Instruments could aid loan market liquidity, provide high-quality investments.
New legislation to set legal guidelines for a US covered bond market could be a boon for treasurers. The instruments have a long history in Europe, but uncertainty over their legal status here has kept the market from developing. If it does, this could be helpful for corporates in two ways.
Covered bonds are similar to asset-backed securities except that the entity that issues them, usually a bank, keeps the assets on its books, rather than selling them to a bankruptcy-remote vehicle. The assets are often corporate loans, and the pool is dynamically managed—reducing the risk that the securities will fall dramatically in value if their collateral deteriorates. The issuers, by definition, have skin in the game.
Covered bonds have tenors between two and 10 years, and they tend to be top-rated, so they could be useful additions to a pension investment portfolio. But they’re also a way to get liquidity into the loan market, since banks have to extend or buy the loans that back them, which can have favorable effects on the pricing and availability of credit.
However, as a market update on the legislation from the law firm Orrick notes, for the covered bond market to succeed it needs to be deep and liquid. It’s not yet clear whether the legislation introduced in the House on March 18 (the Garrett-Kanjorski-Bachus United States Covered Bond Act) will be sufficient to achieve that, but it is a reasonable start.