Attempts to address concerns surrounding the US Covered Bond Act of 2011 are set to take place ahead of a full hearing of the House Financial Services Committee, after its Capital Markets & Government Sponsored Enterprises subcommittee passed the bill with only two “non-controversial” amendments yesterday (Tuesday).

The two amendments were put forward by the sponsors of the bill, Republican Scott Garrett, who chairs the subcommittee, and Democrat Carolyn Maloney.

However, John Campbell, a Republican Representative from California, said that he was “not thrilled” about the bill but did not have an amendment to propose because he had not had sufficient time to prepare one.

“I have concerns about this because of the way that covered bonds work, because of the substitution of collateral issue,” he said. “So you’ve got this pool of mortgages upon which Wall Street loans money to the bank and then if one of those mortgages goes bad the bank has to take a good mortgage out of the bank and put it in the pool and then the bad mortgage goes over into the bank.

Congressman John Campbell

“So if you have a situation like we had in 2008 where a lot of things are going bad, then the Wall Street loans on this, they have to be covered by the bad loans going into the bank and good loans coming from the bank going into this pool. Therefore, potentially – which is why the FDIC has concerns with this – because it potentially creates a problem for the security of that bank and for eventually the FDIC and potentially even taxpayers if you have a bad situation.”

He said that while the two amendments improved the original version of the bill, he was not prepared to support the legislation yesterday. He suggested two limitations be placed on issuance.

“One would be on how much of that substitution of collateral you can do,” he said. “I attended the hearing on this subject, and I get that the investors want as riskless an investment with a return as they can get – we all want that, that’s great, that’s wonderful, that’s fine – but I don’t want that risk put off on the bank, on the FDIC, and potentially the taxpayer.

“So there should be some kind of limitation that at some point we don’t switch this collateral out anymore. If there is a bunch of loans and 50% of them go bad, well, you know, if that many of them go bad, you Mr Investor, are just going to have to take that risk, and we’re not going to swap anymore out anymore.”

He said that a second limitation should be on issuance relative to the size of the bank’s balance sheet.

“A second limitation I would like to see is something that the bank can only do a certain percentage of their assets or their liabilities or their capital on a covered bonds… so that again, you don’t have a potential where a lot of stuff goes bad and then it gets diverted over to the bank and you really, really weaken that bank,” said Campbell. “If you’ve only got 3%, 4% covered loans of, let’s say, of a bank’s assets in covered bonds and all of them go bad, you can’t have more than 4% of the bank go down. You can’t pull more than 4% good assets out of the bank into the cover pool.

“But if you have 20%, you could suck 20% of the bank’s good assets out and now you’ve got a problem.”

Garrett pointed out that the bill gives regulators the ability to set such limits, but Campbell said that he would prefer any limits to be statutory.

Garrett and Maloney had already said that they are open to exploring avenues to address ways in which such concerns among members of the committee, the Federal Deposit Insurance Corporation and others might be addressed through changes to the bill before it is discussed by the full House Financial Services Committee.

“We have reached out to – and they have reached out to us – to the regulators and specifically to the regulator that you referenced as well, to try to hear what their concerns are and understand that they have the concerns, some of which you listed there,” said Garrett. “And what we’d like to do is to continue the dialogue between now… and the full committee markup, and keep involved all those folks.”

This appeared to satisfy Maxine Waters, the ranking Democrat member of the subcommittee, who had also cited concerns about the bill.

“In marking up this bill in subcommittee and working towards full committee consideration of this legislation, I’m very concerned about accommodating the concerns of regulators to the greatest extent possible,” she said. “In particular, the FDIC has raised the concern that covered bonds present risk to the Deposit Insurance Fund when they try to resolve a failed institution.

“Given the new resolution responsibilities provided to the FDIC under the Dodd-Frank Act, we must ensure that their ability to protect the DIF is protected. I know that during the last Congress you were able to accommodate many of these concerns through your work with Congressman Kanjorski and others. I hope that you are similarly willing to work with me and others on balancing the needs of the FDIC with your preferences for how to design a covered bond market in the US.”

The two amendments were not discussed in any detail, with Maloney describing hers as “basically a clarifying amendment” and Garrett’s as “really totally non-controversial”. However, Garrett said that his amendment, among other things, “conforms [sic] the FDIC’s authority to recover losses through existing law” and “clarifies how the cover pool is treated during the FDIC’s exclusivity period”.

The bill was passed by voice vote and Garrett said it would be “favourably reported to the full committee”. He also said that there could be progress on covered bonds in the Senate.

“I’m optimistic about this actually getting over to the Senate as well,” he said.

In mid-March Democrat Senator Charles Schumer said that he was considering introducing a covered bond bill in the Senate.