Alert August 03, 2010

House Financial Services Committee Approves Covered Bonds Legislation

The House Financial Services Committee adopted by voice vote a bill (“H.R. 5823”) that would establish a legislative and regulatory framework for U.S. covered bonds, including a regime to handle the failure of a bond issuer.  H.R. 5823 was introduced by Representative Scott Garrett, along with co-sponsors Representative Paul E. Kanjorski and Financial Services Committee Ranking Member Spencer Bachus, on July 22, 2010 to supersede a pervious version (“H.R. 4884”) that was introduced in March 2010.  While similar in many ways to H.R. 4884, H.R. 5823 also includes some significant differences, as discussed below.  For more information on H.R. 4884, and covered bonds more generally, please see the March 30, 2010 Alert.  Covered bond provisions came very close to inclusion in the recently-enacted Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), but ultimately did not make it out of the conference committee that reconciled the House and Senate versions of the Dodd-Frank Act.

H.R. 5823 originally designated the OCC as the “covered bond regulator” (unlike H.R. 4884, which designated the Secretary of the Treasury as the covered bond regulator).  However, the FDIC, which said it supports expanding the covered bond market, has expressed concerns with certain details of the bill that it believes could potentially make bank failures more expensive.  In partial response to this concern, the House Financial Services Committee adopted by voice vote an amendment from Representative Melissa Bean that would take regulation of covered bonds from the OCC and give it to a consortium of federal regulators, including the FDIC.  Under this amendment, the OCC, FDIC, FRB and the SEC would have to promulgate joint rules dealing with covered bonds, with the primary regulator of the applicable financial institution enforcing such rules.  The regulators also would be required to consult with the FDIC for issuers who are depository institutions and confirm to the FDIC that covered-bond issuances by institutions under their jurisdiction would not “materially increase” the risk of losses or actual losses by the Deposit Insurance Fund.

Eligible issuers under H.R. 5823 include any insured depository institution or subsidiary thereof, any bank holding company or thrift holding company or any subsidiary thereof, and any nonbank financial company that is approved by its primary financial regulatory agency.  Eligible asset classes for cover pools include residential and commercial mortgages, public sector loans and small business loans.  A manager’s amendment offered by Representative Kanjorski eliminated eligible asset classes for home equity loans, auto loans, student loans and credit cards, but left in a provision that allows the covered bond regulators to jointly designate other eligible asset classes.

One important difference from H.R. 4884 is that, under H.R. 5823, the FDIC, if appointed as conservator or receiver for an issuer prior to a default under the issuer’s covered bonds, would have 180 days to elect to transfer the issuer’s covered bond program to another eligible issuer.  Under H.R. 4884, the FDIC would have had only 15 days to make such a transfer.  During such 180-day period, the FDIC would be required to satisfy all outstanding obligations of the issuer under the covered bonds and related transaction documents.

FDIC Chairman Sheila Bair expressed her continued concern with certain parts of the legislation in a letter to Representative Barney Frank, Chairman of the House Financial Services Committee.  Specifically, Chairman Bair noted her concern that H.R. 5823 “would require the FDIC to hand over the excess collateral to covered bond investors without effective compensation.”  Representative Bean offered an amendment to address the FDIC’s concerns, but reportedly withdrew the amendment when Chairman Frank promised to address such concerns before the bill reaches the floor of the House of Representatives.

In the Senate, Senator Bob Corker has urged Senate Banking Committee Chairman Christopher Dodd to hold a hearing on covered bonds as early as this week.

The Alert will continue to monitor this area and provide updates on material developments as they occur.