Covered bond

Covered bonds are debt securities backed by cash flows from mortgages or public sector loans. They are similar in ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet (usually with an appropriate capital charge). The covered bonds continue as obligations of the issuer (often a bank); in essence, the investor has recourse against the issuer and the collateral, sometimes known as "dual recourse." However, there exist other variable types where assets come off balance sheet. As of 2012 volume of outstanding covered bonds worldwide was euro2,813 billion, while largest markets were Germany (€525 bil.), Spain (€440 bil.), Denmark (€366 bil.) and France (€362 bil.).

Detailed explanation

A covered bond is a corporate bond with one important enhancement: recourse to a pool of assets that secures or "covers" the bond if the originator (usually a financial institution) becomes insolvent. These assets act as additional credit cover; they do not have any bearing on the contractual cash flow to the investor, as is the case with Securitized assets. Before the outbreak of the Financial Crisis in 2008, this enhancement typically (although not always) resulted in the bonds being assigned AAA credit ratings. Due to the realization that many of the loans backing these bonds were of a low quality, credit ratings declined sharply. This diminished the demand for all the types of asset backed or covered bonds, contributing to the Global Financial Crisis.