Covered Bond Structuring Alternatives

What are the covered bond structures?

• On-balance sheet
• SPV guarantors
• Special banks
• Pooled issuers

How does the on-balance sheet model work?

The assets that back the bond are simply entered into a register that is maintained until it is needed (the failure or resolution of the issuer). The register forms the basis of a separate legal pool that can be segregated and used to service the bonds.

What are the issues with the on-balance sheet model?

• Some jurisdictions don’t easily accept the concept of ring-fencing assets
• Special status has some practical issues that need to be addressed
• It’s difficult to enter into the swap that most issuers use to protect the holders of covered bonds

How does the SPV guarantors model work?

A separate company is set up. It buys the assets from the bank and uses them as the basis for a guarantee. If the bank fails, the separate company becomes the primary source of repayment of the bonds.

What are the benefits and required considerations for using this structure?

Benefits

• This legal entity can enter into swaps
• There is no uncertainty about who owns the assets in insolvency

Considerations

• You need to be able to transfer the assets in the first place
• The separate company needs to be part of the issuing group for all practical purposes

What is a Special Bank, and what are its disadvantages?

This is an independent bank, owned by a regular bank that exists purely to manage the assets that are funded by covered bonds. This can achieve a much higher degree of legal and operational independence.

Disadvantages

• Expensive
• Time consuming
• Requires close supervision to work well

How does the Pooled Issuers model work?

This involves an agency which issues bonds and then uses the proceeds to on-lend to smaller banks who use the cover pool assets as security for the loan. This is used extensively in Switzerland and France.