Securitised and covered bonds

Banks are the main issuers of securitised or covered bonds, bonds which are secured on assets from the regular and predictable income which companies receive from sources such as mortgages, loans, leases, trade receivables, credit card payments, etc.

Securitised bonds are issued by an entity separate from the owner of the cash flow and therefore can have a separate credit rating which may well be a higher rating than the company/bank as a whole is given. Thus, for example, a bank might set up a separate company which receives monthly income from 1,000 house mortgage payers. This separate company issues bonds secured against the mortgage rights it holds, and the bond interest is paid out of the mortgage receipts from 1,000 households. The interest on these bonds may be fixed at the time of issue or floating relative to a benchmark interest rate such as Libor, a standard rate of interest for loans.

Covered bonds are secured on the cash flows from mortgages, public sector loans or other loan receipts, but the assets (e.g. 1,000 mortgage rights) remain on the balance sheet of the issuer, usually a bank or financial institution, which retains control over them. Thus the covered bond holder has the security of both the assigned assets, e.g. the cash inflows from 1,000 mortgages, and the promise from the issuing firm to make good any shortfall if the securitised assets are not sufficient. Covered bonds usually are perceived as very low risk due to the reliability of the assets they can draw on.