Lesson 1 of 6 · 13 min
Covered bonds: dual recourse and a dynamic pool
A covered bond is senior bank debt backed by a ringfenced pool of loans that stays on the bank's balance sheet, so investors have a claim on the pool and, behind it, on the bank itself.
In short
- Covered bond: a senior debt obligation of a financial institution, backed by a segregated cover pool of assets, typically residential or commercial mortgages or public-sector assets.
- The loans stay on the issuer's balance sheet but are ringfenced. Investors have dual recourse: first to the cover pool, then to the issuer's unencumbered assets.
- Usually one bond class per cover pool, and the pool is dynamic: the issuer must replace prepaid or non-performing assets, and a third party monitors it.
- Extra protection: overcollateralization and LTV eligibility limits on the mortgages in the pool.
- Redemption regimes if the sponsor defaults: hard bullet (default and acceleration at once), soft bullet (new final maturity, usually up to a year later), conditional pass-through (turns into a pass-through).
- Result: covered bonds usually carry lower credit risk and lower yields than otherwise similar ABS.
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