A type of bond that provides its holder, in addition to the recourse to the issuer, with a preferential claim to a separate “cover pool” of mortgage loans or other high quality assets, that would be isolated and treated separately from those of the issuer in the case of liquidation or bankruptcy.
Covered bonds are debt securities issued by a bank or mortgage institution (other regulated institutions) and collateralized against a pool of assets (cover pool) that, in case the issuer falls into default, can cover bondholders’ claims at any point of time.
The loans in the cover pool are originated and managed (that is, sold, replaced or substituted) by the issuer or originator (an SPV created by the issuer). Payment of interest on the bonds and the repayment of principal are guaranteed by ring-fencing (isolating) the assets in the respective pool from other assets of the issuer. This ensures the assets in the cover pool are placed at the disposal of bondholders on a priority basis, and are not affected by the insolvency of the issuer.
Covered bonds are similar to securitized bonds, except that cover bond bondholders would have recourse to both the respective pool of assets and to the issuer itself, as opposed to securitized bonds in which the bondholders have recourse only to the underlying collateralized assets.
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