Everything One Needs to Know About Covered Bond Markets

iQuanti: Covered bonds have been popular in Europe for many years. Washington Mutual became the first U.S. bank to issue euro-issued covered bonds in 2007. Since then, interest in covered bonds has picked up across the United States.

Covered bond markets can be complex. But, people who understand these markets can decide if covered bonds can help them achieve their investment goals. Plus, they can begin to recognize how covered bonds can influence the U.S. real estate market now and in the future, for both residential and commercial real estate lending.

What Are Covered Bonds?

A covered bond consists of a package of loans issued by a bank. This package is sold to another financial institution, which offers it to investors. At the same time, the bank that sold the package manages the loans it encompasses. As such, the package offers an extra layer of protection, since it involves multiple financial institutions.

How Do Covered Bonds Work?

Covered bonds are classified as derivative investments. They work in a similar way to asset- and mortgage-backed securities. However, covered bonds generally offer greater security relative to these alternative investment options.

A typical covered bond includes a cover pool, i.e. a collection of mortgages or public-sector loans. Thus, the bond can generate cash flow in the same way as asset-backed securities.

Comparatively, the loans included in a cover pool remain on the balance sheet of the issuing bank. So, if you buy a covered bond from a bank that goes bankrupt, you can retain access to your cover pool. This also means you'll still likely to get to interest-rate payments when your covered bond matures.

How Much Money Can You Earn from a Covered Bond Investment?

Covered bonds often earn a fixed interest rate. Some even provide an offer to "step up" your rates if there is a designated "credit event" like exercising a call option.  

Review the terms of a covered bond investment before committing any funds. Ask questions to learn as much as possible about the bond and the potential return associated with it. This can help you weigh the pros and cons of investing in a covered bond.

Where Can You Buy a Covered Bond?

Covered bonds are readily available in Europe. For instance, you can find covered bonds called "Pfandbriefe" on the Frankfurt Stock Exchange.

Several U.S. banks have issued covered bonds. These banks include:

  • Bank of America
  • JPMorgan Chase
  • Wells Fargo
  • Citigroup

European banks have shown interest in offering euro-based covered bonds in the United States. Yet, none of these banks have entered the U.S. covered bond markets yet.

Should You Invest in the Covered Bond Markets?

Before you invest in covered bonds, consider the immediate and long-lasting ramifications of doing so. You may discover that the covered bond markets have far-flung effects on investors and the U.S. economy. 

Banks use covered bonds to free up capital. Then, they can use this capital to extend more mortgages to customers and pursue other financial activities to stimulate revenues and growth.

Covered bonds can free up funds for infrastructure development, too. The bonds can reduce the financial strain on local, state, and federal government agencies, which can lead to infrastructure enhancements.

Evaluate the Covered Bond Markets

A covered bond is one of many investment vehicles to consider. Examine this type of bond carefully, and you can get the insights you need to decide whether to move forward with it.

Source: iQuanti, Inc.