Covered Bond
AdvancedA covered bond is a bond issued by a bank and backed by a dedicated pool of high-quality assets, usually mortgages or public sector loans, which gives investors a claim on both the bank and the asset pool.
Covered bonds provide dual recourse. If the issuing bank fails, investors have a priority claim on the cover pool of assets. If the cover pool is insufficient, they also have a claim on the bank’s other assets.
Unlike securitizations, the assets stay on the issuing bank’s balance sheet, and the bank must replace any assets that default or no longer meet quality standards, keeping the pool’s value above the bonds outstanding.
For example, a bank might issue covered bonds backed by a pool of residential mortgages worth more than the bonds, with strict limits on loan-to-value ratios.
Covered bonds have a long history in Europe, dating back to Prussian Pfandbriefe in the eighteenth century, and are widely used in Germany, Denmark, France, Spain and many other countries. They are typically rated highly, pay relatively low interest and receive favourable regulatory treatment. They remained a reliable source of funding for banks even during the 2008 financial crisis. They are much less common in the United States.
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