In a note circulated to clients earlier this week, National Australia Bank's capital financing team has explained the benefits of the A$3.25 billion conditional pass-through covered bond program they have arranged for Bank of Queensland.  In what appears to be designed as part primer for a new class of investment products and part marketing document, NAB also claimed that BOQ's program could include the first cross-border conditional pass-through covered bonds, using a system NAB developed. BOQ, for its part, has yet to actually issue any covered bonds, although the bank conducted an offshore investor roadshow in September last year.  Importantly, it's only when problems strike that the original choice of covered bond structure will make a difference. If the issuer defaults, conditional pass-through covered bonds can have their time to maturity extended, while standard covered bonds pose a market risk owing to potential fire sales. What follows is an edited version of NAB's original note. In the absence of an issuer default, these instruments are very similar to the hard bullet and soft-bullet covered bonds that several Australian banks (the four majors, plus Suncorp and Macquarie) have already issued.  As with any covered bond, the primary recourse is to the issuer, in this case BOQ, with secondary recourse to the covered bond pool, segregated in a special purpose vehicle - the BOQ Covered Bond Trust.  It's therefore crucial to keep up the quality and volume of the cover pool (staying within the eight per cent asset limit). The principal balance of the covered bond must not exceed the value of the assets in the cover pool (excluding defaulted or greater than 90 days' arrears).  Where the products differ is in the case of an issuer default. CPTCBs differ from regular soft bullet covered bond programmes, in that after an issuer default, there are three potential paths to redemption of the bonds - briefly: 1. in the absence of an immediate bond maturity, the next maturing bond will convert to "pass-through" and all other bonds will continue to be redeemed at maturity from available collections and cover pool sales.  2. If at maturity of a bond there is insufficient cash to fully redeem it via available principal collections and cover pool sales, it will convert to pass-through. 3. If the amortisation test is breached (including a breach of the 10 per cent over-collateralisation amount), this results in a conversion event and all bonds become pass-through irrespective of their maturity.  At this point the payment profile of the CPTCBs more closely resembles an RMBS, except that cover pool sales are to be attempted every six months, whilst available collections are paid out on all of the pass-through bonds. Using the proposed BOQ covered bonds as an example, a soft-bullet covered bond would be expected to achieve Aaa (Moody's) and AAA (Fitch) credit ratings with one notch of downside protection. Conditional pass-through covered bonds can be expected to achieve Aaa/AAA ratings with four notches of downside protection from Fitch and full de-linkage from its issuer ratings from Moody's. There is