How do covered bonds differ from residential mortgage-backed securities, commercial mortgage-backed securities, and asset-backed securities

Question

What will be an ideal response?

Answer 1

Covered bonds work as follows. Investors in covered bonds have two claims. The first is a claim on the cover pool. At issuance, there is no legal separation of the cover pool from the assets of the issuing bank. However, if subsequently the issuing bank becomes insolvent, then at that time, the assets included in the cover pool are separated from the issuing bank's other assets for the benefit of the investors in the covered bonds. The second claim is against the issuing bank. Because the covered pool includes high-quality mortgage loans and is issued by strong banks, covered bonds are viewed as highly secure bonds, typically receiving a triple A or double
A credit rating. Covered bonds can be issued in any currency.

Covered bonds in many countries are created using the securitization process. For that reason, covered bonds are often compared to residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), and other asset-backed securities (ABS). The difference between these securities created from a securitization is fourfold.

First, at issuance, the bank that originated the loans will sell a pool of loans to a special purpose vehicle (SPV). By doing so, the bank has removed the pool of loans from its balance sheet. The SPV is the issuer of the securities. In contrast, with covered bonds, the issuing bank holds the pool of loans on its balance sheet. It is only if the issuing bank becomes insolvent that the assets are segregated for the benefit of the investors in the covered bonds. The second difference is that investors in RMBS/CMBS/ABS do not have recourse to the bank that sold the pool of loans to the SPV. In contrast, covered bond investors have recourse to the issuing bank. The third difference is that for RMBS/CMBS/ABS backed by residential and commercial mortgage loans, the group of loans, once assembled, does not change, whereas covered bonds are not static. Finally, covered bonds typically have a single maturity date (i.e., they are bullet bonds), whereas RMBS/CMBS/ABS typically have time tranched bond classes.