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Covered Bonds, Final Policy Statement from the FDIC

Real Estate and Finance Alert | July 29, 2008
By: Timothy E. Davis, Nancy Sabol Frantz, and Clark D. Robertson

On July 15, 2008, the Federal Deposit Insurance Corporation (“FDIC”) approved its Final Policy Statement (the “Statement”) with respect to the issuance of covered bonds by insured depository institutions (“IDIs”).  Covered bonds are general obligation bonds of an IDI secured by underlying “eligible mortgages.”  Significantly, the eligible mortgages, which are the primary source of repayment for the bondholders, remain on the IDI’s balance sheet. 

While covered bonds are relatively new to the United States, they have existed in Europe for some time.  The Statement, a step toward encouraging the issuance of covered bonds in the United States, sets forth how covered bonds are to be treated in the event an IDI fails and the FDIC steps in to run the failed IDI.   

The Statement is the product of the comment and review process the FDIC commenced on April 23, 2008 with an initial statement on covered bonds.  The FDIC apparently received about 130 separate comments from various institutions and individuals covering a wide variety of topics.  

The FDIC elected to limit the definition of “eligible mortgage” despite proposals that it be expanded to include other asset types, including mortgages on commercial properties, second-lien home equity loans and credit card receivables.  An “eligible mortgage” is defined as a first-lien mortgage on a one to four family residence that is underwritten at the fully indexed rate and relies on documented income. 

Only time will tell (i) whether covered bonds will gain widespread acceptance in the United States, and (ii) whether the definition of “eligible mortgage” will remain static or be expanded in the future to include other types of debt instruments.  Early indications, based on recent comments by Treasury Secretary Paulson, are that several of the larger banks in the United States are preparing to utilize covered bonds to help invigorate the current financial market.

The Statement is available from the FDIC website under “Press Releases” at http://www.fdic.gov/ 

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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