Covered Bonds

Key Highlights

• Covered bonds are a form of debt security issued by financial institutions, backed by a portfolio of high-quality assets like mortgage loans or public sector debt.

• Types of covered bonds includes hard bullet, soft bullet and conditional pass-through (CPT).

What is Covered Bonds?

Covered bonds are a form of debt security issued by financial institutions, backed by a portfolio of high-quality assets like mortgage loans or public sector debt. What sets them apart is the dual recourse protection they offer: if the issuer defaults, investors can seek repayment both from the issuing entity and the underlying asset pool, making them safer than unsecured bonds.

Types of Covered Bonds

• Hard Bullet: Must be repaid at maturity; failure triggers default, granting immediate access to the cover pool.

• Soft Bullet: Maturity can extend (typically up to 12 months) if repayment fails, reducing refinancing risk.

• Conditional Pass-Through (CPT): If unpaid at maturity, payments are made as assets are liquidated or mature, extending the payout period but lowering investor risk.

Benefits and Investor Protection

• Higher credit ratings than the issuer due to dual recourse and regulatory oversight.

• Offer stable, low-risk returns, appealing to conservative investors like pension funds, insurance companies, and central banks.

• Enable issuers to access cheaper funding and diversify funding sources compared to unsecured debt.

Regulatory and Legal Framework

• Subject to specific legislation in many countries, ensuring transparency, asset quality, and bondholder protection.

• Regulatory oversight ensures continuous asset coverage, allowing replacement of defaulted or prepaid assets to maintain credit quality.

Why it Matters?

Covered bonds provide a secure investment option with dual recourse and regulatory protections, making them a cornerstone of stable debt markets while offering issuers cost-effective funding solutions.