Valuation models
Covered bonds
The issuer's default from its unsecured spread, then repayment from the cover pool at its overcollateralization less a fire-sale haircut, with the shortfall as an unsecured claim; soft bullets and conditional pass-throughs sell the pool over the extension. Compared with the issuer's unsecured bond and the riskless bond, with the z-spread and CS01.
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Methodology
Conventions
- Dual recourse: the issuer pays while it survives (a hazard from its unsecured spread).
- On the issuer's default, holders are paid from the cover pool at overcollateralization × (1 − haircut); any shortfall ranks as senior unsecured.
- A soft bullet or conditional pass-through sells the pool over the extension, at a smaller haircut, still paying coupons.
References
- ECBC, European Covered Bond Fact Book
Formulas
- Recovery
- R = min(1, OC(1 − h)) + (1 − min(1, OC(1 − h))) R_u