InvestorQ : What are covered bonds and Should I invest?
vani Patil made post

What are covered bonds and Should I invest?

Anjali Desai answered.
1 year ago
See, if I begin explaining the entire structure, it is going to take a while. So, I will give a general understanding for now.

  • At first, an NBFC issues loans to its borrowers.
  • This NBFC then pools these loans into a package and assigns them to a Special Purpose Vehicle (SPV Trust). These loans could be a gold loan, vehicle loans, or be it any loan. An exclusive first charge is created over this pool of assets in favor of the SPV trust.
  • And then, covered bonds are issued against this collateral pool of loans.
  • So basically, the pool of assets acts as collateral for the Covered Bonds. The collateral value should keep a margin that shall be higher than the quantum of covered bonds, say for 60% loan amount, 100% value of the collateral is required the entire amount of covered bonds shall be repaid on the date of maturity, and NBFC takes back the pool of assets.
What is SPV?
SPV is a Special Purpose Vehicle Trust that is created for securitization. Under this, an originator transfers the loan in its book to the Trust, which in turn issues bonds/ securities to the public. The issuing NBFC is responsible for making interest and principal repayments from its cashflowsIfif the issuing NBFC defaults in repayment you have a charge over that pool of assets, so you can recover your money from that pool of assets/loans created by the SPV.

Should you buy it?
The outlining is that these covered bonds are secured bonds, however, these bonds are issued by NBFCs that have a low credit rating. Why? Because it is obvious that no highly rated NBFC is going to from you at higher rates when they could have easy access to lower rate loans. So, these bonds are generally BBB-rated. Therefore, the chances for default increase. Since each covered bond is different, and you are lending your money to a single NBFC, that may have poor quality assets, so the chances of failure are many folds.