Garrett Press Conference on Covered Bonds - Transcript
Tim Skeet and Bert Ely also answered reporters' questions
01/05/2010
On the day before last month's landmark hearing on covered bonds by the U.S. House of Representatives' Committee on Financial Services, Congressman Scott Garrett (R-NJ) held a telephone press conference. Accompanying him were Tim Skeet, head of covered bonds at Bank of America Merrill Lynch, and banking expert Bert Ely of the Ely & Company consulting firm. Each of the three offered some initial remarks on covered bonds for the U.S. before answering questions from the news media.
Topics addressed during the conference call included Rep. Garrett's appraisal of the likelihood that Congress will enact covered bonds legislation in this term, whether the Federal Home Loan Banks would be negatively impacted, and prospects for covered bonds in the absence of legislation.
What follows is a transcript of the press conference, checked against an audio recording.
CONGRESSMAN GARRETT:
Greetings and good morning from New York. This is Scott Garrett speaking, and I want to begin by saying thank you, thank you all for joining us this morning or afternoon for our friends in Europe to discuss, well, a very important topic. And that of course is covered bonds.
Congressman GarrettI'm pleased to be joined by two gentlemen who are the resident experts on the topic here. And that is Bert Ely and Tim Skeet. We'll let them - I'll give a little introduction to them shortly but get their comments as well.
We will give each some preliminary remarks and then open up to your questions. And for those listening, a recording as [the conference call coordinator] said will be made and sent to participants who request one from our office. And I will provide that information at the end of the call, I believe.
So just to begin very briefly for my comments on this, I think we can all agree that the concept of risk retention is a good thing to strive for. I also believe that because of the current problems with the U.S. secondary mortgage market and the lack of liquidity for the securitization process, we really must work and continue to look for new and innovative ways to provide increased funding for our credit markets over here.
Now one of those innovative ways that I believe that really could provide additional liquidity to our credit markets is by establishing a covered bonds marketplace right here in the United States. And so we will be exploring this concept at a hearing tomorrow, Tuesday, at the Financial Services Committee in the House of Representatives.
This is something we've been looking forward to for some time and have been suggesting to Chairman Barney Frank that such a hearing be held. And as you're probably also aware, we have just concluded a number - a multiple of hearings on another subject, which of course is the financial reform legislation that has ultimately passed the House at least this past week.
Now the covered bonds are, I think, most people on the phone are familiar with, are debt instruments issued by financial institutions or backed or covered by a pool of [high] quality bonds. And as such, they're kept on the balance sheets of the issuing institutions, and investors -fortunately for them - have a dual recourse to both the assets used as collateral as well as the underlying institution.
And so again, as you're all familiar, covered bonds have been used in Europe for, I guess, literally hundreds of years now. And they have helped derive additional funding options for the issuing institutions.
They're really a major source of liquidity, as I understand it, for many European nations' mortgage markets, and covered bonds have performed very well. They performed extremely well even during the financial crisis largely because of the high underwriting standards used for the loans and the covered bond pool. And that of course is the nature - because of the nature of the recourse aspect.
Now in the summer of '08, which was a month or so before the financial crisis really began to "set in" in earnest, there was an attempt by the administration here in the U.S. to get this market off the ground, if you will. The U.S. Treasury Department issued a list of what we call best practices, which describe the most prudent ways for interested issuers to offer covered bonds.
Also, at the same time, the FDIC published a final policy statement that provided guidance to investors as to what access the FDIC would offer to the collateral in case of a bank failure. As I understand it that, of course, is one of the key issues that we needed to have addressed to that point.
Today, however, there's only been about two issuances of covered bonds in the U.S.; one by Bank of America and Washington Mutual, which is now of course part of JP Morgan. And over the last several months, however, there [has] been a tremendous increase in demand by investors for these bonds.
And in one week in September alone, I understand, there were seven new issuances in a variety of different European countries that totaled over $20 billion. And one financial analyst went so far as to call it an unprecedented supply frenzy that was occurring.
So at a time when we desperately need more private investment and additional liquidity in the U.S. credit markets, I really believe we must work to set up a system here that will allow covered bonds to flourish and their full prominence to be explored.
So to that end, I've had some legislation introduced into Congress. And that's what we'll be looking at a little bit on Tuesday. What my legislation would do in a nutshell is to lay out a detailed statutory framework to help facilitate the broader use of the funding instruments here in the U.S.
My approach and thinking was the detailed statutory framework is really common in the European countries, where the bond market is flourishing. And it's needed here in this country to provide the investors greater certainty, which is what they're looking for in these markets in regards to their exact recourse if the issuing institution bank fails.
And so to conclude, my legislation also spells out a variety of different asset classes, which will be eligible to be included in a covered bond. It designates the Secretary of Treasury as the covered bond regulator, which of course right now is - we look to have a regulator for every single aspect of the financial institutions or markets our there. That's why we did that.
And we did it also mainly because the Department of Treasury has unique knowledge and expertise of U.S. debt markets. And finally, the legislation will detail the procedures that will be used to follow in a case and issue our covered bond issuance sale or defaults.
That's in a nutshell how it would all work. And now let me turn to introduce to our next speaker. And that of course is Tim Skeet. And before you jump in, let me just give them a little background on you.
He is a member of the U.S. Covered Bond Council Steering Committee, and he was involved in advising back on 2008 - on the 2008 Treasury Best Practice[s] Proposal that I just mentioned a moment ago. And he was a founding member of the ECBC, their steering committee and an advisor to the Covered Bond Investor Council in Europe and is a board member of the International Capital Markets Association. So you sound quite the [unintelligible]. So thank you very much for taking part of this then, and I turn it over to you for your comments.
TIM SKEET:
Well, thank you very much, Congressman, and good morning everyone on the line. Yeah, well, we in the markets and the fellow members of the U.S. Covered Bond Council, we very much welcome Congressman Garrett's words and the work that he and his team has been doing around this covered bond legislation.
Tim SkeetThe lessons from Europe have clearly shown that where the legislators, the regulators and the market could work together, tremendous results can be achieved in terms of mobilizing private money to fund mortgage and public sector funding markets.
Almost 120 billion euros - that's almost, well, around $180 billion U.S. dollars - of new issue volume has been generated in the European market this year alone. And most of that actually in the second half of the year.
In the U.S. today, there is a window of opportunity to establish a version of this asset class that is tailored to fit U.S. market requirements. We have a shot at creating an additional source of funds to provide liquidity to the consumer finance and the mortgage markets.
Now let's be clear that this is not a plan to replace the securitization market nor other established sources of funds, nor do we want or do we look to gloss over the real challenges of establishing a new liquid, high quality asset class with skeptical U.S. investors.
However, with the decline in GSE funding and the disappearance of the TLGP programs, investors we know will be looking for another asset class into which to invest. Covered bonds check a lot of the boxes, although the onus will be on us in the industry to convince investors that we do have here a very high quality asset class.
Now a legal framework is a necessary prerequisite of the establishment of a vibrant U.S. covered bond market and a vital element that will give investors confidence in the solidity of the product. Covered bonds are also a good way of connecting the world of esoteric big market finance back with the vital liquidity needs of consumers and other areas of the U.S. economy.
And if the politicians and the regulators can deliver on a strong law, the establishment of this market represents an important step towards a broader and more stable financial market in the United States. Thank you, and I'll hand back to the Congressman.
CONGRESSMAN GARRETT:
Well, thank you, and I appreciate that. And now let's swing over to Bert Ely. And Bert is a principal over at Ely & Company. Bert has specialized in deposit insurance and banking structure issues all the way back into 1980 or 1981. And he has also helped draft legislation to enact the cross guarantee concept - that's for privatizing banking regulation and regulatory - regularly testifies before our committees in Washington, and our office relies upon him quite extensively on a number of issues and as - with this one as well.
And finally, as a matter of fact, Bert will be one of our witnesses at the hearing that I mentioned earlier on in this conversation. We're going to have a hearing in D.C. tomorrow, I think it's in the morning - yeah, 10:00 am will be the [unintelligible] covered bond prospects for a U.S. market going forward.
And I'll just - before I swing it to you, Bert, just for those listening, a hearing over here simply means that you're discussing the topic, not necessarily moving - or not at all moving the particular bill out of the committee that day. You're just bringing in an expert, such as Bert and others to give us their background and information and expertise on the topic.
And so while some of us have spent some of our time delving into this for months or years now, [for] other members of the committee, it will be a brand new subject to be approached by. So that's why we have a hearing first and then hopefully move along. So Bert, again, thank you for your work in the past and thanks for working with us, and thanks for being on the call with us this morning.
BERT ELY:
Congressman, thank you very much, and I appreciate this opportunity. First, with regard to the hearing tomorrow, the - it will be webcast on a live basis, and also the webcast will be archived. And then additionally, the written testimony supplied by the witnesses including my own testimony will be available on the committee website - I believe by tomorrow morning.
Bert ElySo for those who want to get into this further, I encourage you to visit the committee website and, you know, ideally to listen in on the webcast, either live or recorded.
I really wanted to just emphasize one additional point here. And that is the high credit quality of covered bonds and the investment potential that offers for U.S. investors - especially, as Tim pointed out, we see a decline in the issuance of GSE debt and TLGP guaranteed debt. That really opens up the market for another class of high quality, high rated - highly rated debt. And covered bonds would meet that need.
And I - it's interesting that just this morning in a newsletter that Moody's - one of the credit rating agencies - issued, that it wrote specifically about Congressman Garrett's legislation to create a covered bond law in the United States. And just in quoting, it had this to say; "the latest proposal for covered bond legislation is robust and unlike previously proposed legislation would provide very strong protection to future covered bond investors following an issuer default."
Moody's goes on to say "the development of the covered bond market in the U.S. would be a positive development of the funding profile of U.S. banks by providing an additional funding source for residential mortgage loans." And I might add in terms of residential mortgage loans, we're talking of approximately a $10 trillion market.
Now covered bonds aren't going to capture all that market. But covered bonds have an enormous potential in the United States simply because of the size of the U.S. debt market. In my testimony tomorrow, I will present data indicating that the total loans outstanding in the asset classes that would be authorized for covered bonds as it's provided under Mr. Garrett's legislation, on September 30 totaled over $20 trillion.
And covered bonds certainly are not going to begin to pick up all of that financing load. But even in a relatively small percentage, say 10%, that would be $2 trillion of a type of debt that now is not issued in the United States. And it would create an enormous and I believe highly efficient covered bond market in the United States to match that which is now operating in Europe.
Now with that, Congressman, I'll - I don't have anything further to say at this time, but I'll be glad to participate in the Q&A.
CONGRESSMAN GARRETT:
Well, that's great, thanks for - and I guess that's where we swing to right now. And I believe we are ready to try to answer any questions that callers on the line may have. So if the operator is there, if she is standing by, if you could open the phone lines please.
[Conference call coordinator's instructions and caller introduction omitted.]
THOMAS RESSLER:
Yes, this is Thomas Ressler from Inside Mortgage Finance Publications in Bethesda. I had a question for you, if I may, regarding the covered bonds proposal. There is a lot of concern among Federal Home Loan Bank types that this - that a vibrant covered bond market would be a threat to the advance business of the banks. And I would be interested in finding out if you have any words to reassure them or if you could otherwise comment on that particular consideration.
BERT ELY:
This is Bert. I'd be glad to take a crack at that question because it's been posed to me before. And as I understand it, there are at least some within the Federal Home Loan Bank system that are not too concerned about this because they feel that covered bonds, because of their potential maturity of 10 or 20 years or more, would actually be a complement to Federal Home Loan Bank advances, which tend to be of shorter maturity.
Also, some of the asset classes that are proposed in Mr. Garrett's legislation are not eligible classes as collateral for Federal Home Loan Bank advances. So in my opinion, the concerns about the threat of covered bonds to Federal Home Loan Banks has been overplayed. But I would also say this too, that it would be - covered bonds would represent another - would basically expand options for both investors and financial institutions. And I think that competition would be healthy for the U.S. financial markets.
THOMAS RESSLER:
Thank you.
TIM SKEET:
And from the industry side, if I could just add, I think we do see the - all of these different financing mechanisms as being very complementary. So I think that's really - I just wholeheartedly agree with what Bert had to say.
SCOTT GARRETT:
And I guess - and the description of complementary on that is if you talk to some of the folks with the Federal Home Loan Banks, you know, they're all looking, too, to Washington to see what we can do creatively or otherwise to try to get the economy back on track again. Because until we do that, their business and their markets are going to be somewhat flat anyway. So this is just - plays, as Bert was saying earlier, one piece in the puzzle. So much the better for their business and potentially down the road as well.
So thank you for the question and do we have another question?
[Conference coordinator's caller introduction omitted.]
SPENCER PUNNETT:
Hi, this is Spencer Punnett from Covered Bond Investor™. Directed to the Congressman: How would you define success for this hearing? What outcome would you look to in order to call it a success?
CONGRESSMAN GARRETT:
Okay, that's a good question. Well, first of all, I think it's a success that we're having this hearing. As I noted earlier, I believe, this is something I've been encouraging the Chairman to do for some period of time. And if memory serves, his initial thought was that we should have this hearing sometime in July or before we went on break in August - for the August recess that we have over here. And that, of course, did not occur.
And then the inference was we would have this hearing sometime in September, which is when we returned from break. And of course, that did not occur. And then I continued to talk to the Chair about the importance of this - and he all along saw the benefits of it and is - he, well, supports the idea in general. And as you probably know as well, the ranking member, Spencer Bachus and [Subcommittee] Chairman Kanjorski [unintelligible] the Democrat Chair [are in] support of the idea.
Chairman Frank, however, said that his plate and the timeframe [were] filled at that time with the overall market reform legislation at the - of course, which just completed now. So I think we can check the one box off that we had success, that we're actually scheduling a hearing on it.
And then going forward to answer your question further, if the outcome of this hearing - and we have about five witnesses, I believe, who will be testifying - is that most or that everyone, I think, will be generally speaking on board with the benefits of going forward. And if we get - that's A. And B, that we get an educational component of this hearing to the rest of the members of the committee who are either there or watching, that's another box that can be checked off.
And then thirdly, if we can get some sort of [an] interest by the Chairman to move forward with the legislation which is, as you know, in our scheme of things, in our process, which is an actual hearing on a piece of legislation - this one or otherwise - so that it can actually move to come out of committee.
I'll add one last comment that goes beyond what you were asking. And that is, initially also I asked to the Chairman a month ago, weeks ago, say well, if we're on board with this, why don't we throw in some language into the financial relief reform bill that we just had, so we could get a marker down for it. He didn't see a need for doing that - thought there was enough in the reform legislation that we could move it there as well.
But who knows where that overhaul, that whole huge bill is going to go at this point, with the issues in the Senate and Senator Dodd and what have you. We conceivably could get this as a standalone bill as it is right now through this hearing and then as a markup sometime in the spring and actually move this thing to fruition, which is the ultimate goal here.
SPENCER PUNNETT:
Might I just follow up, Congressman?
CONGRESSMAN GARRETT:
Sure.
SPENCER PUNNETT:
What percentage probability as you're sitting here today do you think there will be that covered bond legislation will be passed in the House this term?
SCOTT GARRETT:
I would say - I can't put a number on it but I would say a high percentage probability. And I - in Congress, you have a couple of issues going here. Is the bill bipartisan? That's probably first and foremost in discussion. This one would be. Secondly, let's see, another factor would be is timewise to get things done. Well, now that we've gotten this huge reform bill out of the way - and I should probably stop calling it a reform bill because it creates a lot of other problems - but as the huge market regulatory bill is now out of the way, the docket should be open as far as our committee is concerned. So those two facts alone should be a good sign that we can move this thing.
SPENCER PUNNETT:
My final question: Do you - are you equally optimistic that covered bond legislation would be passed in both houses and actually become law in this term?
CONGRESSMAN GARRETT:
I never predict what the Senate is going to do because they are just - they operate on a totally different timeframe than we do. If you'd predicted where we'd be on the totally unrelated issue of - as far as healthcare, you know, the Obama administration would probably have thought that we would have done that by now. And of course, as you see in the news, they're running into new roadblocks there as their latest attempt to get that issue resolved. It is now causing problems as well.
The financial reform bill is going to create its own host of issues as well. They work on a different schedule than we do and we have different procedures that we do that sort of tie up their floor time more than us. But because I think it will get bipartisan support over there as well, you know, once we get legs on it here in the House, we'll be doing all we can in the Senate as well to put the pressure there to say that this is a piece of the pie that the administration should look at as far as trying to revive the economy and the securitization markets and these other markets as well. So I would hope they'd pick up and see a benefit to get it done before the end of the term.
SPENCER PUNNETT
Thank you.
CONGRESSMAN GARRETT:
Sure, thank you.
[Conference coordinator's caller introduction omitted.]
BRIAN COLLINS:
Hello, I think this is for Mr. Skeet. The House just passed a bill that contains the risk retention requirement on mortgage securities. Does this make the covered bond option much more attractive for, like, Bank of America and other large institutions that want to do covered bonds?
TIM SKEET:
Well, I don't know about that particular question. But what I can say is that there are a number of issuers who will be looking very closely at this, depending on how the legislation is passed. At this stage, from what we've seen of the outlines, I think it's likely that a number of financial institutions will find this attractive.
Remember, there are several different asset classes covered by the proposal. And I think one of the exciting things about this is that it's potentially there not just to help the mortgage markets but other forms of consumer finance. But the big challenge we have, over and above getting the law in place, will then to be to persuade investors that we have an asset class that they should be buying.
And in the final analysis, what will drive issuance will be the pricing that we can achieve and how we go about distributing this to U.S. investors. I think that'll be our biggest job and that will be the biggest driver of the appetite for this market in terms of who is going to issue, how much they're going to issue, when they're going to issue.
Let's see what we can do once we've got the framework in place. And that is the absolutely necessary first step. I think once investors see that in place, take a close look at it, we're hoping they're going to get very comfortable with it. They'll see the example of Europe and their appetite will then increase and that will put us in the position of where the pricing starts to become compelling for the issuers to start using it as one of their instruments of choice.
BERT ELY:
Brian, Bert Ely here. Just to add onto that - you know, we have some upcoming changes in accounting rules that effectively are going to bring securitized assets back on the balance sheet. In fact - pardon me - the FDIC is going to be addressing this issue at a board meeting tomorrow.
But to the extent that banks and other regulated lenders have to hold additional capital against assets that they have securitized and were previously off balance sheet, that tends to help level the playing field between securitization and keeping the loans on balance sheet.
And of course, with covered bonds, the loans that are funded by these covered bonds stay on the bank's balance sheet. So this may be another factor that tilts companies - banks and others - toward keeping loans on balance sheet and then funding them with covered bonds.
BRIAN COLLINS:
But by keeping the mortgages on their balance sheet, would that basically mean that they wouldn't have to have any risk retention, additional risk retention requirements?
BERT ELY:
Well, basically there would be 100% risk retention. In other words, the 5% risk retention related to securitization is where the loan is sold. But if you don't sell the loan -
BRIAN COLLINS:
So you keep all the risk.
BERT ELY:
You keep all the risk, right. So in effect, you get 100% risk retention.
BRIAN COLLINS:
Okay.
TIM SKEET:
But let's be clear, covered bonds are not about risk transfer. The issuer of the covered bonds keeps all of the risk. What this is is a funding tool whereby investors can look at it and say, I have the issuer on the hook. And if anything goes wrong, we then have a very conservatively structured pool of assets which will repay my bonds.
That's the way it works. And that's the second line of defense - that the overall package with hopefully some very strong legal frameworks gives investors high measures of confidence, as indeed Moody's has identified in their recent write-up.
BRIAN COLLINS:
All right, is - just while I have you on the line there - you don't feel confident going forward with another covered bond transaction unless this type of legislation is passed?
TIM SKEET:
Well, I think just look at the - look at what's happened in Europe. There are two specific jurisdictions in Europe which tried to get by without specific legislation. That was the United Kingdom and Holland - the Netherlands - in recent times.
Both of them have now put in place laws, covered bond laws, really because that's what investors have told them is required. And this is to achieve the best possible price relatively speaking. It's to level the playing field. Investors want to see that kind of level of support, certainly the ones in Europe. And we believe also in the fullness of time, the investors in the United States would we expect to see specific areas of support and legislation, to give them comfort that if something goes wrong, they have access to the security and the collateral. That's very important.
And that's what's been a driver in covered bonds for - for so very long, and this is why at the end of the day, this is one asset class where there's never been a default.
BRIAN COLLINS:
Okay, all right. Well, thank you.
[Conference coordinator's instructions omitted.]
CONGRESSMAN GARRETT:
And if we don't have a question - but I'm open to have another question - but if we don't, I do want to thank everyone for joining us. And particularly I want to thank Bert and Tim very much for participating and giving your wealth of expertise and information on these topics as we - as I say, as we go forward on these things, we'll be relying on you - not only in committee tomorrow, Bert, but both [of] you - Tim as well - as we try to work these things out.
To the one reporter's question, what percentage chance that we're going to get this done? I don't know. But with, I think, everyone on board and pointing out the benefits to the markets and the economy going forward, I think we'll be successful. So thank you, gentlemen. And - unless you have other closing comments?
BERT ELY:
No, I think - this is Bert - just to say one thing. In terms of this hearing tomorrow, that I think it is going to be very important because it is an opportunity to educate the entire committee about covered bonds and the many advantages that they offer and the positive effects that they'll have in the U.S. financial markets.
CONGRESSMAN GARRETT:
Right.
TIM SKEET:
And I would just finish by saying, I think this is the third time lucky. We tried in 2007 in various shapes and forms. We tried again last year with the "best practices" paper. And I think this is the third time and third time lucky. So I think this is tremendously exciting - so let's get it done. I wish everyone well.
SCOTT GARRETT:
Well, we hope to get it done. And for anyone here who would like to have some information either on this call or what happens [in] committee or otherwise, you can get in contact with us - actually you can get in contact with my communication director. Her name is Erica Elliott. That's Erica Elliott. And I guess the best way to get in contact with her is through email.
And the email is - I'll go over this slowly - it's erica.elliott@mail.house.gov. One more time, last time - erica.elliott@mail.house.gov. And gentlemen, thank you and everyone who's on the call, thank you. And for all those who raised questions, [I] very much appreciated them, and thank you very much, and have a good afternoon and a good day.
[Concluding additional thank-you's and good-bye's omitted.]
Editor's Note: The transcript above is from a transcription made available by Congressman Garrett's office, with transcribing errors corrected by Covered Bond Investor™ based on comparison with a digital voice recording of the call.
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