Edward V. Murphy
Specialist in Financial Economics
Covered bonds are a relatively common method of funding mortgages in Europe, but uncommon in the United States. A covered bond is a recourse debt obligation that is secured by a pool of assets, often mortgages. The holders of the bond are given additional protection in the event of bankruptcy or insolvency of the issuing lender. Covered bonds have some features, such as pooled mortgages, that resemble securitization, but the original lenders maintain a continuing interest in the performance of the loans. Because some believe that the subprime mortgage turmoil may have been influenced by poor incentives for lenders using the securitization process, some policymakers have recommended covered bonds as an alternative for U.S. mortgage markets. Although covered bond contracts are not prohibited in the United States, some policymakers believe that legislation and agency rulemaking could facilitate the growth of a domestic covered bond market.
In some countries, covered bonds conforming to statutorily prescribed features may receive enhanced protections or greater regulatory certainty. A statutory framework for covered bonds often includes four elements: (1) the bond is issued by (or bondholders otherwise have full recourse to) a credit institution that is subject to public supervision and regulation; (2) bondholders have a claim against a cover pool of financial assets in priority to the unsecured creditors of the credit institution; (3) the credit institution has the ongoing obligation to maintain sufficient assets in the cover pool to satisfy the claims of covered bondholders at all times; and (4) in addition to general supervision of the issuing institution, public or other independent bodies supervise the institution’s specific obligations to the covered bonds. Some analysts include the presence of such a statutory framework in the definition of a covered bond, in which case there have not been any covered bonds issued in the United States (and many so-called covered bonds issued elsewhere would also no longer be rightfully called covered bonds).
Compared with securitization, covered bonds may be less susceptible to poor underwriting standards because issuers maintain risk exposure or “skin in the game,” perhaps minimizing problems of the “originate to distribute” model of lending. Institutions that issue covered bonds may be less susceptible to investor panic because the status of covered bonds on their balance sheet is transparent. On the other hand, reliance on covered bonds may reduce aggregate lending because it ties up more capital than does securitization.
Potentially, there could be some regulatory uncertainty on the treatment of holders of covered bonds when the Federal Deposit Insurance Corporation (FDIC) places banks in receivership or conservatorship. To address some of these concerns, the FDIC issued two policy statements in 2008 clarifying its obligations to the holders of covered bonds if an FDIC-insured institution is placed in FDIC receivership or conservatorship. Because the use of covered bonds in the United States is rare, there is still little experience in actually resolving a covered bond.
Date of Report: April 26, 2013
Number of Pages: 16
Order Number: R41322
Price: $29.95
To Order:
For email and phone orders, provide a Visa, MasterCard, American Express, or Discover card number, expiration date, and name on the card. Indicate whether you want e-mail or postal delivery. Phone orders are preferred and receive priority processing.
Posts
