The Fall of Covered Bonds in the US

October 17, 2013

The sale of covered bonds in the US has fallen to $17bn this year, down from $45 bn in 2012 and $40 bn in 2011. [1]

Covered bonds being widely perceived as the alternative on-balance sheet option for RMBS, several countries have sought legislation to regulate covered bond issuances.[2] In response to mortgage market turmoil in 2007 and 2008, the Treasury Department and the Federal Deposit Insurance Corporation (FDIC) considered rulemaking to encourage the use of covered bonds as an alternative to mortgage securitization.[3] However, the Federal Reserve Board (FRB) and Federal Deposit Insurance Corporation (FDIC) have yet to recognize covered bonds as a valid source of bank capital. Legislation on covered bonds does not exist as of now, although efforts have been underway for over three years.

Presently, covered bonds are issued under the Securities and Exchange Commission (SEC) 144(a) Private Placement Rules or under Rule 3(a) 2 provisions. This has limited the number of prospective buyers and made covered bonds less attractive for issuers who are seeking large number of bidders to lower their financing costs. This slump is mainly the result of lack of interest by large US banks in the absence of regulation. Since Federal Housing Administration insurance is easily available and there is heavy participation of GSEs in the housing market, there seems to be little incentive for banks to float a market for covered bonds. It is also possible that some banks may not have sufficient collaterals.

The slump in the market was experienced outside the US as well. In Europe also, the recent efforts at reduction of bank’s balance sheets and cheap liquidity available from central banks have caused the demand for funding to slump.[4] Globally, issuances stand at $130 bn, which has decreased by 40 % year on year. Issuances of unsecured bonds have also decreased by 2%. [5]

Notes:

1. See,http://www.ft.com/intl/cms/s/0/f7af1f88-32a3-11e3-b3a7-00144feab7de.html#axzz2hnSeLUcp, http://www.icmagroup.org/resources/market-data/Market-Data-Dealogic/#3
2. Canada recently amended its National Housing Act to bring about a legal framework for covered bonds. Last year, Singapore, South Korea, Australia and New Zealand also developed legislation to regulate covered bonds.
3.  http://www.sifma.org/uploadedFiles/Research/Statistics/SIFMA_USMortgageRelatedIssuance.pdf
4. .http://www.coveredbondnews.com/Article/3227091/Covered-supply-at-lowest-level-since-2009.html
5. .http://www.ft.com/intl/cms/s/7a1420f0-042c-11e3-8aab-00144feab7de,Authorised=false.html?_i_location=http%3A%2F%2Fwww.ft.com%2Fcms%2Fs%2F0%2F7a1420f0-042c-11e3-8aab-00144feab7de.html%3Fsiteedition%3Dintl&siteedition=intl&_i_referer=

Reported by: Shambo Dey