Covered bonds are asset backed debt instruments secured by pool of loan assets to protect investors in case of insolvency of the bond issuers. Credit rating of these bonds are generally few notches above the rating of issuer.
In current scenario, housing finance companies(HFCs) and NBFCs are major issues of these bonds in India.
It differs from traditional securitized debt instruments in following aspects:-
Ø In case of covered bonds assets and related credit risk retained on issuer’s balance sheet while in case of securitized debt papers underlyingasset pool is off balance sheet item
Ø In the event of insolvency, investors have claim on both underlying pool and issuer of the bond
Ø Underlying pool is dynamic i.e. assets can be changed to maintain quality while in case of securitized debt instruments pool is generally static. In case of isuer’s insolvency, asset pool becomes static.
Benefits for investors
Ø Investors have access to higher rated papers than original rating of the issuer.
Ø In case of bankruptcy, investors have dual recourse i.e. recourse on covered pool assets and unlimited unsecured claim on issuers asset.
Ø Underlying asset pool is over collatarized as compared to total issuance amount along with some amount of cash collateral.
Advantage for issuers
Ø Issuers are able to attract borrowers due to higher ratings of covered bonds as compared to issuer rating. For example an A rated issuer can issue AA+ rated covered bonds. Consequently cost of borrowing beomes cheaper.
Ø Issuances of covered bonds enables issuer to diversify funding mix.
Repayment
Issuer makes coupon and redemption payments from its operating cash flow or refunding. In case of issuer insolvency, cash flow from the collateral in the cover pool is used to satisfy the claims of investors.
Covered bond with Market Linked Debenture(MLD) Feature
If a covered bond is embedded with MLD feature, its principal is protected while it can yield higher return in case of specified favourable market condition.
