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Covered bonds are debt instruments issued by Banks that are secured by a cover pool of mortgage loans (property as collateral) or public-sector debt to which investors have a preferential claim in the event of default. While the nature of this preferential claim, as well as other safety features (asset eligibility and coverage, bankruptcy-remoteness and regulation) depends on the specific framework under which a covered bond is issued (tends to change across jurisdictions), it is the safety aspect that is common to all covered bonds. Given the secured nature of the instrument, covered bonds have the highest ratings.
Senior Unsecured / Senior OpCo / Senior Preferred
Senior HoldCo / Senior Non-Preferred
Tier 2
Tier 2 bonds are subordinated instruments issued by banks. Tier 2 bonds have a defined maturity and coupon payment is mandatory. Tier 2 bonds can absorb losses and be bail-in-able so together with AT1 bonds are often called "bank capital". Given the subordinated nature of the bonds and the risk of losing the principal upon Bail-in event, the instruments carry a lower rating to reflect this risk. In Europe, banks are required by the regulator to have a 2% of Risk Weighted Assets in the form of Tier 2 bonds.
Additional Tier 1 ("AT1")
AT1 bonds are the most subordinated form of bonds (and together with Tier 2 instruments are often called "bank capital" instruments) that rank senior only to equity. AT1 bonds have a Perpetual character (no fixed maturity), no incentive to redeem, and the payment of coupons is discretionary (coupons are paid if the bank has distributable reserves). AT1 bonds can absorb losses (be converted to equity or be written-down upon the trigger event) when the capital of the issuing financial institutions falls below a supervisor-determined level. The purpose of AT1 instruments is to have a buffer of a readily available source of capital that protects senior bondholders and depositors in times of crisis. In Europe, banks are required by the regulator to have a 1.5% of Risk Weighted Assets in the form of AT1 bonds.
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