They are rare in the United States, although variations of covered bonds have been used in Europe for centuries. Although covered bonds are not a prohibited form of debt contract in the United States, some observers believe that legislation and agency rulemaking is required to facilitate the growth of a larger domestic covered bond market. In other countries, covered bonds conforming to statutorily prescribed features may receive enhanced protections. For such statutorily protected covered bonds, according to the European Central Bank (ECB), the closest thing to a shared definition is European Covered Bond Council's "essential features of covered bonds," which includes four elements: (1) the bond is issued by (or bondholders otherwise have full recourse to) a credit institution which is subject to public supervision and regulation; (2) bondholders have a claim against a cover pool of financial assets in priority to the unsecured creditors of the credit institution; (3) the credit institution has the ongoing obligation to maintain sufficient assets in the cover pool to satisfy the claims of covered bondholders at all times; and (4) the obligations of the credit institution in respect of the cover pool are supervised by public or other independent bodies. Therefore, covered bonds typically tie up more capital than typical securitizations. Covered bonds might be less subject to investor loss of confidence than securitization because covered bond issuers maintain a long-term interest in the underlying loans and because the exposure of banks to covered bonds remains recorded on their balance sheets. If the underlying loans default, the financial institution is still responsible for payments to the holders of the covered bonds. Policymakers could change the relative capital treatment of securitized assets and covered bonds. Agency Actions on Covered Bonds

In response to mortgage market turmoil in 2007 and 2008, the Treasury Department and the FDIC considered rulemaking to encourage the use of covered bonds as an alternative to mortgage securitization. FDIC Financial Institution Letters

In the United States, the FDIC resolves financial problems of failing banks with insured deposits. 940 would have created a statutory framework for covered bonds in the United States similar to programs in Europe that distinguish contractual from statutory covered bonds. 940 , the term covered bond would have meant any recourse debt obligation of an eligible issuer that (1) has an original term to maturity of not less than one year; (2) is secured by a perfected security interest in or other lien on a cover pool that is owned directly or indirectly by the issuer of the obligation; (3) is issued under a covered bond program that has been approved by the applicable covered bond regulator; (4) is identified in a register of covered bonds that is maintained by the Secretary; and (5) is not a deposit (as defined in section 3(l) of the Federal Deposit Insurance Act (12 U.S.C. There may be instances in which an issuer of covered bonds is placed in receivership or conservatorship before the issuer defaults on any covered bond payments.
Covered bonds are a relatively common method of funding mortgages in Europe, but uncommon in the United States. A covered bond is a recourse debt obligation that is secured by a pool of assets, often mortgages. The holders of the bond are given additional protection in the event of bankruptcy or insolvency of the issuing lender. Covered bonds have some features, such as pooled mortgages, that resemble securitization, but the original lenders maintain a continuing interest in the performance of the loans. Because some believe that the subprime mortgage turmoil may have been influenced by poor incentives for lenders using the securitization process, some policymakers have recommended covered bonds as an alternative for U.S. mortgage markets. Although covered bond contracts are not prohibited in the United States, some policymakers believe that legislation and agency rulemaking could facilitate the growth of a domestic covered bond market.
In some countries, covered bonds conforming to statutorily prescribed features may receive enhanced protections or greater regulatory certainty. A statutory framework for covered bonds often includes four elements: (1) the bond is issued by (or bondholders otherwise have full recourse to) a credit institution that is subject to public supervision and regulation; (2) bondholders have a claim against a cover pool of financial assets in priority to the unsecured creditors of the credit institution; (3) the credit institution has the ongoing obligation to maintain sufficient assets in the cover pool to satisfy the claims of covered bondholders at all times; and (4) in addition to general supervision of the issuing institution, public or other independent bodies supervise the institution's specific obligations to the covered bonds. Some analysts include the presence of such a statutory framework in the definition of a covered bond, in which case there have not been any covered bonds issued in the United States (and many so-called covered bonds issued elsewhere would also no longer be rightfully called covered bonds).
Compared with securitization, covered bonds may be less susceptible to poor underwriting standards because issuers maintain risk exposure or "skin in the game," perhaps minimizing problems of the "originate to distribute" model of lending. Institutions that issue covered bonds may be less susceptible to investor panic because the status of covered bonds on their balance sheet is transparent. On the other hand, reliance on covered bonds may reduce aggregate lending because it ties up more capital than does securitization.
Potentially, there could be some regulatory uncertainty on the treatment of holders of covered bonds when the Federal Deposit Insurance Corporation (FDIC) places banks in receivership or conservatorship. To address some of these concerns, the FDIC issued two policy statements in 2008 clarifying its obligations to the holders of covered bonds if an FDIC-insured institution is placed in FDIC receivership or conservatorship. Because the use of covered bonds in the United States is rare, there is still little experience in actually resolving a covered bond.
This report will be updated as conditions warrant.