Thursday, May 13, 2010

S&P on Proposed U.S. Covered Bond Legislation

NEW YORK (Standard & Poor's) May 7, 2010--If the United States Covered Bond
Act of 2010 (H.R. 4884) is enacted in its current form, it would create a
legal framework for the issuance of covered bonds in the U.S. The bill,
introduced in the House of Representatives by Representative Scott Garrett
(R-N.J.) on March 18, seeks to develop a covered bond market in the U.S. and
create specific provisions aimed at protecting covered bondholders from the
effects of an issuer's bankruptcy.

Covered bonds are essentially bank-issued securities that are typically
collateralized by mortgage loans or public sector assets. Unlike traditional
securitizations, investors have dual recourse to both the issuing bank and to
the assets backing the covered bonds. Because of this dual recourse, covered
bonds offer investors exposure to the mortgage market, yet are seen to have a
stronger credit profile than traditional residential-mortgage backed
securities (RMBS). At year-end 2009, 24 European countries had enacted
legislation governing the issuance of covered bonds.

Based on observations in other jurisdictions, Standard & Poor's believes the
proposed legislation might aid the further development of the covered bond
market in the U.S. However, additional clarification and analysis is required
for us to determine any potential impact that the legislation could have on
our ratings on covered bonds issued by financial institutions domiciled in the

Covered bonds have been a long-standing part of the European capital markets.
They provide investors with access to a greater variety of mortgage-backed and
public sector-backed securities, and they provide issuers with access to
liquid pools of capital that have financed various types of real estate and
public sector lending in many European countries. Outstanding European covered
bond totaled approximately €2.5 trillion (approximately USD3.4 trillion) at
year-end 2009, and very strong issuance continued through the first quarter of

Rep. Garrett's bill addresses, among other matters, covered bondholder rights
and protections in the event of a default of the covered bond or the
insolvency of the issuer or sponsor of the covered bond program, which is an
important aspect of Standard & Poor's analysis of covered bond legislation
(see "Expanding European Covered Bond Universe Puts Spotlight on Key Analytics,
" published July 16, 2004). We believe that greater certainty over the process
and timing to gain access to the covered asset pool would be beneficial for
investors. And, in our opinion, the proposed legislation could mitigate the
effect of collateral liquidation in a very short period, which could otherwise
adversely affect market values of the collateral.

On Dec. 16, 2009, we published our updated methodology and assumptions for
assessing asset-liability mismatch risk in covered bonds (see "Revised
Methodology And Assumptions For Assessing Asset-Liability Mismatch Risk In
Covered Bonds"). In the criteria we introduced a link between the rating on
the covered bond and the rating on the issuing bank. The linkage, which
provides a maximum uplift of seven notches on covered bond ratings, is
intended to communicate the potential risks to assets and cash flows when, in
our view, the program is exposed to asset-liability mismatches. If the
asset-liability mismatch risk is not structurally addressed, based on our
criteria, the amount of the potential rating uplift will be limited based on
our assessment of two factors: 1) the degree of the asset-liability mismatch
that a covered bond program is exposed to, and 2) the program categorization
that encompasses our view of the ability to obtain third-party liquidity or
sell assets to fund any mismatch. The program categorization is dependent on
our assessment of the range of funding options available to the program and
the likelihood of the program sponsor's ability to access these options, which
is largely based on our view of the systemic importance of covered bonds to a
particular jurisdiction's financial system.

Given the relative infancy of the covered bond market in the U.S., it's
difficult to assess how, if at all, the proposed bill would alter the systemic
importance of the U.S. covered bond market in the short term. However,
notwithstanding the exact impact, if any, on our criteria for rating U.S.
covered bonds, we believe that through the introduction of specific investor
protection provisions and clarity on their timing, the proposed United States
Covered Bond Act of 2010 could be a catalyst for the further development of
the U.S. covered bond market as an additional source of private capital to
finance U.S. homeowners.

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