House Hearing Highlighted Moody's Covered Bond Comment

A Sector Comment from Moody's Investors Service on proposed U.S. covered bonds legislation played a part in last week's hearing (Dec. 15) by the House Committee on Financial Services.

The Comment (released Dec. 14) offers the rating agency's view of a comprehensive legislative framework for U.S. covered bonds proposed by Congressman Scott Garrett (R-NJ).   Although the committee hearing's focus was broader — on the merits of covered bonds in general as a potential additional funding source in the U.S. — Rep. Garrett's proposal was discussed by some of the five expert witnesses. 

Witness Bert Ely quoted from the Sector Comment to support his position in favor of developing a U.S. covered bond market based on a strong statutory framework.

"Moody's has written quite positively about . . . [Rep. Garrett's proposed] statutory provisions, stating recently that the latest proposal for covered bond legislation is 'robust' and 'would provide very strong protection to future covered bond investors following an issuer default,'" Ely testified at the hearing.

"Moody's goes on to say that 'the development of a covered bond market in the U.S. would be a positive development for the funding profile of U.S. banks by providing an additional funding source for residential mortgage loans,'" Ely added.

The Sector Comment, written by Moody's VP Yehuda Forster and SVP Brian Harris, characterizes Rep. Garrett's currently proposed legislative framework as more comprehensive and offering more protection than proposed covered bond legislation that Reps. Garrett and Paul E. Kanjorski (D-PA) had introduced earlier this term.  

The new, comprehensive framework was unveiled by Rep. Garrett in the form of a proposed amendment to a financial reform bill.  Although the amendment did not become part of that bill, the framework is expected to serve as the starting-point for future covered bond legislation.

A central feature of any covered bond program is the "cover pool" of loan assets that provide security for bondholders if the issuer were to become insolvent.  As described by Forster and Harris, a major plus of the new proposed legislative framework is that it "would provide predictability and clarity on how the cover pool would be treated following an issuer's insolvency and would significantly mitigate refinancing risk."  In particular, its provisions would allow flexibility in disposing of cover pool assets over time, without being forced into a fire sale situation.

The authors recognize, however, that proposed U.S. covered bond legislation is still at a very early stage.  "The main question now is how much, if any, of the proposed framework will make it through the legislative process."