What are covered bonds?


These are best described as layered refinancing instruments – a sort of a hybrid between the usual mortgage-backed security and a traditional, secured bond issued by a company. However, a covered bond is considered a safer instrument than the traditional bond because the former assures additional cushion to the investor in the shape of claims on the dedicated assets pool of the issuer. Covered bonds are now getting media attention after the credit crisi at non-banking finance companies (NBFCs) that have had to pay significantly more to roll over short-term debt and change their borrowing mix.

1. Dual recourse instruments
These are dual recourse instruments that enable companies to issue non-convertible debentures (corporate bonds) with multiple notches higher than the base credit rating. Both balance sheet and a ringfenced pool of assets provide such dual recourse to the investor in these bonds. These are widely sold globally as they show resilience during turbulent market and economic conditions. These have different names in various countries, although they largely originated in Europe.

2. How do they benefit investors?

Unlike secured corporate bonds that provide recourse against the issuer, covered bonds give a dual recourse. Dual protection is ensured via the issuer’s balance sheet and a legally ring-fenced bankruptcy protected pool of assets. Due to the two-pronged support corporate bonds under the structure can be rated up to six notches higher than the issuer’s regular creditworthiness.

3. Benefits for issuers:
Through this a company can tap altogether a different investor base by issuing much higher rated debt papers.

4. Do covered bonds bear prepayment risk?
Covered bonds do not transfer prepayment risk to investors. It repays cash to investors on pre-fixed dates, not entirely dependent on the cash-flow structure of the collateral pool.

5. When did an Indian entity issue covered bonds?
A couple of months ago, rating company ICRANSE -0.32 % rated India’s first covered bond issuance with AA-(SO) grade. Kogta Financial India, actually rated as BBB+, about three-four notches lower than the covered bond grade, raised ₹25.73 crore by selling such securities. Non-Banking Financial Company, Northern Arc Capital, helped structure the issuance, while Sundaram Mutual Fund invested in it.