What are covered bonds?
Covered bonds represent a type of debt securities issued by banks or Non-Banking Financial Companies (NBFCs), which are backed by a pool of assets. These bonds assure investors that in the event of the issuer's default, the funds can be recovered from the collateralized pool of assets.
The structure of a covered bond is as follows:
- The bank or NBFC issues bonds to investors.
- A cover pool consisting of secured loans is established as a precautionary measure.
- At the bond's maturity, the bank or NBFC repays the principal amount plus interest to the investors.
- If the issuer fails to make the payment, the amount can be recovered from the cover pool.
- The cover pool typically comprises various types of secured loans such as housing, vehicle, gold, and others.
Covered bonds provide dual recourse, unlike secured corporate bonds that only offer recourse against the issuer. This means that investors have a first recourse against the issuer and a bankruptcy-protected recourse against the issuer's assets (the cover pool). Due to this additional layer of security, covered bonds generally receive higher credit ratings than the issuer's standalone rating.
Did you know? Covered bonds cannot be pledged as collateral with Zerodha. The list of approved instruments that can be pledged for margins and the applicable haircut % can be found in this list (DOC).