UNITED STATES DEPARTMENT OF THE TREASURY

BEST PRACTICES FOR RESIDENTIAL COVERED BONDS

July 2008

Henry M. Paulson, Jr.

Secretary of the Treasury
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 2

DEPARTMENT OF THE TREASURY

Table of Contents

I. Background

II. Objective

III. Covered Bond Definition

IV. History of the Covered Bond Market

V. Important Considerations

VI. Best Practices Template

VII. Illustrative Direct Issuance

VIII. Illustrative SPV Issuance

Endnotes

Appendix A: Cover Pool Collateralization Calculation

Appendix B: Final FDIC Covered Bond Policy

Statement

3

6

7

9

10

11

17

18

19

20

21
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 3

DEPARTMENT OF THE TREASURY

I. Background

This Best Practices guide has been prepared by the Department of the Treasury

(“Treasury”) in order to encourage the growth of the Covered Bond market in the

United States. Treasury believes that Covered Bonds represent a potential

additional source of financing that could reduce borrowing costs for homeowners,

improve liquidity in the residential mortgage market, and help depository

institutions strengthen their balance sheets by diversifying their funding sources.

U.S. depository institutions have historically utilized several different funding

sources to originate new residential mortgage loans, both for sale to investors and

for their own portfolios. For loans sold into the market, depository institutions’

funding options included selling the loans directly to investors, Fannie Mae, or

Freddie Mac, and via private-label securitization. For loans retained on their

balance sheets, depository institutions’ funding options included utilizing their

customers’ deposits, issuing unsecured debt, and pledging their mortgages as

collateral for advances from the Federal Home Loan Banks.

Recent market turmoil has severely limited the ability of depository institutions to

sell loans to investors via private-label securitization. Consistent with their

important public policy mission, the government-sponsored enterprises, Fannie

Mae, Freddie Mac and the Federal Home Loans Banks, as well as the Federal

Housing Administration have been playing a critical role by providing mortgage

finance during this strained period. Even so, many depository institutions are

keeping more mortgage loans on their balance sheets and are therefore seeking

new sources of on-balance sheet financing. Many U.S. depository institutions are

examining the potential of Covered Bonds to provide this financing while at the

same time diversifying their overall funding portfolio.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 4

DEPARTMENT OF THE TREASURY

Private-label securitization has become strained. The GSEs, FHA and balance

sheet lending have expanded in response. Nonetheless, total mortgage

originations have fallen.

Mortgage Originations by Source of Funding (trillions of dollars)

$0

$1

$2

$3

$4

20022003200420052006

2007H1*2007H2*2008Q1*

Balance sheet

lending

GSE

MBS

FHA

Private-label

securitization

Source: Inside Mortgage Finance

*Annual rates

The Federal Home Loan Banks are playing an important and expanded role

funding lenders’ balance sheets.

Federal Home Loan Bank Advances

(billions of dollars outstanding, end of period)

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

2001 2002 2003 2004 2005 2006 2007 Mar-08

Source: Federal Deposit Insurance Corporation
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 5

DEPARTMENT OF THE TREASURY

Even with the expanded roles of Fannie Mae, Freddie Mac, the Federal Home

Loan Banks and the Federal Housing Administration, mortgage spreads are

increasing for all classes of mortgage loans.

Mortgage Rate Spreads to 10-Year Treasury (percent)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Conventional Mortgages

Jumbo Mortgages

Sources: Board of Governors of the Federal Reserve System

and the Wall Street Journal

Covered Bonds present an alternative source of funding for institutions that can

complement other sources of financing for a wide range of high-quality assets. In

Europe, Covered Bonds are highly liquid instruments which are typically sold to

rate-product investors rather than credit-product investors. While a Covered

Bond market is already well-established in Europe, to date only two U.S.

depository institutions have issued Covered Bonds. Given current challenges in

other financing markets, U.S. institutions may find Covered Bonds to be an

attractive source of funding for mortgage loans.

Treasury expects private-label securitization to return to the U.S. mortgage

market, enabling homeowners to benefit from a broad, global investor base. Given

the size of the U.S. residential mortgage market, Treasury believes there will be a

role for all sources of mortgage funding in the future.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 6

DEPARTMENT OF THE TREASURY

II. Objective

In preparing this report, Treasury seeks to bring increased clarity and

homogeneity to the United States Covered Bond market by developing a series of

Best Practices. Although the United States does not have dedicated Covered Bond

legislation, Treasury believes these Best Practices may serve as a starting-point

for the market, by encouraging issuers to use a common and simplified structure

with high quality collateral for Covered Bond issuances. However, this document

does not imply that Treasury favors Covered Bonds over other financing options

available to depository institutions. Instead, Treasury views Covered Bonds as an

additional, complementary funding source for the $11 trillion residential mortgage

market.

Treasury has limited these Best Practices specifically to Covered Bonds backed

by collateral consisting of high quality residential mortgage loans for two reasons.

First, a liquid Covered Bond market based on residential mortgages may provide

additional funding for the housing market, in turn lowering mortgage rates for

homeowners. Second, focusing on one type of collateral while the market is

nascent will provide simplicity for market participants. However, Treasury

expects that the Covered Bond market to develop over time and the collateral

securing Covered Bonds may eventually include other asset classes.

It should be noted that these Best Practices serve as a complement to the Federal

Deposit Insurance Corporation’s Final Covered Bond Policy Statement dated July

15, 2008 (see Appendix B). This statement specifies actions that the FDIC will

take during an insolvency or receivership if the Covered Bond meets certain

minimum requirements.

Finally, while these Best Practices have been developed to facilitate the growth of

the Covered Bond market, they should not constrain the market in the future.

Treasury fully expects the structure, collateral and other key terms of Covered

Bonds to evolve with the growth of this market in the United States.

In preparing this Best Practices document, Treasury discussed the potential

development of the U.S. Covered Bond market with both U.S. and European

regulators, as well as numerous market participants, including potential issuers,

investors, underwriters, rating agencies, law firms, financial counterparties,

service providers and trade associations.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 7

DEPARTMENT OF THE TREASURY

III. Covered Bond Definition

For the purposes of this document, a Covered Bond is defined as follows:

A Covered Bond is a debt instrument secured by a perfected security interest in a

specific pool of collateral (“Cover Pool”). A Covered Bond provides funding to a

depository institution (“issuer”) that retains a Cover Pool of residential mortgage

assets and related credit risk on its balance sheet. Interest on the Covered Bond is

paid to investors from the issuer’s general cash flows, while the Cover Pool serves

as secured collateral. This Cover Pool consists of a portfolio of performing

residential mortgage loans that meet specified underwriting criteria and are

actively managed by the issuer to meet certain characteristics. If assets within the

Cover Pool become non-performing, they must be replaced with performing

assets. Finally, the issuer must maintain a Cover Pool in excess of the notional

value of the Covered Bond (“overcollateralization”) at all times. Multiple

issuances for a depository institution may utilize a common Cover Pool.

In the event of an issuer default, Covered Bond investors first have recourse to the

Cover Pool. In the event the Cover Pool returns less than par in liquidation,

investors retain an unsecured claim on the issuer ranking pari passu with other

unsecured creditors. Hence, Covered Bonds provide dual recourse to both the

Cover Pool and the issuer, and the overcollateralization of the Cover Pool helps to

mitigate the risk that investors would receive less than par in the event of an

issuer default.

Comparison to Unsecured Debt

Unsecured debt differs significantly from Covered Bonds because of the absence

of secured collateral underlying the obligation of the issuer. While unsecured

debt investors retain an unsecured claim on the issuer in the event of issuer

default, Covered Bond investors possess dual recourse to both the underlying

collateral of a Covered Bond and to the individual issuer. Accordingly, Covered

Bonds provide investors with additional protection on their investment compared

with unsecured debt.

Comparison to Mortgage-Backed Securities

Although both mortgage-backed securities (“MBS”) and Covered Bonds are a

potential source of long-term funding for residential mortgage loans, there are

several essential differences between Covered Bonds and MBS that make each

attractive to different types of investors:

 Mortgages that secure a Covered Bond remain on the issuer’s balance

sheet, unlike MBS where mortgages are packaged and sold to

investors.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 8

DEPARTMENT OF THE TREASURY

 The cash flow from the mortgages and credit enhancements in MBS

are generally the only source of principal and interest payments to the

MBS investors. In a Covered Bond, principal and interest are paid by

the issuer’s cash flows, while the mortgages in the Cover Pool only

serve as collateral for investors.

 The collateral underlying Covered Bonds is dynamic and nonperforming (or prepaying) assets within the Cover Pool must be

substituted with performing mortgages. Mortgages underlying MBS

are static and remain in each MBS until maturity.

 In the case of an issuer default, Covered Bonds are structured to avoid

prepayment prior to the date of maturity. This is accomplished

through swap agreements and deposit agreements (e.g., guaranteed

investment contracts). MBS investors, in contrast, are exposed to

prepayment risk in the case of a mortgage default or prepayment.

 In the event that the Covered Bonds do accelerate and repay investors

at an amount less than the principal and accrued interest, investors

retain an unsecured claim on the issuer. MBS investors generally do

not retain any claim on the issuer in the event of repayment at an

amount less than the principal and interest owed.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 9

DEPARTMENT OF THE TREASURY

IV. History of the Covered Bond Market

The Covered Bond market has a long and extensive history in Europe, dating back

more than 230 years to the initial Prussian issuance in 1770. Covered Bonds were

initially used to finance agriculture and later became focused on residential and

commercial real estate markets. While Covered Bonds remained popular

throughout the 19th century, during the 20th century they were somewhat eclipsed

given other advances in the inter-bank financing markets. However, in 1995 the

first German jumbo Covered Bond was issued, meeting investor demand for

increasingly liquid products.1Since that time, the Covered Bond market has

accelerated in Europe, partly due to the fact that Europe does not have

government-sponsored enterprises such as Fannie Mae, Freddie Mac or the

Federal Home Loan Banks. Furthermore, the collateral behind European Covered

Bonds includes residential and commercial mortgages as well as public sector

debt. At the end of 2007, the Covered Bond market stood at over EUR 2.11

trillion.2To date, two U.S. institutions have issued Covered Bonds.

Nearly all European countries have adopted Covered Bonds into their financial

system. Depending on the jurisdiction, Covered Bonds may be governed by

legislation (i.e. a “legislative framework”) or by contract (i.e. a “structured

framework”). Typically, a legislative framework exists in nations with a long

history of Covered Bonds while nations with a relatively young Covered Bond

market, such as Canada and Japan have a structured framework. In countries with

a legislative framework there is often a dedicated regulator that governs the

issuance and repayment of Covered Bonds. Moreover, a legislative framework

helps to standardize Covered Bonds, providing homogeneity and simplicity to the

market. This Best Practices document seeks to offer such structure to the U.S.

market.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 10

DEPARTMENT OF THE TREASURY

V. Important Considerations

The purpose of this document is to present a standardized model for Covered

Bonds issued in the United States in the absence of dedicated legislation.

Investors should recognize that like all investments, Covered Bonds carry risk.

Investors should perform their own due diligence and review risk factors and

associated disclosure before investing in any Covered Bond. These Best Practices

only serve as a template for market participants and do not in any way provide or

imply a government guarantee of any kind. It should also be understood that

these Best Practices do not attempt to address requirements arising from federal

securities laws or any other legal framework.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 11

DEPARTMENT OF THE TREASURY

VI. Best Practices Template

For a Covered Bond program to be consistent with this Best Practices Template,

the program’s documentation must conform to the following provisions

throughout the life of the program, not only at the time of issuance. Italics

indicate provisions that are specified in the final FDIC policy statement3.

Issuer The issuer may be:

 A newly created, bankruptcy-remote SPV (“SPV

Structure”)4

 A depository institution and/or a wholly-owned

subsidiary of a depository institution (“Direct Issuance

Structure”)

Security Under the current SPV Structure, the issuer’s primary assets

must be a mortgage bond purchased from a depository

institution. The mortgage bond must be secured at the

depository institution by a dynamic pool of residential

mortgages.

Under the Direct Issuance Structure, the issuing institution

must designate a Cover Pool of residential mortgages as the

collateral for the Covered Bond, which remains on the

balance sheet of the depository institution.

In both structures, the Cover Pool must be owned by the

depository institution. Issuers of Covered Bonds must

provide a first priority claim on the assets in the Cover Pool

to bond holders, and the assets in the Cover Pool must not be

encumbered by any other lien. The issuer must clearly

identify the Cover Pool’s assets, liabilities, and security

pledge on its books and records.

Maturity The maturity for Covered Bonds shall be greater than one

year and no more than thirty years. While the majority of

early issuances will likely have maturities between one and

ten years, we expect longer dated issuances may develop

over time.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 12

DEPARTMENT OF THE TREASURY

Eligible Cover

Pool Collateral

The collateral in the Cover Pool must meet the following

requirements at all times:

 Performing mortgages on one-to-four family

residential properties

 Mortgages shall be underwritten at the fully-indexed

rate5

 Mortgages shall be underwritten with documented

income

 Mortgages must comply with existing supervisory

guidance governing the underwriting of residential

mortgages, including the Interagency Guidance on

Non-Traditional Mortgage Products, October 5, 2006,

and the Interagency Statement on Subprime Mortgage

Lending, July 10, 2007, and such additional guidance

applicable at the time of loan origination

 Substitution collateral may include cash and Treasury

and agency securities as necessary to prudently

manage the Cover Pool

 Mortgages must be current when they are added to the

pool and any mortgages that become more than 60-

days past due must be replaced

 Mortgages must be first lien only

 Mortgages must have a maximum loan-to-value

(“LTV”) of 80% at the time of inclusion in the Cover

Pool

 A single Metro Statistical Area cannot make up more

than 20% of the Cover Pool

 Negative amortization mortgages are not eligible for

the Cover Pool

 Bondholders must have a perfected security interest in

these mortgage loans.

Overcollateralization

Issuers must maintain an overcollateralization value at all

times of at least 5% of the outstanding principal balance of

the Covered Bonds (see “Asset Coverage Test”).

For the purposes of calculating the minimum required

overcollateralization in the Covered Bond, only the 80%

portion of the updated LTV will be credited. If a mortgage

in the Cover Pool has a LTV of 80% or less, the full

outstanding principal value of the mortgage will be credited.

If a mortgage has a LTV over 80%, only the 80% LTV

portion of each loan will be credited (see Appendix A for

examples).
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 13

DEPARTMENT OF THE TREASURY

Issuers must update the LTV of mortgages in the Cover Pool

on a quarterly basis using a nationally-recognized, regional

housing price index or other comparable measurement.

Currency Covered Bonds may be issued in any currency.

Interest Type Covered Bonds may either be fixed or floating instruments.

Interest Payment

Swaps

Issuers may enter into one or more swap agreements or

similar contractual arrangements at the time of issuance.

The purpose of such agreements include:

 To provide scheduled interest payments on a temporary

basis in the event the issuer becomes insolvent

 To mitigate any timing mismatch, to the extent

applicable, between interest payments and interest

income

These swap agreements must be with financially sound

counterparties and the identity of the counterparties must be

disclosed to investors.

Currency Swap If a Covered Bond is issued in a different currency than the

underlying Cover Pool (or Mortgage Bond, if applicable),

the issuer shall employ a currency swap.

Specified

Investment

Contract

Issuers must enter into a deposit agreement, e.g., guaranteed

investment contract, or other arrangement whereby the

proceeds of Cover Pool assets are invested (any such

arrangement, a “Specified Investment”) at the time of

issuance with or by one or more financially sound

counterparties. Following a payment default by the issuer or

repudiation by the FDIC as conservator or receiver, the

Specified Investment should pay ongoing scheduled interest

and principal payments so long as the Specified Investment

provider receives proceeds of the Cover Pool assets at least

equal to the par value of the Covered Bonds.

The purpose of the Specified Investment is to prevent an

acceleration of the Covered Bond due to the insolvency of

the issuer.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 14

DEPARTMENT OF THE TREASURY

Cover Pool

Disclosure

Issuers must make available descriptive information on the

Cover Pool with investors at the time an investment decision

is being made and on a monthly basis after issuance. The

SEC’s Regulation AB provides a helpful template for

preparing pool level information, such as presenting

summary information in tabular or graphical format and

using appropriate groups or ranges.

Issuers must make this information available to investors no

later than 30 days after the end of each month.

As the Covered Bond market develops, issuers should

consider disclosing metrics on the Cover Pools from their

prior Covered Bonds whenever a new issuance occurs.

Substitution If more than 10% of the Cover Pool is substituted within any

month or if 20% of the Cover Pool is substituted within any

one quarter, the issuer must provide updated Cover Pool

information to investors.

Issuer Disclosure The depository institution and the SPV (if applicable) must

disclose information regarding its financial profile and other

relevant information that an investor would find material.

Asset Coverage

Test

The issuer must perform an Asset Coverage Test on a

monthly basis to ensure collateral quality and the proper

level of overcollateralization and to make any substitutions

that are necessary to meet the provisions of this template.

The results of this Asset Coverage Test and the results of

any reviews by the Asset Monitor must be made available to

investors.

Asset Monitor The issuer must designate an independent Asset Monitor to

periodically determine compliance with the Asset Coverage

Test of the issuer.

Trustee The issuer must designate an independent Trustee for the

Covered Bonds. Among other responsibilities, this Trustee

must represent the interest of investors and must enforce the

investors’ rights in the collateral in the event of an issuer’s

insolvency.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 15

DEPARTMENT OF THE TREASURY

Treatment of

Covered Bond

Proceeds

In the event of a default, any losses must be allocated pro

rata across Covered Bond issuances that utilize a common

Cover Pool, irrespective of the maturity of the individual

issuances.

SEC Registration Covered Bonds may be issued as registered securities or

may be exempt from registration under securities laws. This

template is not meant to address disclosure and other

requirements for a security registered with the Securities and

Exchange Commission.

Regulatory

Authorization

Issuers must receive consent to issue Covered Bonds from

their primary federal regulator. Upon an issuer’s request,

their primary federal regulator will make a determination

based on that agencies policies and procedures whether to

give consent to the issuer to establish a Covered Bond

program. Only well-capitalized institutions should issue

Covered Bonds.

As part of their ongoing supervisory efforts, primary federal

regulators monitor an issuer’s controls and risk management

processes.

Issuance

Limitations

Covered Bonds may account for no more than four percent

of an issuers’ liabilities after issuance.

Event of Breach

of the Asset

Coverage Test

If the Asset Coverage Test of the Covered Bond program is

breached, the issuer has one month to correct such breach.

If, after one month, the breach remains, the Trustee may

terminate the Covered Bond program and principal and

accrued interest will be returned to investors. While such a

breach exists, the issuer may not issue any additional

Covered Bonds.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 16

DEPARTMENT OF THE TREASURY

Insolvency

Procedures

As conservator or receiver for an insured depository

institution (IDI), the FDIC has three options in responding

to a properly structured Covered Bond transaction of the

IDI:

1) continue to perform on the Covered Bond transaction

under its terms;

2) pay-off the Covered Bonds in cash up to the value of the

pledged collateral; or

3) allow liquidation of the pledged collateral to pay-off the

Covered Bonds.

If the FDIC adopts the first option, it would continue to

make the Covered Bond payments as scheduled. The second

or third options would be triggered if the FDIC repudiated

the transaction or if a monetary default occurred. In both

cases, the par value of the Covered Bonds plus interest

accrued to the date of the appointment of the FDIC as

conservator or receiver would be paid in full up to the value

of the collateral.

If the value of the pledged collateral exceeded the total

amount of all valid claims held by the secured parties, this

excess value or over collateralization would be returned to

the FDIC, as conservator or receiver, for distribution as

mandated by the Federal Deposit Insurance Act.

If there were insufficient collateral pledged to cover all valid

claims by the secured parties, the amount of the claims in

excess of the pledged collateral would be unsecured claims

in the receivership.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 17

DEPARTMENT OF THE TREASURY

VII. Illustrative Direct Issuance

This diagram is meant to show what a potential structure could look like if the

issuer of a Covered Bond were a depository institution. It is not intended to

endorse a specific structure but rather serves an illustrative purpose. Issuers may

develop other structures that are consistent with the template.

Covered Bond

Currency & Rate

Mortgage Bond

Currency & Rate

Swap

Provider(s)

Asset

Monitor

Covered Bond

Investors

Covered

Bond

Proceeds

Covered

Bonds

Cover Pool

Issuing Depository Institution

Specified Investment

Provider

Covered Bond

Trustee
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 18

DEPARTMENT OF THE TREASURY

VIII. Illustrative SPV Issuance

This diagram is meant to show what a potential structure could look like if the

issuer of a Covered Bond were a SPV. It is not intended to endorse a specific

structure but rather serves an illustrative purpose. Issuers may develop other

structures that are consistent with the template.

Covered Bond Currency

& Rate

Income & Principal

from Specified

Investment

Mortgage Bond

Currency & Rate

Mortgage Bond

Trustee

Specified

Investment

Provider

Swap

Provider(s) Covered Bond

Trustee

Covered Bond

Investors

Mortgage

Bond

Proceeds

Mortgage

Bonds

Mortgage Bond Proceeds

Covered

Bond

Proceeds

Covered

Bonds

Issuing

SPV

Mortgage Bond Issuer

Cover Pool

Asset

Monitor
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 19

DEPARTMENT OF THE TREASURY

Endnotes

1 European Covered Bond Council, December 2007.

2

Ibid

3 The FDIC’s Final Covered Bond Policy Statement dated July 15, 2008 outlines specific actions

that the FDIC will take during an insolvency or receivership if certain conditions are met.

Italicized terms indicate provisions that are part of both the FDIC’s statement and this Best

Practices Template. However, these italicized terms are not meant to cover all of the provisions of

the FDIC statement. Market participants should independently review the FDIC’s statement to

ensure conformity with all provisions.

4

In addition to SPV programs with a single issuer, multiple depository institutions could

potentially utilize a joint SPV to pool assets. Each issuer would be responsible for meeting

appropriate requirements and receiving consent from its primary federal regulator.

5 The fully indexed rate equals the index rate prevailing at origination plus the margin to be added

to it after the expiration of an introductory interest rate. For example, assume that a loan with an

initial fixed rate of 7% will reset to the six-month London Interbank Offered Rate (LIBOR) plus a

margin of 6%. If the six-month LIBOR rate equals 5.5%, lenders should qualify the borrower at

11.5% (5.5% + 6%), regardless of any interest rate caps that limit how quickly the fully indexed

rate may be reached.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 20

DEPARTMENT OF THE TREASURY

Appendix A: Cover Pool Collateralization Calculation

As stated in Section VI., a minimum overcollateralization of 5% of the principal

value of the Covered Bond must be maintained. Furthermore, mortgages must

have a maximum LTV of 80% at the time of inclusion in the Cover Pool.

For the purposes of calculating the overcollateralization, 80% of the updated LTV

will be credited towards the Cover Pool. For mortgages with an LTV of 80% or

less, the full outstanding principal value will be credited. For mortgages with an

LTV over 80%, only the 80% LTV portion of each loan will be credited.

This appendix provides examples of how loans may be credited against the

required collateral of the Cover Pool.

ILLUSTRATIVE ASSUMPTIONS:

- $1,000 Covered Bond issuance

- Minimum overcollateralization of 5%

- Updated maximum LTV of 80% credited toward overcollateralization

- $1,050 of required collateral ($1,000 x 1.05)

Scenario A:

 Pool of $80 loans on homes with an updated value of $100

 $1,050 / ($80 x 1.0) = 13.125 loans required in Cover Pool

Scenario B:

 Pool of $60 loans on homes with an updated value of $100

 $1,050 / ($60 x 1.0) = 17.500 loans required in Cover Pool

Scenario C:

 Pool of $80 loans on homes with an updated value of $80

 $1,050 / ($80 x 0.8) = 16.406 loans required in Cover Pool
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 21

DEPARTMENT OF THE TREASURY

Appendix B: Final FDIC Covered Bond Policy Statement

FEDERAL DEPOSIT INSURANCE CORPORATION

Covered Bond Policy Statement

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Final Statement of Policy

-----------------------------------------------------------------------

SUMMARY: The Federal Deposit Insurance Corporation (the FDIC) is

publishing a final policy statement on the treatment of covered bonds in a

conservatorship or receivership. This policy statement provides guidance on the

availability of expedited access to collateral pledged for certain covered bonds

after the FDIC decides whether to terminate or continue the transaction.

Specifically, the policy statement clarifies how the FDIC will apply the consent

requirements of section 11(e)(13)(C) of the Federal Deposit Insurance Act (FDIA)

to such covered bonds to facilitate the prudent development of the U.S. covered

bond market consistent with the FDIC's responsibilities as conservator or receiver

for insured depository institutions (IDI). As the U.S. covered bond market

develops, future modifications or amendments may be considered by the FDIC.

FOR FURTHER INFORMATION CONTACT: Richard T. Aboussie, Associate

General Counsel, Legal Division (703) 562-2452; Michael H. Krimminger,

Special Advisor for Policy (202) 898-8950.

SUPPLEMENTARY INFORMATION

I. Background

On April 23, 2008, the FDIC published the Interim Final Covered Bond Policy

Statement for public comment. 73 FR 21949 (April 23, 2008). After carefully

reviewing and considering all comments, the FDIC has adopted certain limited

revisions and clarifications to the Interim Policy Statement (as discussed in Part

II) in the Final Policy Statement.1

Currently, there are no statutory or regulatory prohibitions on the issuance of

covered bonds by U.S. banks. Therefore, to reduce market uncertainty and clarify

the application of the FDIC's statutory authorities for U.S. covered bond

transactions, the FDIC issued an Interim Policy Statement to provide guidance on

the availability of expedited access to collateral pledged for certain covered bonds

by IDIs in a conservatorship or a receivership. As discussed below, under section

11(e)(13)(C) of the FDIA, any liquidation of collateral of an IDI placed into
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 22

DEPARTMENT OF THE TREASURY

conservatorship or receivership requires the consent of the FDIC during the initial

45 days or 90 days after its appointment, respectively. Consequently, issuers of

covered bonds have incurred additional costs from maintaining additional

liquidity needed to insure continued payment on outstanding bonds if the FDIC as

conservator or receiver fails to make payment or provide access to the pledged

collateral during these periods after any decision by the FDIC to terminate the

covered bond transaction. The Policy Statement does not impose any new

obligations on the FDIC, as conservator or receiver, but does define the

circumstances and the specific covered bond transactions for which the FDIC will

grant consent to expedited access to pledged covered bond collateral.

Covered bonds are general, non-deposit obligation bonds of the issuing bank

secured by a pledge of loans that remain on the bank's balance sheet. Covered

bonds originated in Europe, where they are subject to extensive statutory and

supervisory regulation designed to protect the interests of covered bond investors

from the risks of insolvency of the issuing bank. By contrast, covered bonds are a

relatively new innovation in the U.S. with only two issuers to date: Bank of

America, N.A. and Washington Mutual. These initial U.S. covered bonds were

issued in September 2006.

In the covered bond transactions initiated in the U.S. to date, an IDI sells

mortgage bonds, secured by mortgages, to a trust or similar entity ("special

purpose vehicle" or "SPV").2The pledged mortgages remain on the IDI's balance

sheet, securing the IDI's obligation to make payments on the debt, and the SPV

sells covered bonds, secured by the mortgage bonds, to investors. In the event of a

default by the IDI, the mortgage bond trustee takes possession of the pledged

mortgages and continues to make payments to the SPV to service the covered

bonds. Proponents argue that covered bonds provide new and additional sources

of liquidity and diversity to an institution's funding base.

The FDIC agrees that covered bonds may be a useful liquidity tool for IDIs as

part of an overall prudent liquidity management framework and within the

parameters set forth in the Policy Statement. While covered bonds, like other

secured liabilities, could increase the costs to the deposit insurance fund in a

receivership, these potential costs must be balanced with diversification of

sources of liquidity and the benefits that accrue from additional on-balance sheet

alternatives to securitization for financing mortgage lending. The Policy

Statement seeks to balance these considerations by clarifying the conditions and

circumstances under which the FDIC will grant automatic consent to access

pledged covered bond collateral. The FDIC believes that the prudential limitations

set forth in the Policy Statement permit the incremental development of the

covered bond market, while allowing the FDIC, and other regulators, the

opportunity to evaluate these transactions within the U.S. mortgage market. In

fulfillment of its responsibilities as deposit insurer and receiver for failed IDIs, the

FDIC will continue to review the development of the covered bond marketplace
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 23

DEPARTMENT OF THE TREASURY

in the U.S. and abroad to gain further insight into the appropriate role of covered

bonds in IDI funding and the U.S. mortgage market, and their potential

consequences for the deposit insurance fund. (For ease of reference, throughout

this discussion, when we refer to "covered bond obligation," we are referring to

the part of the covered bond transaction comprising the IDI's debt obligation,

whether to the SPV, mortgage bond trustee, or other parties; and "covered bond

obligee" is the entity to which the IDI is indebted.)

Under the FDIA, when the FDIC is appointed conservator or receiver of an IDI,

contracting parties cannot terminate agreements with the IDI because of the

insolvency itself or the appointment of the conservator or receiver. In addition,

contracting parties must obtain the FDIC's consent during the forty-five day

period after appointment of FDIC as conservator, or during the ninety day period

after appointment of FDIC as receiver before, among other things, terminating

any contract or liquidating any collateral pledged for a secured transaction.3

During this period, the FDIC must still comply with otherwise enforceable

provisions of the contract. The FDIC also may terminate or repudiate any contract

of the IDI within a reasonable time after the FDIC's appointment as conservator or

receiver if the conservator or receiver determines that the agreement is

burdensome and that the repudiation will promote the orderly administration of

the IDI's affairs.4

As conservator or receiver for an IDI, the FDIC has three options in responding to

a properly structured covered bond transaction of the IDI: 1) continue to perform

on the covered bond transaction under its terms; 2) pay-off the covered bonds in

cash up to the value of the pledged collateral; or 3) allow liquidation of the

pledged collateral to pay-off the covered bonds. If the FDIC adopts the first

option, it would continue to make the covered bond payments as scheduled. The

second or third options would be triggered if the FDIC repudiated the transaction

or if a monetary default occurred. In both cases, the par value of the covered

bonds plus interest accrued to the date of the appointment of the FDIC as

conservator or receiver would be paid in full up to the value of the collateral. If

the value of the pledged collateral exceeded the total amount of all valid claims

held by the secured parties, this excess value or over collateralization would be

returned to the FDIC, as conservator or receiver, for distribution as mandated by

the FDIA. On the other hand, if there were insufficient collateral pledged to cover

all valid claims by the secured parties, the amount of the claims in excess of the

pledged collateral would be unsecured claims in the receivership.

While the FDIC can repudiate the underlying contract, and thereby terminate any

continuing obligations under that contract, the FDIA prohibits the FDIC, as

conservator or receiver from avoiding any legally enforceable or perfected

security interest in the assets of the IDI unless the interest was taken in
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DEPARTMENT OF THE TREASURY

contemplation of the IDI's insolvency or with the intent to hinder, delay, or

defraud the IDI or its creditors.5This statutory provision ensures protection for

the valid claims of secured creditors up to the value of the pledged collateral.

After a default or repudiation, the FDIC as conservator or receiver may either pay

resulting damages in cash up to the value of the collateral or turn over the

collateral to the secured party for liquidation. For example, if the conservator or

receiver repudiated a covered bond transaction, as discussed in Part II below, it

would pay damages limited to par value of the covered bonds and accrued interest

up to the date of appointment of the conservator or receiver, if sufficient collateral

was in the cover pool, or turn over the collateral for liquidation with the

conservator or receiver recovering any proceeds in excess of those damages. In

liquidating any collateral for a covered bond transaction, it would be essential that

the secured party liquidate the collateral in a commercially reasonable and

expeditious manner taking into account the then-existing market conditions.

As noted above, existing covered bond transactions by U.S. issuers have used

SPVs. However, nothing in the Policy Statement requires the use of an SPV.

Some questions have been posed about the treatment of a subsidiary or SPV after

appointment of the FDIC as conservator or receiver. The FDIC applies welldefined standards to determine whether to treat such entities as "separate" from

the IDI. If a subsidiary or SPV, in fact, has fulfilled all requirements for treatment

as a "separate" entity under applicable law, the FDIC as conservator or receiver

has not applied its statutory powers to the subsidiary's or SPV's contracts with

third parties. While the determination of whether a subsidiary or SPV has been

organized and maintained as a separate entity from the IDI must be determined

based on the specific facts and circumstances, the standards for such decisions are

set forth in generally applicable judicial decisions and in the FDIC's regulation

governing subsidiaries of insured state banks, 12 C.F.R. § 362.4.

The requests to the FDIC for guidance have focused principally on the conditions

under which the FDIC would grant consent to obtain collateral for a covered bond

transaction before the expiration of the forty-five day period after appointment of

a conservator or the ninety day period after appointment of a receiver. IDIs

interested in issuing covered bonds have expressed concern that the requirement

to seek the FDIC's consent before exercising on the collateral after a breach could

interrupt payments to the covered bond obligee for as long as 90 days. IDIs can

provide for additional liquidity or other hedges to accommodate this potential risk

to the continuity of covered bond payments but at an additional cost to the

transaction. Interested parties requested that the FDIC provide clarification about

how FDIC would apply the consent requirement with respect to covered bonds.

Accordingly, the FDIC has determined to issue this Final Covered Bond Policy

Statement in order to provide covered bond issuers with final guidance on how

the FDIC will treat covered bonds in a conservatorship or receivership.
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DEPARTMENT OF THE TREASURY

II. Overview of the Comments

The FDIC received approximately 130 comment letters on the Interim Policy

Statement; these included comments from national banks, Federal Home Loan

Banks, industry groups and individuals.

Most commenters encouraged the FDIC to adopt the Policy Statement to clarify

how the FDIC would treat covered bonds in the case of a conservatorship or

receivership and, thereby, facilitate the development of the U.S. covered bond

market. The more detailed comments focused on one or more of the following

categories of issues: (1) the FDIC's discretion regarding covered bonds that do not

comply with the Policy Statement; (2) application to covered bonds completed

prior to the Policy Statement; (3) the limitation of the Policy Statement to covered

bonds not exceeding 4 percent of liabilities; (4) the eligible collateral for the cover

pools; (5) the measure of damages provided in the event of default or repudiation;

(6) the covered bond term limit; and (7) federal home loan bank advances and

assessments.

Certain banks and industry associations sought clarification about the treatment of

covered bonds that do not comply with the Policy Statement by the FDIC as

conservator or receiver. Specifically, commenters asked the FDIC to clarify that if

a covered bond issuance is not in conformance with the Policy Statement, the

FDIC retains discretion to grant consent prior to expiration of the 45 or 90 day

period on a case-by-case basis. Under Section 11(e)(13)(C) of the FDIA, the

exercise of any right or power to terminate, accelerate, declare a default, or

otherwise affect any contract of the IDI, or to take possession of any property of

the IDI, requires the consent of the conservator or receiver, as appropriate, during

the 45-day period or 90-day period after the date of the appointment of the

conservator or receiver, as applicable. By the statutory terms, the conservator or

receiver retains the discretion to give consent on a case-by-case basis after

evaluation by the FDIC upon the failure of the issuer.

Comments from banks who issued covered bonds prior to the Policy Statement

requested either 'grandfathering' of preexisting covered bonds or an advance

determination by the FDIC before any appointment of a conservator or receiver

that specific preexisting covered bonds qualified under the Policy Statement.

After carefully considering the comments, the FDIC has determined that to

'grandfather' or otherwise permit mortgages or other collateral that does not meet

the specific requirements of the Policy Statement to support covered bonds would

not promote stable and resilient covered bonds as encompassed within the Policy

Statement. If preexisting covered bonds, and their collateral, otherwise qualify

under the standards specified in the Policy Statement, those covered bonds would

be eligible for the expedited access to collateral provided by the Policy Statement.
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DEPARTMENT OF THE TREASURY

A number of commenters requested that the limitation of eligible covered bonds

to no more than 4 percent of an IDI's total liabilities should be removed or

increased. Commenters also noted that other countries applying a cap have based

the limitation on assets, not liabilities. The Policy Statement applies to covered

bond issuances that comprise no more than 4 percent of an institution's total

liabilities since, in part, as the proportion of secured liabilities increases the

unpledged assets available to satisfy the claims of the Deposit Insurance Fund,

uninsured depositors and other creditors decreases. As a result, the FDIC must

focus on the share of an IDI's liabilities that are secured by collateral and balance

the additional potential losses in the failure of an IDI against the benefits of

increased liquidity for open institutions. The 4 percent limitation under the Policy

Statement is designed to permit the FDIC, and other regulators, an opportunity to

evaluate the development of the covered bond market within the financial system

of the United States, which differs in many respects from that in other countries

deploying covered bonds. Consequently, while changes may be considered to this

limitation as the covered bond market develops, the FDIC has decided not to

make any change at this time.

A number of commenters sought expansion of the mortgages defined as "eligible

mortgages" and the expansion of collateral for cover pools to include other assets,

such as second-lien home equity loans and home equity lines of credit, credit card

receivables, mortgages on commercial properties, public sector debt, and student

loans. Other commenters requested that "eligible mortgages" should be defined

solely by their loan-to-value (LTV) ratios. After considering these comments, the

FDIC has determined that its interests in efficient resolution of IDIs, as well as in

the initial development of a resilient covered bond market that can provide

reliable liquidity for well-underwritten mortgages, support retention of the

limitations on collateral for qualifying covered bonds in the Interim Policy

Statement. Recent market experience demonstrates that many mortgages that

would not qualify under the Policy Statement, such as low documentation

mortgages, have declined sharply in value as credit conditions have deteriorated.

Some of the other assets proposed are subject to substantial volatility as well,

while others would not specifically support additional liquidity for wellunderwritten residential mortgages. As noted above, certain provisions of the

Policy Statement may be reviewed and reconsidered as the U.S. covered bond

market develops.

With regard to the comments that LTV be used as a guide to determine an

"eligible mortgage," the FDIC does not believe that LTV can substitute for strong

underwriting criteria to ensure sustainable mortgages. In response to the

comments, and the important role that LTV plays in mortgage analysis, the Policy

Statement will urge issuers to disclose LTV for mortgages in the cover pool to

enhance transparency for the covered bond market and promote stable cover

pools. However, no specific LTV limitation will be imposed.
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DEPARTMENT OF THE TREASURY

Two commenters suggested that the Policy Statement should be clarified to

permit the substitution of cash as cover pool collateral. The Policy Statement has

been modified to allow for the substitution of cash and Treasury and agency

securities. The substitution of such collateral does not impair the strength of the

cover pool and may be an important tool to limit short-term strains on issuing

IDIs if eligible mortgages or AAA-rated mortgage securities must be withdrawn

from the cover pool.

A number of commenters requested guidance on the calculation of damages the

receiver will pay to holders of covered bonds in the case of repudiation or default.

Under 12 USC § 1821(e)(3), the liability of the conservator or receiver for the

disaffirmance or repudiation of any contract is limited to "actual direct

compensatory damages" and determined as of the date of appointment of the

conservator or receiver. In the repudiation of contracts, such damages generally

are defined by the amount due under the contract repudiated, but excluding any

amounts for lost profits or opportunities, other indirect or contingent claims, pain

and suffering, and exemplary or punitive damages. Under the Policy Statement,

the FDIC agrees that "actual direct compensatory damages" due to bondholders,

or their representative(s), for repudiation of covered bonds will be limited to the

par value of the bonds plus accrued interest as of the date of appointment of the

FDIC as conservator or receiver. The FDIC anticipates that IDIs issuing covered

bonds, like other obligations bearing interest rate or other risks, will undertake

prudent hedging strategies for such risks as part of their risk management

program.

Many commenters suggested that the 10-year term limit should be removed to

permit longer-term covered bond maturities. After reviewing the comments, the

FDIC agrees that longer-term covered bonds should not pose a significant,

additional risk and may avoid short-term funding volatility. Therefore, the FDIC

has revised the Interim Policy Statement by increasing the term limit for covered

bonds from 10 years to 30 years.

A number of the Federal Home Loan Banks, and their member institutions,

objected to the inclusion of FHLB advances in the definition of "secured

liabilities," any imposed cap on such advances, and any change in assessment

rates. Under 12 C.F.R. Part 360.2 (Federal Home Loan Banks as Secured

Creditors), secured liabilities include loans from the Federal Reserve Bank

discount window, Federal Home Loan Bank (FHLB) advances, repurchase

agreements, and public deposits. However, the Policy Statement does not impose

a cap on FHLB advances and has no effect on an IDI's ability to obtain FHLB

advances or its deposit insurance assessments. The Policy Statement solely

addresses covered bonds.
BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 28

DEPARTMENT OF THE TREASURY

However, as noted above, where an IDI relies very heavily on secured liabilities

to finance its lending and other business activities, it does pose a greater risk of

loss to the Deposit Insurance Fund in any failure. Should the covered bond market

develop as a significant source of funding for IDIs, and should that development

create substantial increases in an IDI's reliance on secured funding, it would

increase the FDIC's losses in a failure and perhaps outweigh the benefits of

improved liquidity. As a result, it is appropriate for the FDIC to consider the risks

of such increased losses. Consideration of these risks may occur in a possible

future request for comments on secured liabilities, but they are not addressed in

this Policy Statement.

III. Final Statement of Policy

For the purposes of this final Policy Statement , a "covered bond" is defined as a

non-deposit, recourse debt obligation of an IDI with a term greater than one year

and no more than thirty years, that is secured directly or indirectly by a pool of

eligible mortgages or, not exceeding ten percent of the collateral, by AAA-rated

mortgage bonds. The term "covered bond obligee" is the entity to which the IDI is

indebted.

To provide guidance to potential covered bond issuers and investors, while

allowing the FDIC to evaluate the potential benefits and risks that covered bond

transactions may pose to the deposit insurance fund in the U.S. mortgage market,

the application of the policy statement is limited to covered bonds that meet the

following standards.

This Policy Statement only applies to covered bond issuances made with the

consent of the IDI's primary federal regulator in which the IDI's total covered

bond obligations at such issuance comprise no more than 4 percent of an IDI's

total liabilities. The FDIC is concerned that unrestricted growth while the FDIC is

evaluating the potential benefits and risks of covered bonds could excessively

increase the proportion of secured liabilities to unsecured liabilities. The larger the

balance of secured liabilities on the balance sheet, the smaller the value of assets

that are available to satisfy depositors and general creditors, and consequently the

greater the potential loss to the Deposit Insurance Fund. To address these

concerns, the policy statement is limited to covered bonds that comprise no more

than 4 percent of a financial institution's total liabilities after issuance.

In order to limit the risks to the deposit insurance fund, application of the Policy

Statement is restricted to covered bond issuances secured by perfected security

interests under applicable state and federal law on performing eligible mortgages

on one-to-four family residential properties, underwritten at the fully indexed rate

and relying on documented income, a limited volume of AAA-rated mortgage

securities, and certain substitution collateral. The Policy Statement provides that

the mortgages shall be underwritten at the fully indexed rate relying on
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DEPARTMENT OF THE TREASURY

documented income, and comply with existing supervisory guidance governing

the underwriting of residential mortgages, including the Interagency Guidance on

Non-Traditional Mortgage Products, October 5, 2006, and the Interagency

Statement on Subprime Mortgage Lending, July 10, 2007, and such additional

guidance applicable at the time of loan origination. In addition, the Policy

Statement requires that the eligible mortgages and other collateral pledged for the

covered bonds be held and owned by the IDI. This requirement is designed to

protect the FDIC's interests in any over collateralization and avoid structures

involving the transfer of the collateral to a subsidiary or SPV at initiation or prior

to any IDI default under the covered bond transaction.

The FDIC recognizes that some covered bond programs include mortgage-backed

securities in limited quantities. Staff believes that allowing some limited inclusion

of AAA-rated mortgage-backed securities as collateral for covered bonds during

this interim, evaluation period will support enhanced liquidity for mortgage

finance without increasing the risks to the deposit insurance fund. Therefore,

covered bonds that include up to 10 percent of their collateral in AAA-rated

mortgage securities backed solely by mortgage loans that are made in compliance

with guidance referenced above will meet the standards set forth in the Policy

Statement. In addition, substitution collateral for the covered bonds may include

cash and Treasury and agency securities as necessary to prudently manage the

cover pool. Securities backed by tranches in other securities or assets (such as

Collateralized Debt Obligations) are not considered to be acceptable collateral.

The Policy Statement provides that the consent of the FDIC, as conservator or

receiver, is provided to covered bond obligees to exercise their contractual rights

over collateral for covered bond transactions conforming to the Interim Policy

Statement no sooner than ten (10) business days after a monetary default on an

IDI's obligation to the covered bond obligee, as defined below, or ten (10)

business days after the effective date of repudiation as provided in written notice

by the conservator or receiver.

The FDIC anticipates that future developments in the marketplace may present

interim final covered bond structures and structural elements that are not

encompassed within this Policy Statement and therefore the FDIC may consider

future amendment (with appropriate notice) of this Policy Statement as the U.S.

covered bond market develops.

IV. Scope and Applicability:

This Policy Statement applies to the FDIC in its capacity as conservator or

receiver of an insured depository institution.
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DEPARTMENT OF THE TREASURY

This Policy Statement only addresses the rights of the FDIC under 12 U.S.C. §

1821(e)(13)(C). A previous policy statement entitled "Statement of Policy on

Foreclosure Consent and Redemption Rights," August 17, 1992, separately

addresses consent under 12 U.S.C. § 1825(b), and should be separately consulted.

This Policy Statement does not authorize, and shall not be construed as

authorizing, the waiver of the prohibitions in 12 U.S.C. § 1825(b)(2) against levy,

attachment, garnishment, foreclosure or sale of property of the FDIC, nor does it

authorize or shall it be construed as authorizing the attachment of any involuntary

lien upon the property of the FDIC. The Policy Statement provides that it shall not

be construed as waiving, limiting or otherwise affecting the rights or powers of

the FDIC to take any action or to exercise any power not specifically mentioned,

including but not limited to any rights, powers or remedies of the FDIC regarding

transfers taken in contemplation of the institution's insolvency or with the intent

to hinder, delay or defraud the institution or the creditors of such institution, or

that is a fraudulent transfer under applicable law.

The Board of Directors of the FDIC has adopted a final Covered Bond Policy

Statement. The text of the Covered Bond Policy Statement follows:

COVERED BOND POLICY STATEMENT

Background

Insured depository institutions ("IDIs") are showing increasing interest in issuing

covered bonds. Although covered bond structures vary, in all covered bonds the

IDI issues a debt obligation secured by a pledge of assets, typically mortgages.

The debt obligation is either a covered bond sold directly to investors, or

mortgage bonds which are sold to a trust or similar entity ("special purpose

vehicle" or "SPV") as collateral for the SPV to sell covered bonds to investors. In

either case, the IDI's debt obligation is secured by a perfected first priority

security interest in pledged mortgages, which remain on the IDI's balance sheet.

Proponents argue that covered bonds provide new and additional sources of

liquidity and diversity to an institution's funding base. Based upon the information

available to date, the FDIC agrees that covered bonds may be a useful liquidity

tool for IDIs as part of an overall prudent liquidity management framework and

the parameters set forth in this policy statement. Because of the increasing interest

IDIs have in issuing covered bonds, the FDIC has determined to issue this policy

statement with respect to covered bonds.

(a) Definitions.

(1) For the purposes of this policy statement, a "covered bond" shall be defined as

a non-deposit, recourse debt obligation of an IDI with a term greater than one year

and no more than thirty years, that is secured directly or indirectly by perfected
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DEPARTMENT OF THE TREASURY

security interests under applicable state and federal law on assets held and owned

by the IDI consisting of eligible mortgages, or AAA-rated mortgage-backed

securities secured by eligible mortgages if for no more than ten percent of the

collateral for any covered bond issuance or series. Such covered bonds may

permit substitution of cash and United States Treasury and agency securities for

the initial collateral as necessary to prudently manage the cover pool.

(2) The term "eligible mortgages" shall mean performing first-lien mortgages on

one-to-four family residential properties, underwritten at the fully indexed rate6

and relying on documented income, and complying with existing supervisory

guidance governing the underwriting of residential mortgages, including the

Interagency Guidance on Non-Traditional Mortgage Products, October 5, 2006,

and the Interagency Statement on Subprime Mortgage Lending, July 10, 2007,

and such additional guidance applicable at the time of loan origination. Due to the

predictive quality of loan-to-value ratios in evaluating residential mortgages,

issuers should disclose loan-to-value ratios for the cover pool to enhance

transparency for the covered bond market.

(3) The term "covered bond obligation," shall be defined as the portion of the

covered bond transaction that is the insured depository institution's debt

obligation, whether to the SPV, mortgage bond trustee, or other parties.

(4) The term "covered bond obligee" is the entity to which the insured depository

institution is indebted.

(5) The term "monetary default" shall mean the failure to pay when due (taking

into account any period for cure of such failure or for forbearance provided under

the instrument or in law) sums of money that are owed, without dispute, to the

covered bond obligee under the terms of any bona fide instrument creating the

obligation to pay.

(6) The term "total liabilities" shall mean, for banks that file quarterly Reports of

Condition and Income (Call Reports), line 21 "Total liabilities" (Schedule RC);

and for thrifts that file quarterly Thrift Financial Reports (TFRs), line SC70 "Total

liabilities" (Schedule SC).

(b) Coverage. This policy statement only applies to covered bond issuances made

with the consent of the IDI's primary federal regulator in which the IDI's total

covered bond obligation as a result of such issuance comprises no more than 4

percent of an IDI's total liabilities, and only so long as the assets securing the

covered bond obligation are eligible mortgages or AAA-rated mortgage securities

on eligible mortgages, if not exceeding 10 percent of the collateral for any

covered bond issuance, Substitution for the initial cover pool collateral may

include cash and Treasury and agency securities as necessary to prudently manage

the cover pool.
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DEPARTMENT OF THE TREASURY

(c) Consent to certain actions. The FDIC as conservator or receiver consents to a

covered bond obligee's exercise of the rights and powers listed in 12 U.S.C. §

1821(e)(13)(C), and will not assert any rights to which it may be entitled pursuant

to 12 U.S.C. § 1821(e)(13)(C), after the expiration of the specified amount of

time, and the occurrence of the following events:

(1) If at any time after appointment the conservator or receiver is in a monetary

default to a covered bond obligee, as defined above, and remains in monetary

default for ten (10) business days after actual delivery of a written request to the

FDIC pursuant to paragraph (d) hereof to exercise contractual rights because of

such monetary default, the FDIC hereby consents pursuant to 12 U.S.C. §

1821(e)(13)(C) to the covered bond obligee's exercise of any such contractual

rights, including liquidation of properly pledged collateral by commercially

reasonable and expeditious methods taking into account existing market

conditions, provided no involvement of the receiver or conservator is required.

(2) If the FDIC as conservator or receiver of an insured depository institution

provides a written notice of repudiation of a contract to a covered bond obligee,

and the FDIC does not pay the damages due pursuant to 12 U.S.C. § 1821(e) by

reason of such repudiation within ten (10) business days after the effective date of

the notice, the FDIC hereby consents pursuant to 12 U.S.C. § 1821(e)(13)(C) for

the covered bond obligee's exercise of any of its contractual rights, including

liquidation of properly pledged collateral by commercially reasonable and

expeditious methods taking into account existing market conditions, provided no

involvement of the receiver or conservator is required.

(3) The liability of a conservator or receiver for the disaffirmance or repudiation

of any covered bond issuance obligation, or for any monetary default on, any

covered bond issuance, shall be limited to the par value of the bonds issued, plus

contract interest accrued thereon to the date of appointment of the conservator or

receiver.

(d) Consent. Any party requesting the FDIC's consent as conservator or receiver

pursuant to 12 U.S.C. § 1821(e)(13)(C) pursuant to this policy statement should

provide to the Deputy Director, Division of Resolutions and Receiverships,

Federal Deposit Insurance Corporation, 550 17th Street, NW, F-7076,

Washington DC 20429-0002, a statement of the basis upon which such request is

made, and copies of all documentation supporting such request, including without

limitation a copy of the applicable contract and of any applicable notices under

the contract.

(e) Limitations. The consents set forth in this policy statement do not act to waive

or relinquish any rights granted to the FDIC in any capacity, pursuant to any other

applicable law or any agreement or contract. Nothing contained in this policy
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DEPARTMENT OF THE TREASURY

alters the claims priority of collateralized obligations. Nothing contained in this

policy statement shall be construed as permitting the avoidance of any legally

enforceable or perfected security interest in any of the assets of an insured

depository institution, provided such interest is not taken in contemplation of the

institution's insolvency, or with the intent to hinder, delay or defraud the IDI or its

creditors. Subject to the provisions of 12 U.S.C. § 1821(e)(13)(C), nothing

contained in this policy statement shall be construed as permitting the conservator

or receiver to fail to comply with otherwise enforceable provisions of a contract

or preventing a covered bond obligee's exercise of any of its contractual rights,

including liquidation of properly pledged collateral by commercially reasonable

methods.

(f) No waiver. This policy statement does not authorize, and shall not be

construed as authorizing the waiver of the prohibitions in 12 U.S.C. § 1825(b)(2)

against levy, attachment, garnishment, foreclosure, or sale of property of the

FDIC, nor does it authorize nor shall it be construed as authorizing the attachment

of any involuntary lien upon the property of the FDIC. Nor shall this policy

statement be construed as waiving, limiting or otherwise affecting the rights or

powers of the FDIC to take any action or to exercise any power not specifically

mentioned, including but not limited to any rights, powers or remedies of the

FDIC regarding transfers taken in contemplation of the institution's insolvency or

with the intent to hinder, delay or defraud the institution or the creditors of such

institution, or that is a fraudulent transfer under applicable law.

(g) No assignment. The right to consent under 12 U.S.C. § 1821(e)(13)(C) may

not be assigned or transferred to any purchaser of property from the FDIC, other

than to a conservator or bridge bank.

(h) Repeal. This policy statement may be repealed by the FDIC upon 30 days

notice provided in the Federal Register, but any repeal shall not apply to any

covered bond issuance made in accordance with this policy statement before such

repeal.

By order of the Board of Directors

Dated at Washington, DC this ______ day of ______, 2008.

Federal Deposit Insurance Corporation

Robert E. Feldman

Executive Secretary

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BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 34

DEPARTMENT OF THE TREASURY

1 For ease of reference, the Interim Final Covered Bond Policy Statement,

published on April 23, 2008, will be referred to as the Interim Policy Statement.

The Final Covered Bond Policy Statement will be referred to as the Policy

Statement.

2 The FDIC understands that certain potential issuers may propose a different

structure that does not involve the use of an SPV. The FDIC expresses no opinion

about the appropriateness of SPV or so-called "direct issuance" covered bond

structures, although both may comply with this Statement of Policy.

3 See 12 U.S.C. § 1821(e)(13)(C).

4 See 12 U.S.C. §§ 1821(e)(3) and (13). These provisions do not apply in the

manner stated to "qualified financial contracts" as defined in Section 11(e) of the

FDI Act. See 12 U.S.C. § 1821(e)(8).

5 See 12 U.S.C. §1821(e) (12).

6 The fully indexed rate equals the index rate prevailing at origination plus the

margin to be added to it after the expiration of an introductory interest rate. For

example, assume that a loan with an initial fixed rate of 7% will reset to the sixmonth London Interbank Offered Rate (LIBOR) plus a margin of 6%. If the sixmonth LIBOR rate equals 5.5%, lenders should qualify the borrower at 11.5%

(5.5% + 6%), regardless of any interest rate caps that limit how quickly the fully

indexed rate may be reached.
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DEPARTMENT OF THE TREASURY

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BEST PRACTICES FOR RESIDENTIAL COVERED BONDS 36

DEPARTMENT OF THE TREASURY

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