Covered Bond

Covered Bond

covered bond is a debt obligation backed by a segregated pool of assets called a “cover pool”. Covered bonds are similar to securitized bonds but offer bondholders additional protection if the financial institution defaults. A financial institution that sponsors securitized bonds transfers the assets backing the bonds to a SPV. If the financial institution defaults, investors who hold bonds in the financial institution have no recourse against the SPV and its pool of assets because the SPV is a bankruptcy-remote vehicle; the only recourse they have is against the financial institution itself. In contrast, in the case of covered bonds, the pool of assets remains on the financial institution’s balance sheet. In the event of default, bondholders have recourse against both the financial institution and the cover pool. Thus, the cover pool serves as collateral. If the assets that are included in the cover pool become non-performing (i.e., the assets are not generating the promised cash flows), the issuer must replace them with performing assets. Therefore, covered bonds usually carry lower credit risks and offer lower yields than otherwise similar securitized bonds.