A deep and liquid US covered bond market would be positive for bank funding but could interfere with the Federal Home Loan Banks (FHLB) system, according to Moody’s, while Fitch has criticised a Federal Deposit Insurance Corporation covered bond issuance limit for preventing covered bonds from becoming a viable alternative funding option.

Moody’s suggested that FHLBanks’ advance lending programmes would suffer from competition with a robust covered bond market. It said that if covered bonds were to be offered as an alternate funding tool, this could reduce the “overall footprint and profitability” of FHLBanks.

Moody's, New York

The rating agency also cautioned that during periods of greater stress, too much reliance on the covered bond market might have negative consequences for the US housing finance market.

In a recent Fitch report on US covered bonds that was cited by Representative Carolyn Maloney in a House Financial Services Subcommittee hearing last Friday, the rating agency’s primary concern was the current FDIC limit on covered bonds issuance at up to 4% of total assets. Assuming all banks meet this maximum issuance, the total would represent 11% of mortgage securitisations outstanding for Fannie Mae and Freddie Mac.

Fitch was also concerned that US investors might be hindered by single name investment limitations if they view covered bonds as a form of bank exposure. This would further restrain covered bond issuance, according to Fitch, and prevent the covered bond market from gaining traction.

“It is unlikely that smaller institutions would be able to actively engage in the covered market,” added Fitch.

Source: FDIC, Fannie Mae and Freddie Mac public filings, Fitch Ratings.

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