Further to the recent financial crisis, it is agreed that investment vehicles that are highly leveraged with little security may be gone forever in organized covered markets. Of course, whenever something is taken away it is replaced by something new. That new tool here is the covered bond.
The long-term debt securities of covered bonds are secured by specific assets determined by the bond issuer. Should the balance of those assets not be enough to cover a bondholder’s repayment at maturity, they have an unsecured claim against the issuer for the shortfall. A knowledgeable professional may compare covered bonds to secured bonds. Secured bonds are different in that the “cover” assets of the bond issue are not “fenced” to ensure future security.
Research shows that covered bonds have historically been a tool in Europe and have only been extended to North America and Asia in recent years. In fact, US issuers entered this market in 2006 with an offering by Washington Mutual. Growth of such issues skyrocketed from that time until the global financial crisis.
During the recent financial crisis there was a great deal of publicity for securitization or the pooling of contractual debt, such as mortgages. The purpose and benefits of covered bonds and securitization are similar in that both are liquid investments that also offer investors a lower level of risk.
A major difference is in regards to the asset pool; in securitization, the asset pool is fixed, whereas the covered bonds asset pool is segregated to pay the bondholders’ claims. If the assets are insufficient to pay the covered bonds, the investors have legal claims to recoup the balance of investment.
In sum, covered bonds and securitization are both alike and different. Covered bonds, although not new financing tools, are relatively recent in today’s financial market, and it is up to the promoter/investor to decide which to choose.
Always make sure that you make an informed decision in all cases,
All the Best,