banks, has sought flexibility in dealing with the bonds in the event of a failure -- including the authority to repudiate a covered bond.

Failed Amendments

“The FDIC’s concerns, I believe, continue to be legitimate,” said Representative Barney Frank, the senior Democrat on the committee, who unsuccessfully offered two amendments drafted with the agency to change the measure. “The FDIC believes, I think correctly, there will be problems in some of these cases and the FDIC will not be fully protected.”

In an effort to alleviate some of the agency’s concerns, Representative Carolyn Maloney, a New York Democrat, offered a successful amendment that extended to one year, from 180 days, the amount of time the FDIC would have in event of a bank failure to hold the exclusive right to transfer the covered pool to another eligible issuer.

The panel also agreed, by voice vote, to a requirement that the Treasury write rules to cap the maximum amount outstanding, as a percentage of total assets, that any one issuer can hold.

Andrew Gray, the FDIC’s spokesman, said in an e-mailed statement that the bill would subsidize covered bond investors with the deposit insurance fund and “will add to the funding advantage” of large banks.

‘Super Class’

“The bill creates a super class of protected investors that will face no risk with their investment -- giving them rights available to no other private secured creditor and freeing them of the market discipline we are trying to restore,” Gray said.

The largest U.S. financial industry trade groups, including the Securities Industry and Financial Markets Association and the American Securitization Forum, supported Garrett’s measure.

“Investors will not dedicate funds to this market unless the legal regime is unequivocal and the risks can be identified and underwritten,” Kenneth Bentsen, the executive vice president for public policy at Sifma, which represents banks including Goldman Sachs Group Inc. and JPMorgan, said in a June 20 letter of support to the committee.

Only two U.S. banks, Bank of America and JPMorgan, ranked among the top 30 in global covered bond issuance in 2010, combining for 2.9 percent of the world’s market share.

Private Equity

In its other action, the committee, by voice vote, approved a full exemption in Dodd-Frank for private-equity fund advisers from the law’s requirement that most advisers to private investment funds register with the Securities and Exchange Commission. Current law, which the SEC moved to implement today, exempts advisers to private funds with less than $150 million in assets under management.

Frank, a Massachusetts Democrat, criticized the bill for removing a requirement that was “hardly the heavy hand of regulation.”

Representative Robert Hurt of Virginia, the Republican sponsor of the bill, and Representative Jim Himes, a Democrat from Connecticut, agreed on an amendment that would revoke the exemption for all firms with leverage any higher than twice its assets.

Representative David Schweikert, an Arizona Republican, sponsored a measure to increase the registration exemption threshold for smaller securities offerings over a 12-month period. The bill, which also was approved by a voice vote, would exempt public offerings of $50 million or less from SEC registration. The bill would raise the exemption threshold to $45 million from its current level of $5 million.

Executive Pay

The panel also approved, 33-21, the repeal of an 18-line provision from Dodd-Frank that requires all publicly traded companies to report the ratio between chief executive officer compensation and that of their median employee salary.

The provision in Dodd-Frank is “a burdensome regulation that provides no benefit and has substantial costs,” Representative Nan Hayworth of New York, the Republican sponsor of the bill. “It creates heat but no light.”

If the bills are approved by the full House they would need to clear the Democratic-controlled Senate and the White House before becoming law.

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