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COVERED BONDS: PROSPECTS FOR 

A U.S. MARKET GOING FORWARD 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

DECEMBER 15, 2009 

Printed for the use of the Committee on Financial Services 

Serial No. 111–95 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES A. WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

DAN MAFFEI, New York 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

December 15, 2009 ........................................................................................... 1 

Appendix: 

December 15, 2009 ........................................................................................... 25 

WITNESSES 

TUESDAY, DECEMBER 15, 2009 

Boyce, Alan, Chief Executive Officer, Absalon ...................................................... 7 

Ely, Bert, Ely & Company Inc. ............................................................................... 10 

Hoeffel, J. Christopher, Managing Director, Investcorp International, Inc., 

on behalf of the Commercial Mortgage Securities Association (CMSA) .......... 14 

Phoa, Wesley, Senior Vice President, the Capital Group Companies ................. 12 

Stengel, Scott A., Partner, Orrick, Herrington & Sutcliffe LLP, on behalf 

of the U.S. Covered Bond Council ....................................................................... 9 

APPENDIX 

Prepared statements: 

Marchant, Hon. Kenny ..................................................................................... 26 

Boyce, Alan ....................................................................................................... 28 

Ely, Bert ............................................................................................................ 39 

Hoeffel, J. Christopher ..................................................................................... 50 

Phoa, Wesley ..................................................................................................... 62 

Stengel, Scott A. ............................................................................................... 67 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Ely, Bert: 

Written response submitted for the record to a question posed by Chairman Frank during the hearing .................................................................... 77 

(1) 

COVERED BONDS: PROSPECTS FOR 

A U.S. MARKET GOING FORWARD 

Tuesday, December 15, 2009 

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The committee met, pursuant to notice, at 10:02 a.m., in room 

2128, Rayburn House Office Building, Hon. Barney Frank [chairman of the committee] presiding. 

Members present: Representatives Frank, Maloney, Watt, Moore 

of Kansas, Baca, Scott, Green, Cleaver, Bean, Perlmutter, Foster, 

Carson, Minnick, Adler, Peters; Bachus, Royce, Hensarling, Garrett, Marchant, Jenkins, Lee, and Paulsen. 

The CHAIRMAN. This is a hearing on the subject of covered bonds, 

and I recognize for 2 minutes the gentleman from Illinois, Mr. Foster. 

Mr. FOSTER. Thank you, Mr. Chairman. I would just like to say 

very briefly that I think this is a great initiative, and it is wonderful to see the Republican Party claiming their historical support for 

European financial and social structures—but all kidding aside—if 

you look at the history of how different segments of the economies 

in different countries have performed in the last crisis, one of the 

high points is the covered bond, the performance of the covered 

bond market. 

I think particularly the—one of the segments that will be 

brought up in the testimony here is in fact a variation of these that 

is supported in Denmark has maintained very good liquidity across 

the whole crisis, as well as historically provided the best deal for 

consumers. This, I think, is a fundamental issue here. We have to 

look at what provides over time the best stability and the best deal 

for consumers, and I think that both of these lead to the covered 

bond market as the way forward. 

I’m also very interested in the possibilities for covered bonds to 

provide a path forward out of the situation with Fannie Mae and 

Freddie Mac, which no one likes. And I think that having a strong 

covered bond market out there will make all the decisions we’re 

going to be faced with much, much easier. So, for all these reasons, 

I think this is a great initiative. I think this is an example where— 

another point that is made in some of the testimony that we ought 

to pay attention to is that the markets that have held up the best 

have been those—in terms of having small spreads, are ones where 

there’s quite prescriptive legislation, because one of the variables 

that we have to address if we’re going to go ahead and provide legislative support for this is the degree to which we should say here 

2 

is exactly the simple form of covered bonds that we’re going to legislatively support or whether we just provide—let a thousand flowers bloom and let a very broadly regulated market provide a variety of products. 

It’s a very interesting lesson that it appears as though the market in times of stress prefers to have a rather tightly prescribed set 

of conditions. And as we try to bootstrap the covered bond market, 

I think that we may want to err on the side of being more prescriptive and saying, here is the simple form that we’re going to start 

out with. And when we have a successful covered bond market in 

the United States, then perhaps loosen the rules to allow more 

elaborate products. 

So those are the things that I will be keeping my eyes on in the 

testimony. I read it all last night, and I found it very, very encouraging, and I yield back. 

Mr. SCOTT. [presiding] The gentleman from New Jersey, Mr. 

Garrett, is recognized for 5 minutes. 

Mr. GARRETT. And I thank the chairman. I thank Chairman 

Frank for working with me during the last few months on this and 

helping to schedule today’s hearing. I would also like to thank 

Chairman Kanjorski and Ranking Member Bachus for their continued support and hard work on this important issue. I appreciate 

the opening comments from Bill over there, as well. 

The United States continues to recover from the financial crisis, 

as you referenced, over the last year, and so it is essential that 

Congress examines new and innovative ways to basically unthaw 

or unlock the credit markets and encourage private capital to confidently reengage by turning cash now on the sidelines into active 

investments in our country’s future. And one of those innovative 

ways that I believe could provide that additional liquidity to our 

credit markets is by establishing covered bonds in the marketplace 

here in the United States. Covered bonds are simply debt instruments issued by financial institutions and backed, or covered if you 

will, by a pool of high-quality loans. Covered bonds are kept on the 

balance sheet of the issuing institution, which is important, and investors have a dual recourse to both the assets used as collateral 

as well as the underlying institution. 

Covered bonds have been used, as I said, in Europe for hundreds 

of years to help provide additional funding options for the issuing 

institutions, and are a major source of liquidity for many European 

nations’ mortgage markets. Covered bonds have performed extremely well during the financial crisis, largely because of the high 

underwriting standards used for loans in the covered pools. And so 

I do believe that a robust U.S. covered bond market would offer numerous benefits to investors and consumers in the broader financial sector. 

Investors would benefit by having a new, safe, innovative vehicle 

which will allow for more diversification in their portfolio. Consumers would stand to benefit greatly by the increase in liquidity 

to their credit markets. There will be more funding available for 

loans and thus lower rates for home mortgages, auto and student 

loans, and for small businesses. 

One of the problems that we experienced during our current crisis was the difficulty of modifying mortgage loans because the ownVerDate Nov 24 2008 13:49 May 11, 2010 Jkt 056238 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 K:\DOCS\56238.TXT TERRIE
3 

ership of those loans had been transferred out through the 

securitization process. Not here. This is not a problem with covered 

bonds, because they are held in service by the lender. The lending 

institution thus has a greater ability to modify consumer mortgage 

loans, which will benefit the consumer. 

Finally, the broader financial markets will stand to benefit from 

a covered bond market. Covered bonds provide an additional lowcost, diverse funding tool for financial institutions. They will ensure more stable and longer-term liquidity in the credit markets, 

which reduces refinancing risk, as well as exposure to sudden 

changes in interest rates and investor confidence as well. And they 

also allow U.S. financial institutions to compete more effectively, I 

believe, against their global peers. 

Now to date, there have only been two issuances of covered 

bonds here in the United States. That was by Bank of America and 

Washington Mutual, which is now part of JPMorgan Chase. But 

over the last several months, there has been a tremendous increase 

in demand by investors for these bonds. In 1 week in September 

alone, there were 7 new issuances in a variety of different European countries, and that totaled over $20 billion. And for the year 

to date, there has been a total of around $120 billion of covered 

bonds issued in Europe alone. Also, the European covered bond 

market was one of the first markets to rebound when the financial 

panic ebbed, and I think that’s important. 

And so that is why during this committee’s consideration of the 

Financial Stability Improvement Act, I offered an amendment that 

would create a detailed statutory framework to help facilitate the 

broader use of these funding instruments in the United States. A 

detailed statutory framework is common in the European countries 

where these bonds basically flourish, and is indeed in this country 

to provide the investors what they’re looking for, and that is greater certainty in regards to exact recourse if the issuing institution 

fails. 

This legislation will spell out the variety of different asset classes 

which will be eligible to be included in the covered bonds. In Europe, the covered bond market is very narrowly tailored to just residential mortgage. However, in ours, we would include a wider 

array of asset classes, like commercial mortgages, as well as auto 

loans, small business loans, and public sector loans. And so we will 

be working there to increase liquidity to a broader consumer base 

and allow financial institutions to further spread their risk. 

So finally, this legislation also designates the Secretary of the 

Treasury as a covered bond regulator, because the Department of 

the Treasury, basically they have the unique knowledge and expertise in this area of the U.S. debt market which is needed here. And 

it also details the procedures that are to be followed in the case 

that an issuer of a covered bond were to fail or default, also all 

needed. 

So a U.S. covered bond market offers a wide variety of possible 

benefits to investors, to consumers, and to our capital markets as 

a whole. And so at a time when our credit markets are still experiencing a great deal of difficulty and our financial institutions are 

slow to reopen on a broader basis to our American public, we must 

consider these new and innovative methods, and so I’m pleased 

4 

that this committee is taking a closer look into this unique funding, 

and I’m pleased that the chairman and the ranking member have 

been working with us to move this matter along. 

Thank you, Mr. Chairman, and I yield back. 

The CHAIRMAN. The gentleman from Georgia is recognized for 3 

minutes. 

Mr. SCOTT. Thank you, Mr. Chairman. First, let me thank you 

and the ranking member for holding this important hearing. Our 

economy is still struggling, despite the fact, the good news of Wall 

Street’s recovering to a degree that many have said that we’re out 

of the recession. The stock market has rebounded, and they’re saying we’re out of the recession, but nothing can be further from the 

truth for many, many of the communities in this country, for 

they’re not only not out of the recession, their economic indicators 

point very dramatically that many of them are in fact in a depression. 

It’s a struggle, with jobs, foreclosure rates continue to hit record 

highs. The employment rate continues to hover around 10 percent, 

and in many communities, it’s hovering at 40 and 50 percent. 

As this hearing focuses on the potential role that covered bonds 

could have in U.S. markets, I am interested in identifying the possible benefits they could have for our market stability and our 

economy, particularly in some very, very depressed communities. 

Since the original lenders of covered bonds retain an ongoing interest in the performance of the loans, this type of loan could provide 

a sense of accountability for both the lender and the borrower. The 

bank must stand behind the mortgage it issues in this case, which 

could potentially decrease risky lending practices. This area is 

clearly in need of investigation and improvement. 

My home State of Georgia has the 7th highest foreclosure rate 

in the country. I have 2 counties that have among the highest of 

the top 20 counties in the country of foreclosure rates. With covered bonds, the collateral pool, the bonds against which the bonds 

are written may be swapped out for better assets if it begins to 

underperform. So we have to question if this practice could promote 

more careful lending. Covered bonds are used exclusively in Europe 

now, but they are nearly untested in the United States, and that’s 

what makes this hearing so important this morning, that we can 

determine what the full potential is of covered bonds here in the 

United States economy. 

I yield back the balance of my time. Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman from Texas, Mr. Hensarling, is 

recognized for 2 minutes. 

Mr. HENSARLING. Thank you, Mr. Chairman, and I’m certainly 

glad I could arrive early enough to get a good seat. I suppose that 

battle fatigue over the last 3 weeks may have taken its toll, but 

I’m glad the members who are here are here, and I think that the 

subject matter is one that certainly deserves our attention. I want 

to thank you, Mr. Chairman, for calling this hearing, and I certainly want to thank the ranking member of the Capital Markets 

Subcommittee for his leadership on this issue for a matter of 

months in attempting to ensure that we look at all possible avenues to bring private investment back into our mortgage markets. 

And certainly, I think that most of us have an open mind and a 

5 

hopeful mind that covered bonds may pose a very promising option 

in that regard. 

As we have come off the recent debate of the last several weeks, 

I and many others still remain concerned about the role that the 

Government-Sponsored Enterprises, Fannie Mae and Freddie Mac, 

are playing in our mortgage markets, particularly given that we 

now have a trillion dollars of taxpayer funds that have been exposed to their operations. This is unwise, and this is unsustainable. 

And so I would hope that we would look at all different types of 

avenues to start leveling the playing field and transition Fannie 

and Freddie back to a competitive marketplace. 

I am concerned that too much action taken by the Administration and Congress has let too much private investment remain on 

the sidelines. I am hopeful again that if there is a statutory infrastructure, if you will, or foundation that can be placed under covered bonds, that again it is a hopeful and promising regime to get 

private investment and liquidity into our mortgage marketplace. 

Knowing that we have an important hearing soon, I yield back 

the balance of my time. 

The CHAIRMAN. The gentlewoman from Illinois is recognized for 

3 minutes. 

Ms. BEAN. Thank you, Mr. Chairman, for yielding and for holding today’s hearing. I want to thank our panel for joining us today 

and sharing their expertise on this important topic. As the 

securitization market for residential and commercial mortgages has 

dried up over the last 2 years, this is a timely hearing as the committee looks for new mechanisms that will increase liquidity in a 

prudent manner. 

Toward that end, a well-structured U.S. covered bond market 

could be helpful in adding much-needed liquidity to our secondary 

mortgage market. This is an issue that I—along with others—have 

been looking at over the last year, recognizing that counterparts in 

Europe have been operating a covered bond market since 1770 and 

have relied on covered bonds as a stable and relatively safe source 

of funding for residential mortgages and other assets. 

As noted earlier, the FDIC and Treasury issued guidance last 

year to encourage financial institutions to issue covered bonds. To 

my knowledge, however, no financial institution has issued a covered bond in the United States under that guidance. So I look forward to hearing from our witnesses today about whether legislation is needed to establish a statutory structure for a U.S. covered 

bond market, and I’m interested in knowing if they feel that European nations who have successful covered bond markets have done 

so because they have established a statutory structure. 

I’m also interested in how covered bonds compare to traditional 

mortgage-backed securities in terms of curing troubled mortgages 

within the pool. One of the most frustrating aspects of the current 

foreclosure crisis is that some investors in mortgage-backed securities, depending on the tranche they hold, can veto loan modifications that would benefit both the borrower and the collective pool. 

My understanding is that is not an issue with covered bonds because the mortgages stay on the bank’s books and the bank is required to remove troubled mortgages from the pool and replace 

them with performing mortgages. 

6 

Establishing a U.S. covered bonds market could be very helpful 

to the residential and commercial mortgage market, and other 

asset markets like public sector loans and other consumer loans as 

well. I look forward to today’s hearing and potential action by this 

committee to establish such a market. 

Thank you. I yield back. 

The CHAIRMAN. The gentleman from Alabama is recognized for 

2 minutes. No, I take it back. I’m now told there’s a change here, 

that he gets 3 minutes. 

Mr. BACHUS. All right. Thank you, Mr. Chairman. Thank you for 

holding this hearing, and I thank the ranking member of the subcommittee for introducing this legislation on covered bonds. 

The collapse of Fannie Mae and Freddie Mac and their subsequent trillion dollar Federal bailout have renewed calls to explore 

innovative private market alternatives to the government-sponsored model of mortgage financing. America is about innovation, 

competition, and the private market, and I think covered bonds 

could be part of our solution. As one of our witnesses at today’s 

hearing, Mr. Scott Stengel of the U.S. Covered Bond Council, states 

in his testimony, ‘‘covered bonds also represent a cost effective form 

of on balance sheet financing for financial institutions that in turn 

can reduce the cost of credit for families, small businesses and the 

public sector.’’ And obviously, that is something we should all strive 

for. 

Covered bonds are also a private market solution to the need for 

market participants to have skin in the game. The issuers of covered bonds are responsible to their bondholders for the risk posed 

by the underlying loan pool. For example, if the underlying loans 

default, bondholders have a secured claim to the assets in the loan 

pool as well as recourse to other assets of the insolvent firm. Additionally, issuers of covered bonds are required to account for the 

risk posed by their bonds on their balance sheet. In June, Mr. Garrett introduced legislation providing a statutory framework for a 

U.S. covered bond market that promotes greater legal certainty for 

investors in these instruments. 

Chairman Frank should be commended for convening this hearing on Mr. Garrett’s legislation, and other ideas for encouraging 

the development of a covered bond market in this country. Mr. 

Chairman, a functioning securitization market is necessary for successful housing market recovery. Covered bonds are one of several 

solutions this committee should explore as we move forward with 

proposals to revive stalled private mortgage credit markets. 

I look forward to hearing expert testimony from the witnesses 

and working with you. And I’m pleased that this seems to be a bipartisan effort and that members on both sides of the aisle realize 

that this could be a potential source of funding for our mortgage 

market and a safe source as well. 

I yield back the balance of my time. 

The CHAIRMAN. The time has expired, and we will now go to the 

witnesses. I begin with Mr. Alan Boyce, who is chief executive officer of Absalon. Let me say at this point that with unanimous consent, any member who wishes to enter matter into the record will 

be recognized, and the witnesses at the conclusion of their oral 

7 

statements will be free to submit any other material, including the 

rest of their statements, into the record. 

Mr. Boyce? 

STATEMENT OF ALAN BOYCE, CHIEF EXECUTIVE OFFICER, 

ABSALON 

Mr. BOYCE. Mr. Chairman, Ranking Member Bachus, Representative Garrett, and members of the committee, I very much appreciate the chance to testify today. In my testimony, I would first like 

to discuss the general benefits of covered bonds and then to discuss 

the importance of specialized and rigorous legislation to provide a 

framework for this market. I will conclude by briefly examining an 

additional proposal that can make the covered bond approach even 

more effective in helping homeowners and investors alike. 

Covered bonds offer several potential advantages. In the recent 

past, issuers of loans sold into asset-backed securities were less 

concerned than they should have been about the quality of these 

loans, since they were often completely off the hook within weeks 

of making the loan. By requiring the institution to retain the loan 

on its balance sheet, covered bonds substantially mitigate this 

problem. 

Covered bonds are simple and transparent, unlike the complex, 

idiosyncratic, and opaque asset-backed securitization structures of 

the recent past. Covered bonds can help banks more cleanly manage interest rate risk by matching long-term assets with long-term 

liabilities. Finally, covered bonds can offer a much needed, low-cost 

method of private financing, particularly in the context of an appropriate regulatory and legal framework. Substantial risks do of 

course remain. 

The overall 200-year success of the European covered bond market is due to its consistently conservative approach. The U.S. covered bond market should copy this and be started with high-quality 

assets and strict standards. This should start with a specialized 

rather than a general law-based approach. It is my view that in 

starting a covered bond program, covered assets should be limited 

to well-underwritten, conservative loan-to-value ratio, first-lien 

mortgages. This is the asset class where the benefits of this approach are the greatest. The legislation should also include strict 

lending standards, including specific loan-to-value ratio limits, and 

requiring full recourse. 

Strict asset liability management practices should be mandated 

through an appropriate balance of legislation and regulation. The 

European covered bond market came to a halt last year after the 

Lehman bankruptcy filing. While the credit quality of the underlying covered pool assets had deteriorated somewhat, the significant factor was the inability of issuers to raise new liabilities to 

pay off mismatched maturing covered bonds. 

Given the recent experience and future threats to covered bonds 

from asset liability management risks, the bond ratings agencies 

have proposed significant changes to their covered bond rating 

methodologies. I believe that this committee should work in concert 

with these efforts. 

Successful covered bond programs also have clear and definitive 

rules to deal with problems. The simplest problem arises when 

8 

there is a bad loan in the covered pool. The best policy approach 

is to insist that cash be the only substitute for a bad loan. The 

rules for estate separation should be clearly defined with a strong 

covered bond regulator empowered to make quick decisions. 

The benefits of covered bonds are maximized when the term of 

the bond exactly matches the term of the underlying assets. When 

each loan is exactly balanced by a portion of an identical, transparent, and tradable bond, this is called the principle of balance. 

Instituting the principle of balance can allow for better-aligned interests between borrowers, intermediaries, and investors. 

Indeed, this system has worked extraordinarily well in Denmark 

since 1797, while the United States Congress was still meeting in 

Congress Hall in Philadelphia. Further, when combined with optional redemption mortgages, this system can significantly limit 

the threat of foreclosure during housing busts. 

Optional redemption mortgages like covered bonds are a fairly 

simple idea, but one that is unfamiliar to many in this country. 

Just as homeowners are allowed to refinance when interest rates 

drop, optional redemption mortgages offer the homeowner the option of refinancing when the value of his or her mortgage drops due 

to rises in interest rates. Optional redemption mortgages thus put 

households in the same situation as corporate treasurers who have 

the ability to purchase their own debt back at a lower value in the 

open market when the value of that debt falls. This feature would 

profoundly improve the overall situation facing the housing market 

during most housing price declines by directly and substantially reducing the number of homeowners who are underwater. 

Transitioning to a new and simpler and more stable system could 

be done efficiently and effectively by refinancing performing mortgage loans into new standardized principle of balance loans. Many 

other transition paths can also be considered. 

In conclusion, the U.S. Government has become the single payor 

supporting the mortgage market. As such, it has a profound ability 

to influence the design of the system moving forward. There should 

be added urgency to mortgage reform, given the threat from the 

embedded extension risk that exists in the current mortgage market. Covered bonds can be an important part of the solution. Introducing a legislated covered bond market is a big step in rebuilding 

the mortgage market in a sound and sustainable fashion. A few additional changes can make this an even more effective step, and I 

urge the committee to carefully examine the potential of the market in which standardized mortgages with optional redemption are 

funded through simple and transparent securities. 

[The prepared statement of Mr. Boyce can be found on page 28 

of the appendix.] 

The CHAIRMAN. Your time has expired, Mr. Boyce. Again, members of the panel should feel free to submit anything further that 

they wish. 

Next, Mr. Scott Stengel. 

9 

STATEMENT OF SCOTT A. STENGEL, PARTNER, ORRICK, 

HERRINGTON & SUTCLIFFE LLP, ON BEHALF OF THE U.S. 

COVERED BOND COUNCIL 

Mr. STENGEL. Chairman Frank, Ranking Member Bachus, and 

members of the committee, I am grateful for your invitation to testify today on the crucial role that U.S. covered bonds can play in 

stabilizing our financial system and funding the needs of consumers, small businesses, and State and local governments. 

I am a partner with Orrick, Herrington & Sutcliffe and a member of the steering committee for the U.S. Covered Bond Council. 

The Council is comprised of investors, issuers, dealers, and other 

participants in the covered bond market, and we strive to develop 

policies and practices that harmonize the views of these different 

constituencies and that promote an efficient market for U.S. covered bonds. 

Recent reports have confirmed what we are seeing on the ground. 

Our Nation’s economic recovery remains slow and uneven, and the 

foundations of our financial system are not yet fully repaired. In 

this volatile environment, credit remains tight for both families and 

small businesses, public sector resources are increasingly strained, 

and consumers are understandably cautious. 

In the Council’s view, sustained economic growth begins with a 

stable financial system. This in turn requires an ample supply of 

long-term and cost-effective funding that is sourced from diverse 

parts of the private sector capital markets and that can be translated into meaningful credit for households, small businesses, and 

State and local governments. We believe that covered bonds are an 

untapped but proven resource that could be invaluable in meeting 

this need. We also believe that the time for U.S. covered bonds is 

now. 

At its core, a covered bond is simply a form of high-grade debt 

that is issued by a bank or other regulated institution and that is 

secured by a cover pool of financial assets which is continually replenished. Over the course of their 240-year history, covered bonds 

have been backed by residential mortgage loans, commercial mortgage loans, agricultural loans, ship loans, and public sector loans. 

And in the Council’s view, loans for small businesses, students, 

automobile owners, and consumers using credit or charge cards 

also are appropriate. 

U.S. covered bonds can bring a stabilizing influence to our financial system in several ways. First with maturities that range from 

2 to 10 years or more, covered bonds can infuse longer-term liquidity into the credit markets. Second, by providing more cost-effective 

funding for lenders, covered bonds can produce less expensive and 

more available credit for consumers, small businesses, and the public sector. Third, covered bonds can add funding from a separate investor base that would not otherwise make liquidity available 

through the unsecured debt or securitization markets. Fourth, covered bonds can deliver funding from the private sector even in distressed market conditions without relying on U.S. taxpayers for 

support. Fifth, because covered bond issuers continue to own the 

assets in their cover pools and have 100 percent skin in the game, 

incentives relating to loan underwriting, performance and modifications can be strongly allied. And sixth, as a straightforward finanVerDate Nov 24 2008 13:49 May 11, 2010 Jkt 056238 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\56238.TXT TERRIE
10 

cial instrument, covered bonds can increase transparency and uniformity in our capital markets. 

Covered bonds, however, are no silver bullet, and action is still 

needed to resuscitate securitization and the rest of the capital markets. But in our view, covered bonds represent a critical step toward restoring financial stability, and in this constrained credit environment, one that is urgently needed now. 

To function effectively, however, a U.S. covered bond market 

must be deep and highly liquid, and that requires the kind of legal 

certainty that only legislation can provide. Covered bonds developed in Europe under dedicated legislative frameworks, and this 

precedent, now found in almost 30 countries, has set expectations. 

Covered bonds programs must be subject to strong public supervision that is designed to protect investors. And a separate resolution process must exist that provides a clear road map in the event 

of the issuer’s default or insolvency, and avoids the waste inherent 

in a forced liquidation of collateral. 

While a covered bond regulator can supply more detailed criteria 

for cover pools and other aspects of covered bond programs, the features that give covered bonds their unique character can be supplied only by legislation. Without action by Congress, European 

banks will be left to capture the investor demand for covered bonds 

that is growing in the United States. The result will be an increasingly uneven playing field for U.S. banks of all sizes, and more expensive and less available credit for families, small businesses, and 

the public sector. 

The Council therefore fully supports the kind of comprehensive 

covered bond legislation that Congressman Garrett has offered, and 

I want to thank him for his leadership and Chairman Frank for 

holding this hearing, and I would be pleased to answer any questions that the committee may have. 

[The prepared statement of Mr. Stengel can be found on page 67 

of the appendix.] 

The CHAIRMAN. Mr. Ely? 

STATEMENT OF BERT ELY, ELY & COMPANY INC. 

Mr. ELY. Chairman Frank, Ranking Member Bachus, and members of the committee, I very much appreciate the opportunity to 

testify today about covered bonds and the prospects for a U.S. covered bond market going forward. 

In my written testimony, I provided a brief description of covered 

bonds, discussed the many benefits they will bring to the U.S. financial system, and described a legislative and regulatory framework for fostering growth of covered bonds in the United States. 

I am speaking today only for myself as a champion of covered 

bonds. While others have discussed covered bonds, I want to first 

stress the principal benefits of covered bonds, as follows: 

One, better credit risk management due to lenders retaining 100 

percent of the credit risk. 

Two, better borrower protection, because lenders will keep the 

loans they make. They will have to eat their own cooking. 

Three, if needed, loan modifications would be much less complicated, because the lender will own the loan outright. 

11 

Four, highly efficient funding of loans financed with covered 

bonds, because their high credit ratings and low transaction costs 

will bring lower interest rates to borrowers. 

Five, reduced maturity mismatching by lenders, and an attendant reduction in interest rate risk due to the medium- and longterm maturities of covered bonds. 

Six, a substantial new supply of high-quality debt for investors to purchase. Given that $21 trillion of loans currently outstanding 

in the United States are potential candidates for covered bond financing, a highly liquid covered bond market of several trillion dollars could readily develop, approaching the size of the Europe covered bond market. 

Seven, covered bonds would appeal to investors internationally, 

which is important, given that non-U.S. investors currently provide 

$7.7 trillion of debt financing to U.S. borrowers. 

It is absolutely crucial to have a sound, efficient legal structure 

governing the issuance of covered bonds, which consists of three 

layers: One, a statutory foundation; two, a regulatory mechanism 

based on that statutory foundation to oversee the day-to-day functioning of the covered bond market; and three, bond indentures tailored to the unique circumstances of a covered bond issuer and the 

assets in a cover pool securing those assets. 

Essential to the development of a U.S. covered bond market is 

for Congress to enact a covered bond law which creates a sound, 

efficient legal framework for the issuance of covered bonds by 

banks and other entities. 

The statute must create legal certainty for covered bond investors, specifically the certainty that no matter what happens to the 

issuer, principal and interest will be paid on the covered bonds at 

the contracted time and that the covered bonds will not be stripped 

of their cover pool should the issuer default on the bond or be 

placed in a receivership or bankruptcy proceeding. 

That certainty is absolutely crucial to covered bonds being able 

to obtain and retain the triple-A rating that covered bonds almost 

always earn. 

However, the covered bond statute should not overreach or get 

too precise about the specific protections and processes. That is, the 

statute should not love covered bonds to death by being overly prescriptive. 

Instead, the more detailed prescriptions and processes governing 

covered bonds should be left to regulation, to a covered bond regulator, and to the indentures governing specific covered bond 

issuances. 

Moody’s has written quite positively about these 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 initial default. 

Moody’s goes on to say that the development of a covered bond 

market in the United States would be a positive development for 

the funding profile of U.S. banks, by providing an additional funding source for residential mortgage loans. 

The Treasury Department as the covered bond regulator would 

develop regulations to implement the statute and then enforce 

those regulations. Specific regulations could cover each covered 

12 

bond class, such as maximum loan-to-value ratio and minimum 

credit scores for borrowers, and other criteria for loans eligible for 

a cover pool. 

The rules would also provide for an independent cover pool monitor to ensure that each cover pool was monitored on a continuous 

basis. This rule-making process also would enable Treasury to keep 

covered bond regulations up to date. 

Although seldom discussed in the legislative arena, each covered 

bond issuance would be governed in its most specific detail by a 

bond indenture. The administration of the indenture would be carried out by an independent bond trustee, who would perform its 

duties in accord with the covered bond statute and regulations and 

enforceable in the appropriate court of law. 

Finally, in the covered bond marketplace, issuers and investors 

will be the ultimate covered bond regulator; for covered bond 

issuance will not take off and function in the United States if covered bonds do not meet the needs of both issuers and investors. 

However, this marketplace will not develop until such time as 

Congress enacts a sound covered bond statute which provides for 

the efficient regulation and operation of the U.S. covered bond marketplace. 

Mr. Chairman, I thank you for this opportunity to testify to this 

committee today. I welcome the opportunity to answer questions 

posed by members of the committee. 

Thank you. 

[The prepared statement of Mr. Ely can be found on page 39 of 

the appendix.] 

The CHAIRMAN. Mr. Phoa? 

STATEMENT OF WESLEY PHOA, SENIOR VICE PRESIDENT, THE 

CAPITAL GROUP COMPANIES 

Mr. PHOA. Good morning, Chairman Frank, Ranking Member 

Bachus, and members of the committee. 

Thank you for the invitation to testify today on the U.S. covered 

bond market. It is very encouraging to see the remarkable progress 

being made on financial regulatory reform. 

Covered bonds could, I think, help in this process by playing an 

important role in making the financial system more robust and less 

dependent on government support. They also have a useful role to 

play in investors’ portfolios. 

I manage portfolios of the Capital Group Companies. You may 

know us because we manage the American Funds family of mutual 

funds. I would like to explain briefly how, in my opinion, covered 

bonds help us serve the needs of our clients. 

Investors have different needs. Workers saving for retirement 

have to build their savings, and for them, we try to purchase 

shares in good companies from around the world. Retirees need a 

reliable income to support them, and so we look for stocks and 

bonds that will generate the income they require. 

And almost everyone needs to protect a portion of their savings 

through difficult markets. So we must also find good sound investments whose value holds up in rough times. This means investing 

for safety, not just growth or income. 

13 

In the past, when investing for safety, we and other investors 

have turned to government bonds and government-sponsored securities. This has worked well, but it means sacrificing income and 

diversity and making our portfolios more sensitive to government 

policy decisions. 

We seek private sector alternatives. In Europe, the covered bond 

market has played this role for more than 2 centuries. The safety 

comes from good collateral rather than government support. We 

ourselves have invested in European covered bonds on behalf of 

European clients for 2 decades. They have earned the confidence of 

investors by holding their value through turbulent markets. 

Thus, firms which can tap this market have access to a broad 

and deep base of investors to help them continue lending, even in 

bad recessions. 

Covered bond financing also aligns the interest of issuers and investors, since firms continue to hold the collateral on balance sheet 

and remain exposed to any losses. 

I was therefore very encouraged when a U.S. covered bond market started to emerge in the years immediately before the crisis. 

Hence, my involvement in the U.S. Covered Bond Council. 

While only two U.S. financial institutions raised covered bond financing, a number of European banks also tapped the U.S. dollar 

markets. And it looked as if a diverse market was starting to 

evolve. 

Unfortunately, the global financial crisis intervened. As you 

know, this severely affected all parts of the private sector bond 

market, shutting firms off from debt finance. The European covered 

bond market actually weathered the crisis reasonably well, and European banks were able to resume issuing covered bonds well before they could issue any other kind of debt that was not government guaranteed. 

This includes many of the smaller banks, not just the larger 

firms. 

The nascent U.S. covered bond market did not fare as well for 

a number of reasons. It was very immature. The investor base was 

not yet fully developed. Liquidity deteriorated much more sharply 

than in Europe. And crucially, the uncertainty about decisions 

being taken by policymakers and regulators weighed heavily on investors’ minds. 

The legal framework in the United States offered less clarity 

than the more specific principles enshrined in European covered 

bond legislation. We could not be completely sure precisely what 

would happen if an issuer failed. 

The FDIC and the Treasury Department did take some actions 

in 2008 to mitigate this uncertainty. But administrative and regulatory actions can’t substitute for clear legislation. 

I think it is possible for this market to make a fresh start on a 

sound legislative basis. Today’s environment, where there are plenty of savings looking for a conservative home, is quite conducive to 

the development of a robust and reliable market. 

To sum up, it’s good for the economy and good for investors if we 

have a private sector financial system that can stand on its own 

2 feet during the most severe recessions and continue lending freely on prudent terms to households and small businesses. 

14 

A healthy, well-regulated, and supervised U.S. covered bond market, established on a firm legal basis, should make an important 

contribution towards this goal, as well as creating a useful asset 

class for us to invest in. 

Again, I appreciate the opportunity to testify before the committee, and I hope my remarks have been of some assistance. 

[The prepared statement of Mr. Phoa can be found on page 62 

of the appendix.] 

The CHAIRMAN. Mr. Hoeffel? 

STATEMENT OF J. CHRISTOPHER HOEFFEL, MANAGING DIRECTOR, INVESTCORP INTERNATIONAL, INC., ON BEHALF 

OF THE COMMERCIAL MORTGAGE SECURITIES ASSOCIATION (CMSA) 

Mr. HOEFFEL. Thank you, Mr. Chairman. My name is Christopher Hoeffel, and I am the managing director at Investcorp, a 

provider and manager of altered investment products for both private and institutional clients. 

I am testifying today on behalf of the Commercial Mortgage Securities Association, or CMSA, where I serve on the Executive 

Committee and am immediate past president. 

CMSA represents the collective voice of all market participants 

in the commercial real estate capital markets, including lenders 

and issuers, investors, rating agencies, and servicers, among others. 

I currently am an investor in the commercial mortgage-backed 

securities (CMBS) market, but I have more than 2 decades of experience as a commercial lender and a CMBS issuer and originator. 

CMSA would like to thank the committee for the opportunity to 

share our perspective on the creation of a U.S. covered bond market. 

Today, the commercial real estate finance markets remain severely constrained, despite extraordinary borrower demand. In fact, 

there is more than $1 trillion of commercial real estate loans maturing in the next several years. At the same time, the CMBS market, which accounted for $240 billion, or approximately half of all 

commercial lending in 2007, has provided only $1 billion of new 

lending this year. 

As such, we applaud the committee’s timely efforts to consider a 

covered bond framework. We also applaud Capital Markets Subcommittee Ranking Member Garrett and Subcommittee Chairman 

Kanjorski for introducing legislation to facilitate this market and 

for including commercial mortgages in CMBS as collateral. 

Overall, our members believe that covered bonds would be a 

helpful financing tool for the commercial property market. Certainly covered bonds would not replace CMBS as the capital source 

for commercial real estate; however, it would be an additive tool 

that provides liquidity, helps institutions raise capital to fund 

loans, and eases the credit crisis facing commercial real estate. 

In the current environment, covered bonds could be a helpful 

means of raising capital relative to CMBS, as today the cost of capital related to a covered bond deal may be less volatile than CMBS. 

Moreover, such conditions could assist financial institutions in agVerDate Nov 24 2008 13:49 May 11, 2010 Jkt 056238 PO 00000 Frm 00018 Fmt 6633 Sfmt 6633 K:\DOCS\56238.TXT TERRIE
15 

gregating collateral for a covered bond issuance, in contrast with 

the aggregation difficulties now being faced by the CMBS market. 

Additionally, a broader-covered bond market would be a valuable 

financing tool for smaller banks. Securitization is often not an option for some smaller banks that lack a critical mass of collateral 

in one asset category. 

But the ability to use diverse asset cover pools, made possible 

under a broad covered bond regime, could give smaller banks a 

useful new source of capital, enhancing their viability. 

Today, commercial mortgages in CMBS are already permitted in 

covered bond pools in most European jurisdictions. These jurisdictions accord the necessary and appropriate regulatory treatment, 

including capital requirements, with respect to covered bonds, to 

facilitate the market and to better serve consumers and businesses 

seeking access to credit. 

It follows that in order to be globally competitive, any U.S. covered bond regime should be closely aligned with the approach used 

by our European counterparts. Such a framework will give U.S. 

consumers and businesses access to the same sources of credit 

availability and support our overall economic recovery. 

Also, a covered bond market would attract new investors to the 

commercial real estate market. This would increase the potential 

sources of the capital available for consumers and businesses, enhance liquidity, and help to create stability and asset values. 

As the previous and current Administrations have rightfully 

pointed out, no recovery plan will be successful unless it helps restart the securitization markets. Covered bonds should be viewed 

in the same light, as an important component of any economic recovery plan. 

All available tools should be employed to strengthen the credit 

markets and to provide the certainty and confidence that private 

investors, who fuel lending, seek. 

However, all of these issues and efforts cannot be viewed or considered in a vacuum. 

Today, recovery efforts in the commercial real estate market, including TALF and PPIP, have been helpful, but they remain in a 

delicate stage. They have led to increased liquidity for certain commercial real estate securities, but there still remain serious impediments to new lending for several reasons, including aggregation 

issues and enormous uncertainty in the securitized credit markets. 

In this regard, our markets face unprecedented and retroactive 

accounting changes, including FAS 166 and 167, that will undoubtedly impact capital and liquidity. 

In conclusion, the ongoing credit crisis presents enormous challenges for the commercial real estate sector. With traditional 

sources of credit such as CMBS developing slowly due to technical 

and regulatory hurdles, financial institutions need all tools to raise 

capital for commercial real estate and other asset classes in a 

sound manner. 

Accordingly, we urge Congress to include in reform legislation a 

framework for covered bonds in order to promote global competitiveness and to give U.S. consumers and businesses access to the 

same sources of credit availability. 

16 

Thank you for your leadership on these issues. CMSA stands 

ready to assist you. 

[The prepared statement of Mr. Hoeffel can be found on page 50 

of the appendix.] 

The CHAIRMAN. Thank you. Let me begin, Mr. Hoeffel, and I 

apologize for mispronouncing your name earlier. 

I was struck because there was this concern about commercial 

real estate. But you have found the combined efforts of the Treasury and the Federal Reserve to be useful? 

Mr. HOEFFEL. They have been useful in creating demand for securities, so that there has been active secondary trading in commercial mortgage-backed securities, both investment grade, or triple-A and below. Credit spreads have come in. 

So it has been very valuable, I think, in clearing bank balance 

sheets, in creating liquidity, and in helping shore-up demand for 

the securities. It has not, however, inspired new lending. So there 

has been no incremental credit offering— 

The CHAIRMAN. I understand that, but to the extent that it has 

had an effect, it has been a beneficial effect. Because there have 

been people who have been very critical. 

Are these efforts ongoing? Would you have them stop them now? 

Mr. HOEFFEL. I think that they have created investor demand, 

and they don’t need to continue indefinitely. We have started to see 

a very few— 

The CHAIRMAN. Well, indefinitely, I would agree. Nothing should 

continue indefinitely, like this hearing. 

[laughter] 

The CHAIRMAN. But what about, would you stop them now? 

When would you stop them? 

Mr. HOEFFEL. Well, I wouldn’t stop them now because— 

The CHAIRMAN. Okay— 

Mr. HOEFFEL. You said you’re not going to stop them now. You 

need to carry through with the original term. 

The CHAIRMAN. I appreciate that. Thank you. 

Mr. Ely, again on some of the issues, I’m struck by, on page 7 

of your written testimony, your proposal that the Federal Reserve 

Bank of New York should lend on a collateralized basis to the covered bond trust, etc. We haven’t heard many calls for a greater role 

for the Federal Reserve Bank of New York. So I thought we would 

draw on this. 

They would be allowed to lend their funds, Federal Reserve 

funds, it says, ‘‘to make timely payments on principal and interest.’’ 

This would be if the trustee was somehow unable to do that temporarily? Is that the issue? 

Mr. ELY. Yes. First of all, I think it would be a rarely used borrowing power. An alternative that has been suggested as— 

The CHAIRMAN. Well, let’s not talk about the alternative. Let’s 

talk about what you propose. 

Mr. ELY. Okay. 

The CHAIRMAN. I want to see how it works. 

Mr. ELY. The situation would arise where for some reason the assets in the cover pool backing the covered bonds weren’t generating 

enough cash flow in a period of time to cover the interest and principal payments due on the covered bonds that were secured by 

17 

those assets. Only in effect, it would be a short-term bridging type 

of loan. 

The CHAIRMAN. Well, the Federal Reserve would be able to step 

in and lend the money to cover the shortfall? 

Mr. ELY. Yes. But it would obviously have a secured interest in— 

The CHAIRMAN. Yes. Then there are some who would say that 

was a bailout by the Federal Reserve, of short duration. But it 

would have to be collateralized. 

But the principle allowing the Federal Reserve to being sufficiently collateralized isn’t a problem for me. That makes sense 

here. 

Mr. ELY. I would not consider it to be a bailout, but rather a 

short-term secured, interest-bearing loan— 

The CHAIRMAN. But they would step in, there would be a shortfall in the private sector’s ability to make these payments. And the 

Federal Reserve Bank of New York would step in and advance 

money to carry them over that shortfall. Correct? 

Mr. ELY. Yes, it’s a bridging loan. 

The CHAIRMAN. Okay. Thank you. 

And the only other point I would make is to note that I welcome 

the acknowledgement that sometimes we can look at European— 

the gentleman from Illinois said it, he said kiddingly, but it’s a 

very important point, because there have been, during our most recent debate, people who said, ‘‘Look, forget about Europe, this is 

America,’’ and the notion that there is nothing to be gained from 

others’ experience, or that we have no need to do things in parallel, 

I think, is gravely mistaken. 

So I am struck by the unanimity that the European experience 

has been a good one, that it is instructive for us, that it gives us 

lessons, and that this is a case where acknowledging that something has been done in Europe has some useful lessons for us, we 

ought to go forward. 

So I appreciate that. 

And I will tell you, Mr. Boyce, that the Majority Leader will appreciate your invocation of Denmark. He often notes that he is the 

only Dane serving in Congress. And this cultural reinforcement, 

I’m sure, if and when we get to legislation, will help us get him 

to schedule it. 

Mr. ELY. Mr. Chairman? 

The CHAIRMAN. Yes. 

Mr. ELY. If I could pick up on what you said about learning from 

Europe, I think it is important to pick up on their experience. The 

key thing is that in many ways, the European mortgage market is 

a more privatized market because of covered bonds. And I think 

that it has demonstrated that it can work very well— 

The CHAIRMAN. I agree, it is privatized and we would have a 

privatized one until and unless the private market got in trouble, 

and then the Federal Reserve Bank of New York could step in and 

help them out. 

The gentleman from New Jersey? 

Mr. GARRETT. I thank the Chair. And my understanding is that 

the Speaker is traveling to Europe later this week for the specific 

purposes of examining the covered bond market. 

18 

To the last point, Mr. Ely, can you inform me, though, what is 

the backstop, if you will, in the European model? 

Mr. ELY. I’m sorry? 

Mr. GARRETT. What is the backstop in the European model? You 

suggested a reserve instead of the Federal financing bank here. 

Mr. ELY. There have been, as I understand it—and there may be 

others on the panel who can speak to this more specifically—that 

there have been some situations where there has been some ad hoc 

mechanism created to deal with short-term cash flow and market 

problems. 

Mr. GARRETT. Does anybody else want to chime in on that? Yes, 

sure, Mr. Boyce? 

Mr. BOYCE. The assumption was that in the event that the covered bond matured and the cash flows from the assets were insufficient, the assumption was that assets would be able to be sold, or 

that the covered bond issuer would be able to raise other liabilities. 

Last year, what happened was that sovereign governments of 

Ireland, the United Kingdom, The Netherlands, Belgium, and Germany had to rescue the financial institutions. That was the backstop. 

Mr. GARRETT. Mm-hmm. But prior to that, there was not? 

Mr. BOYCE. No. 

Mr. GARRETT. Right. And so—because over there, there was no 

statutory framework for it, right? That was specifically touched 

upon, that point, as you say, ‘‘The assumption was,’’ or I guess you 

would say priced into the model of it, then, that’s how they would 

assume that they would be covered. So that was in the pricing 

mechanism. 

So—and I’ll have to delve into this a little bit deeper. But I guess 

you could also put that, if the statutory framework here was just 

the contrary here, as far as not having the backstop, then I guess 

that would just be part of the pricing of the project as well. 

Would it not? 

Mr. STENGEL. Congressman Garrett, if I could speak to that? 

Mr. GARRETT. Sure. 

Mr. STENGEL. I agree completely. One concern that has existed, 

trying to transplant the covered bond system in the United States, 

is to make crystal clear here that there is neither an explicit or implicit guarantee from the government. 

I think what we found in Europe was silence in the legislative 

frameworks on what would happen when the issuer defaulted, a 

separate resolution process began for this cover pool. 

It was silent at that point. And I think some in the market 

thought that implied a guarantee from the government. 

And so by providing liability only, no credit risk—so the same 

kind of borrowing that banks can get from the discount window— 

the notion, at least in the Council’s view, is that this kind of clear 

borrowing only for liability, only until cash comes in from the assets themselves, is critical. 

Mr. GARRETT. Okay. Oh, yes, we have had that problem here, of 

course, in other areas where there was an implicit guarantee, that 

some people thought was an explicit guarantee. And then it turned 

out to be an explicit guarantee. 

Mr. ELY. And Mr. Garrett, if I could just add to that? 

19 

Mr. GARRETT. Sure. 

Mr. ELY. My proposal as I talked about it in my statement, is 

again just following up on Mr. Stengel’s comments, that it is strictly a liability support, comparable to banks borrowing from the Fed 

discount window, with no loss intended for the taxpayer. 

Mr. GARRETT. Okay. 

I will just run down the line, if anybody wants to make any comments. In our proposal, there is language there with regard to a 

wider array of asset classes, one being commercial properties. And 

you addressed that issue. 

The European model does not have that. Do you just want to 

comment on if there’s a reason why you saw that is not in that 

model, and why that is a benefit to our model? I think you touched 

about the benefit here— 

Mr. HOEFFEL. Well, there are commercial mortgages in the European model. In fact, I think one of the reasons— 

Mr. GARRETT. I’m sorry. I should say it’s not in the U.S. model, 

what has begun over here, I should have said. 

Mr. HOEFFEL. Well, it hasn’t been. And thank you, you have been 

very supportive in trying to add commercial real estate to the legislation, so we’re thankful for that. 

Mr. GARRETT. Right. 

Mr. HOEFFEL. We see no reason not to include it. It has been a 

viable asset class in Europe, and in fact, it has been probably the 

prevalent source of commercial mortgage financing from banks in 

Europe. 

Mr. GARRETT. Okay. And from anyone on the panel, what is the 

timeframe, assuming that we have a hearing today, and then a 

markup soon, and this legislation moves expeditiously through the 

House and the Senate, how quickly can this market actually blossom and grow into something of a sizeable nature? 

I have heard all sorts of, not just timeframes, but size of the 

market. But how quickly can this really grow here in the United 

States? 

Mr. HOEFFEL. Congressman, I think the market needs to start 

quickly, and we need to enact this quickly in order for it to have 

the best benefit. Because right now, the traditional securitization 

markets are somewhere impeded. And covered bonds, we’re not 

thinking are going to be a replacement for securitization, but an 

additional tool for banks. 

So to the extent that we can get the legislation out quickly, I 

think banks will take very good advantage of it in the near term. 

As securitization markets recover and we have some basis for 

new issuance, I think covered bonds will be another tool, but may 

not be the predominant tool. 

The CHAIRMAN. The gentleman from North Carolina? 

Mr. WATT. Thank you, Mr. Chairman. Since we have a classified 

briefing coming up, and Mr. Foster has been active in this area, I’m 

going to yield my time to him, if it’s okay— 

The CHAIRMAN. The gentleman from Illinois is recognized for 5 

minutes. 

Mr. FOSTER. Thank you. 

The CHAIRMAN. I’m not going to make the classified briefing. I’ll 

wait and read about it tomorrow. 

20 

Mr. FOSTER. Thank you. 

You mentioned that the European covered bond market froze at 

least temporarily in the crisis last year. It’s my understanding that 

the covered bond market in Denmark did not, and this is at least 

partially attributable to the principle of balance. 

I was wondering if any of you could elucidate on how the different segments of the covered bond market responded to the crisis? 

I guess, starting with Mr. Boyce. 

Mr. BOYCE. The last covered bond issued in Europe last year was 

the week before the Lehman Brothers bankruptcy. The most severe 

pressure in the global financial markets was in October. Every day 

in the fall of 2008, the Danish mortgage market, which is funded 

by the issuance of standardized covered bonds, functioned. 

I would say that the European covered bond market has performed rather well recently, but it has come back earlier this year, 

and was still quite limited. And it was the announced purchase intentions of the ECB in May of the purpose of 60 billion Euros 

worth of covered bonds that really got their market going. 

So I would say that the lessons that we should take from that 

are that the transparency and asset liability mismatches, the two 

things that were the biggest vectors of problems in the European 

covered bond market, should be avoided when we set up ours. 

Mr. FOSTER. Thank you. And in terms of generating an efficient 

market, which ultimately yields a good deal for consumers and better mortgage rates, and so on, how do the different variations of 

covered bond markets compare historically and during the crisis? 

Whoever wants to answer. 

Mr. PHOA. We’re happy dealing with different covered bond 

frameworks. 

What we require as investors is: first, enough disclosure and 

transparency, so that we can carry out our own due diligence within whatever framework; second, a market that however it is structured, is well-regulated and well-supervised; and third, legislative 

clarity about what the rights and duties of the different parties are, 

if an issuer fails. 

Mr. FOSTER. Yes. But have there been differences within the different flavors of covered bond markets, in terms of the spread? 

Mr. PHOA. Yes, in Europe there has been considerable differentiation between spreads and behavior of markets, particularly between the U.K. jurisdiction, where there is no, or there had been 

no established covered bond legislation, and the European jurisdictions, such as Germany and France, where there had been a longestablished legislative framework. 

Mr. FOSTER. Okay. So the lesson to be drawn there is that a 

strong legislative framework is important to preserving a good deal 

for consumers, especially in bad times? 

Mr. PHOA. Yes. 

Mr. FOSTER. Are there any other comments? 

Mr. BOYCE. I can back that up. Before the financial crisis, I 

would say that all covered bonds in Europe traded at very tight 

spreads to each other, that the bond market did not significantly 

differentiate between specialized and general law, and between the 

types of collateral and the specifics of the law. Since then, I would 

21 

say general covered bond law, covered bonds, have widened out by 

30 or 40 basis points on average. 

Mr. ELY. If I could add to that, I think one of the things we have 

to keep in mind is that in Europe, you have a number of different 

countries, with varying covered bond laws. 

If Congress enacts one law and there is one regulator, given the 

potential size of a U.S. covered bond market, which could easily be 

several trillion dollars or more, just the sheer size of that market 

operating under one set of rules rather than a number of different 

sets of rules would provide liquidity and depth to the market, and, 

if you will, interchangeability among various covered bond instruments, that would go a long way toward maintaining the liquidity 

of the market, even in crisis times. 

Mr. STENGEL. If I could add, from the Council’s perspective, I 

think one primary factor has been the depth of the domestic market. 

German investors were willing to invest in German covered 

bonds, French investors in French covered bonds, and certainly one 

focus of the Council has been a development of a deep U.S. domestic market, and we find the demand is there. 

Mr. FOSTER. And could you talk briefly about a possible role for 

local community banks? How do they relate to the covered bond 

market in Europe, for example? 

Mr. STENGEL. Lending from community banks in the United 

States is critical. And so there are a couple of places in the legislative framework where they have a role. 

One is a system for them to issue pooled covered bonds. They 

would issue their own, and then create diversity in the underlying 

pool, so that they could match it and mark it in size, and issue 

competitively. 

The CHAIRMAN. We do have the briefing, so I appreciate it. If you 

can elaborate on that in writing, it would be helpful. 

The time has expired. The gentleman from Texas is recognized 

for 5 minutes. 

Mr. MARCHANT. Mr. Chairman, my first question is, in a resolution such as bankruptcy or an FDIC proceeding or under the legislation that was just passed, a resolution from the new agency, what 

is the standing in recovered bond as opposed to preferred shares 

or other bonds that are issued by that entity? 

Mr. STENGEL. Under current law, covered bonds are secured 

debt, so they would rank equally with other secured lenders in any 

bankruptcy or receivership. The one issue that’s created under current law, however, is that there is a standstill, a stay, while either 

the bankruptcy court or the FDIC decides what to do with the 

broader resolution. And that kind of delay and that kind of uncertainty, the discretion given to managing the broader receivership 

or bankruptcy case, creates a lot of uncertainty for the investment 

community in what is supposed to be a high-grade and defensive 

investment. And so, the proposed legislative framework would lift 

out the covered bond program to be resolved separately with only 

one exception, and that being if the FDIC is appointed as conservator/receiver, having a reasonable period of time to transfer the 

entire program to another eligible issuer, much like Washington 

Mutuals was transferred to JPMorgan Chase. 

22 

Mr. MARCHANT. So the legislation, as it is written or proposed, 

would alleviate the FDIC’s concerns? 

Mr. STENGEL. I believe so, and in two different ways. One, this 

is about maximizing the value of the collateral. And the FDIC’s 

largest concern is losing the value of any equity or surplus collateral in that pool and by having it separately managed, having uninterrupted servicing of that pool, that’s going to maximize the 

value. There’s also a residual interest that’s automatically created 

that represents that residual that would be in the form of a security that could be sold or otherwise monetized so the FDIC or creditors don’t have to wait around while covered bonds pay off and the 

program winds down. They would have something immediately 

that could be monetized. So, I think both of those should assuage 

the FDIC’s concerns. 

Mr. MARCHANT. My next question is, do all the bonds in the offering have the same status or are there tranches similar to mortgage bank security? 

Mr. STENGEL. There are no tranches. It could be that a bank decides to set up multiple covered bond programs. One for residential 

mortgages, another for commercial mortgages, another for student 

loans. There would be no mixing of those collateral; they would all 

be separate. There could be multiple covered bond programs but all 

bonds have equal access to the assets in the covered pool that are 

securing them. 

Mr. MARCHANT. Mr. Phoa, in a mature covered bond market, 

what is the right spread over a comparable treasury? 

Mr. PHOA. That tends to vary a lot of the cycle. For example, a 

spread of say, 45, 50, 60 basis points might be observed during 

calm periods. And spreads will tend to widen during periods of 

market turbulence, but certainly much less so than spreads on unsecured debt. I think in Europe, we have seen spread volatility of 

covered bonds being a small percentage of that of unsecured debt. 

Mr. MARCHANT. And Mr. Ely, last question. Would it have the effect of taking the more conservatively unwritten loans out of the 

market and have them packaged with covered bonds, leaving the 

more risky loans to be underwritten and written by the government? 

Mr. ELY. No, I think that it is conceivable to establish covered 

bond programs that can deal with loans of all degrees of risk. What 

you would have is, obviously, for a covered bond would be an overcollateralization requirement that would have to be adjusted according to the risk, with a riskier pool of loans backing a covered 

bond issuance having a higher over collateralization requirement 

than would be the case with safer loans. 

So, my assessment is that covered bonds can deal, and have the 

potential to deal with loans of not only different types, but also different degrees of credit risk. 

Mr. MARCHANT. Thank you, Mr. Chairman. 

The CHAIRMAN. The gentleman from Missouri. 

Mr. CLEAVER. Thank you, Mr. Chairman. This covered bond business is new for me, but I do have one question as I’m trying to digest all of the information that you’re providing. Last summer, 

former Secretary Paulson actually endorsed this entire concept of 

covered bonds and I’m just wondering why, and maybe you can’t 

23 

even answer this question, why the initiative was not brought forth 

by the Administration? If the Secretary of the Treasury was strongly supportive of it, do any of you have any idea why that was not 

done? The Secretary made a speech about best practices and talked 

about this, so? 

Mr. STENGEL. I think from the market’s perspective, the market 

did try to act on the initiatives that were provided by both the 

Treasury and the FDIC. What was learned, not only through the 

crisis associated with Lehman and liquidity disruptions throughout 

our entire financial system, but what was found was, the legal certainty and the public supervision that is found in legislative frameworks is critical to this deep and liquid market that’s needed for 

covered bonds. 

And so I think, at least from the Council’s perspective, there has 

been a conclusion that without legislation, without the legal certainty provided, and without the public supervision provided 

through legislation, that this kind of market, which really needs to 

be deep and liquid, can develop. It can’t start with just a couple 

of issuances and have sporadic issuance, have shallow trading; it 

needs to be deep and liquid in a very short order. 

Mr. ELY. Mr. Cleaver, my understanding is along that line, too, 

which is why other countries that didn’t have a covered bond statute have moved in that direction, the U.K. being one. We have 

seen, for instance in Canada, a couple of the major banks either 

have issued or are about to issue covered bonds without a statute, 

but at the same time, Canada is working on a covered bond statute. So, the global experience seems to indicate, from the market’s 

perspective, that in order to get a really good, sustainable market 

going, there has to be a strong legislative framework that establishes the certainty that investors in AAA bonds need to have. 

Mr. CLEAVER. So, this is going to go global, you think? 

Mr. ELY. Yes. 

Mr. BOYCE. Yes. Just to add to those comments. One of the 

things that was learned from last fall’s crisis in Europe was that 

significant asset liability mismatches were a source of problems, so 

the rating agencies have all come out with very clear guidance and 

S&P is the last one that should come out soon requiring substantially minimized asset liability mismatches. 

Mr. ELY. And the good news is that, particularly when you have 

the strong legal environment, you can have long-term covered 

bonds of maturities of 10, 15, 20 years or more and that the long 

maturity of these bonds is what is key to minimizing maturity mismatch. But again, for that long-term debt to be out there, for the 

investors to buy it, you have to have the legal certainty that can 

only come from statutory law. 

Mr. CLEAVER. All right. Thank you. That’s all, Mr. Chairman. 

The CHAIRMAN. Would the gentleman yield? Mr. Boyce, I want 

to make sure I understood you. You’re saying that the rating agencies learned as a result of their experience that a severe mismatch 

between assets and liabilities was a bad thing? Is that what they 

learned last year? 

Mr. BOYCE. You are correct. 

The CHAIRMAN. Wow. The gentleman from New York. 

24 

Mr. LEE. Thank you. I also am weaving my way through this and 

came down here to understand a little bit more about the covered 

bond market. I’m thinking that maybe I’ll start with Mr. Stengel 

on this question and you can help educate me. And it has to do 

more with, obviously, secured creditors. In the bill that was passed 

last week, there had been an amendment inserted, the MillerMoore amendment, with regards to a provision in that bill that 

would allow the FDIC to impose a 10 percent haircut to secured 

creditors. 

My concern is over this, how this would play out in a covered 

bond market? And what impact would it have? 

Mr. STENGEL. I think the market was very concerned about that 

particular amendment. It really threw off the playing field with 

which creditors have interacted with borrowers. I think we were 

grateful to see that was scaled back on the House Floor to debt 

that is under 30 days in length. So, very, very short term debt is 

now covered by that amendment, although that is still somewhat 

concerning to the capital markets. 

With covered bonds having very long maturities, 2 to 10 years or 

more, and at least in the proposed legislation, by definition, at least 

one year, I don’t think, at least the Miller-Moore amendment in its 

current form, would pose any issue for covered bonds. 

Mr. LEE. Do you think it’s going to restrict investors coming into 

the market knowing that potential liability stick is out there? 

Mr. STENGEL. I think the market, and again, just speaking for 

myself here, not the entire market, but I think there is market concern when the government suggests that secured creditors should 

not be entitled to all of their collateral. It really creates uncertainty 

and disruption in expectations. And so I think when Chairman 

Bair first made that suggestion some time ago, there was quite a 

quick market reaction to that suggestion. I think when the amendment was introduced, another reaction as well. And so, I think if 

that is going to be part of our law going forward, it’s going to take 

some getting used to, but I think it is somewhat concerning for the 

market. 

Mr. LEE. I would completely agree. With that, I’ll yield back. 

Thank you. 

The CHAIRMAN. The hearing is now adjourned. I appreciate the 

witnesses and any further information, obviously, with questions, 

if you want to elaborate on any of the answers, we would welcome 

that. This is a subject that the committee will be dealing with next 

year. 

[Whereupon, at 11:13 a.m., the hearing was adjourned.] 

(25) 

A P P E N D I X 

December 15, 2009 

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