Speaking on behalf of the Securities Industry and Financial Markets Association, which views CBs as "an untapped but proven resource," Stengel said such certainty was "critical. Invstors will not dedicate funds to this market unless the legal regime is unequivocal and the risks can be identified and underwritten."

To date, no such legal regime exists in the US, although it's not due to lack of trying. Shortly after the FDIC issued a policy statement on CBs in July 2008, Rep. Scott Garrett (R-NJ) introduced a CB bill. He reintroduced the legislation in 2009 and again on three separate occasions this year.

Garrett's current bill, H.R. 5823, would define a covered bond, establish parameters for CB programs, stipulate which institutions could issue them and map out what constitutes eligible assets for the pools covering the bonds. These would include first-lien residential mortgages, commercial mortgages, state or municipal loans or securities and loans made through SBA programs, among other assets.

Testifying before the same Senate committee, Garrett said CBs "will ensure more stable and longer-term liquidity in the credit markets, which reduces refinancing risks as well as exposure to sudden changes in interest rates and investor confidence. And they will allow US financial institutions to compete more effectively against their global peers." Added to which, he said, "covered bond legislation offers a way for the government to provide additional certainty to private enterprise and generate increased liquidity through the innovation of a new marketplace without putting the taxpayers on the hook.

"I don't pretend to believe that covered bonds are some sort of magic bullet that will help solve all of our funding needs," Garrett continued. "However, I do know that during a time of economic uncertainty, lack of liquidity and rising budget deficits, we must consider innovative approaches to help attract private investment back into our capital markets. I believe this legislation can help us in that regard."

Garrett will likely have to make his sixth go at CB legislation when the next Congressional session begins in January. The House Financial Services Committee passed Garrett's H.R. 5283 this past July, but the measure hadn't made it to the floor of the full House as of early November. In the Senate, Banking Committee member Sen. Bob Corker (R- TN) this past March introduced CB legislation as an amendment, but it didn't make the cut. Pinedo says she expects CB legislation will probably be enacted sometime in 2011, especially now that passage of Dodd- Frank is out of the way.

It's not any hot-potato aspect that has kept a domestic CB statute from clearing all the legislative hurdles. Rather, it's been lack of familiarity here with the CB structure and, until recently, a lack of compelling need for alternatives to the existing channels. On mortgage funding, for instance, banks have long been able to look to government-sponsored entities as well as the Federal Home Loan Banks, and thus they tapped into the securitization market. European countries have no real equivalent to the GSE structure, and partly as a result CBs playa more dominant role overseas.

Today, the future of the GSEs is far from certain, and the 2008 capital markets crisis left financial institutions worldwide with liquidity issues that they're still trying to overcome. Amid this crisis, CBs held up better than CMBS, Pinedo pointed out at a MoFo panel discussion in October. She noted that the liquidity crisis and other factors represented "a coalescence of events" that have spurred newfound domestic interest in the bonds.

In fact, two major US banks did introduce CBs prior to the downturn: for CB issue in the US. The CB trust is one tier, while the bank/mortgage bond issuer represents the upper

tier. This work-around is intended to prevent an acceleration of the CBs. "We wouldn't need this complexity if we had legislation, because then there would be certainty, post-receivership, that the covered bond pool would continue to exist and the covered bonds wouldn't accelerate," says Pinedo.

SIFMA cites several reasons for supporting CBs, and therefore enacting the appropriate legislation. Among them: CBs represent stable liquidity, offer a cost-efficient form of onbalance-sheet financing for financial institutions and entail a high degree of transparency and uniformity.

The fact that CBs would represent a source of funding from private-sector capital markets rather than the public sector (i.e. taxpayers) is also a plus, according to SIFMA. Additionally, CBs represent" 100% skin in the game," according to the association, because, in contrast to securitization, a financial institution issuing the bonds continues to own the assets in the cover pool that are pledged as security.

CBs differ from CMBS in a number of ways. For one thing, they're simpler. "There's no trancheing, interest-only or other complicated pieces," Pinedo said at October's panel discussion. Unlike RMBS or CMBS, CBs have a fixed maturity, and therefore there's no risk of acceleration due to prepayment of the mortgage assets backing the bonds.

And as opposed to the static pool of assets underpinning mortgage backed securities, CBs are secured by a "dynamic" pool of high-quality collateral. Assets can be added to a CB's "cover pool," or taken out as necessary to maintain the pool's coverage requirements. That provides an upside for investors in terms of protection from investments going sour.

In addition, should a CB deal go into receivership, investors have recourse to both the bond's issuer and to the pool. That isn't the case with CMBS. Nor is there acceleration of the bonds if the issuer becomes insolvent.

What happens to the assets in the event of insolvency is a bone of contention as far as the FDIC is concerned. The agency says it wants post-bankruptcy access to the assets through its repudiation powers, arguing that a bank's depositors are encumbered by too much risk if the pools fence off a large portion of the bank's assets from being claimed. "We support covered bond legislation, but not at the expense of our obligation to protect the deposit insurance fund," FDIC deputy to the chairman Michael H. Krimminger told the New York Times in November.

Should the FDIC's position prevail, it would eliminate "the unique level of market-value risk found in the US, but would not put US covered bonds on a level playing field with their European counterparts," Moody's Investors Service noted in a recent update. "The ability of the FDIC to repudiate at all introduces prepayment risk that traditional covered bond investors do not want."

Pinedo predicts that once CB legislation is enacted, a US regulatory regime would likely be developed soon thereafter. She says the statutes in many European jurisdictions could serve as a good frame of reference for developing CB regulation here.

At the MoFo panel discussion, Jerry Marlatt, senior counsel in the capital markets practice, predicted that regional lenders would make widespread use of CBs, more so than money-center banks. He pointed out that for issuers, CBs offer more flexibility regarding collateral than does CMBS, and with longer maturity periods, generally seven to 10 years-and prior to the credit crisis some ran even longer than that-CBs can help banks extend the maturity of their wholesale debt.

For investors, Marlatt said, CBs are viewed as safe investments, comparable to sovereign debt or agency debt. In fact, panelists pointed out that CMBS and CBs really appeal to two different classes of investors, with CBs generally appealing mainly to banks, central banks, funds and insurance companies.

Typically, CB buyers will not buy asset-backed securities of any kind, or any type of secure bank debt. Some are likely, however, to buy GSE debt.

It's not clear what role the post crisis GSEs would play in a domestic CB market, and Pinedo says, "Many market participants tell us that the lack of clarity regarding the future of the GSEs also impedes an active covered bond market from developing." Some have speculated that Fannie Mae and Freddie Mac could issue CBs of their own, while others suggest that a Fannie- or Freddie- type entity could provide a guarantee of sorts to bonds issued by regional banks as a way of encouraging mortgage lending. "But there is too much uncertainty regarding the GSEs to make an educated guess," she adds.The new regulatory regime under Dodd-Frank does not present anything that impedes the development of an active covered bond market, says Pinedo. "On the contrary, Dodd- Frank will so substantially change the landscape for securitization, that banks and other financial institutions may begin to look more closely at viable alternatives or supplements to securitization."

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