Last week saw Westpac sell a new $400m 10-year covered bond – but what is a covered bond?
A covered bond is much like a normal bond – except that covered bonds are backed by the issuer as well as by a specific pool of assets, generally a pool of loans, which is known as the ‘cover pool’. In practice covered bonds generally have a tenor of between two and 10 years.
Because the assets backing the bonds are ring-fenced, easily identifiable and stay on the issuer’s balance sheet, the bonds tend to have a higher credit rating than bonds that are not covered, depending on the quality of the pool of loans backing the bond.
From an investor perspective, such bonds can be attractive because they are high-quality instruments that offer attractive yields. Covered bonds are viewed as defensive in nature and as a result, in a narrowing market, covered bonds might be expected to underperform senior debt.
From an issuer perspective, such bonds can be a low-cost way to expand the business in preference to issuing unsecured debt instruments.
In Australia in recent years, covered bonds have lost some of their popularity as the market has seen an increase in the issue of RMBS. So far this year, the five domestic banks have issued $14.2bn in covered bonds. RMBS differ from covered bonds in that while they are backed by a pool of mortgages, they are not backed by the mortgage provider.