The recent global meltdown
has adversely impacted the
ability of banks and financial institutions to raise
funds through securitization products and innovative unsecured debt
instruments. In fact, almost all other forms of funding have
dried up except for the covered bond market, which has not
suffered quite as much.
Banks, looking for sources of medium and long-term
funding, are, therefore, increasingly considering covered bonds as an
alternative to securitization transactions. While covered bonds provide
an alternative financing tool, their use also diversifies a bank's
overall funding portfolio. Although these bonds have been in use for a
long time and proved very popular in Europe, until recently they
were not a significant feature in other markets of the world.
Covered bonds are secured debt instruments issued by
regulated financial institutions. The issuer pledges high quality assets,
typically high quality mortgage loans or public sector debts, as
collateral to secure or `cover' the bonds in the event the issuer
becomes insolvent. The mortgages (cover pool) securing covered bonds
remain on the issuer's balance sheet. Non-performing loans
or prematurely repaid debts in the cover pool are replaced by
performing assets. Interest on the covered bonds is paid to
investors from the issuer's general cash flows, while the cover pool
serves as secured collateral. This cover pool consists of a portfolio of
performing residential mortgage loans that meet specified
underwriting criteria and are actively managed by the issuer to
meet certain criteria. If assets within the cover pool become
non-performing, they must be replaced with performing assets. |
