Commerzbank breaks cover with SMEs
LONDON, Dec 7 (IFR) - Commerzbank has structured a new bank funding instrument, with the potential to transform small and medium-sized enterprise lending across Europe. It has issued a programme to back its own debt with a pool of SME loans - the long-awaited SME-covered bond.
Banks across Europe have been looking at this kind of instrument for at least 18 months, as two trends have converged - political pressure to lend more to SMEs and a shift towards collateralised borrowing for banks.
Low pre-crisis funding costs for banks meant there was little pressure to use SME loans to back borrowing, but when banks did so, it was generally through securitisation or using government guarantees.
Covered bonds have benefited from regulatory favour since the crisis, with the ECB allocating EUR100bn to buy covered bonds outright and setting haircut margins at favourable levels against comparably-rated securitisations.
Partly because of this regulatory favour, a covered bond-like instrument should be able to attract a much greater depth of demand than is available for SME securitisations today, particularly if Commerzbank succeeds in selling a deal to traditional covered bond investors.
A successful deal should also make SME lending more attractive to banks, since it would show that they can use this collateral to cut funding costs.
Turkey's Sekerbank issued the first SME-backed covered bond in July 2011, but this was not considered a mainstream instrument - it was in lire and fully subscribed by UniCredit, the IFC and FMO. It went on the road for a follow-up offering at the end of November through Commerzbank and UniCredit.
For Commerzbank, there are no immediate plans to issue under its new programme.
The German bank's five-year senior unsecured debt is trading at around 75bp over mid-swaps, according to Tradeweb, and it funds tighter still in the private markets.
"When issuing we would expect to realise a significant funding advantage against our senior unsecured funding costs," said a Commerzbank spokesman. "We already have enough funding this year, and our needs next year are also very limited."
The first deal is likely to be a five-year. SEALS OF APPROVAL Selling the deal to covered bond purists may be challenging, however, since the deal does not fit within the covered bond legal framework in Germany, and comes without a Triple A rating.
The covered bond sector in Europe has been moving to a legislative market in the past few years, as countries pass laws specifically authorising covered bonds, governing which assets can be used to back them and how they will be treated in an insolvency.
These are seen as having better credit quality than instruments that create similar economic structures but do not comply with the legislation. In countries with long traditions of legislative covered bonds, such as Germany or Denmark, instruments structured under these acts are often seen as having implicit state backing.
In July, Belgium became the most recent country in Western Europe to pass such legislation.
Germany's strict covered bond legislation, the Pfandbrief Act, does not allow SME-backed instruments, so Commerzbank has used some securitisation-style elements for this structure, such as a liquidity facility.
German market participants are often wary of anything that could dilute the reputation of Pfandbriefe - as covered bond bankers are fond of pointing out, there have been no defaults in the product's 250-year history.
As a result, Jens Tolckmitt, chief executive of the Association of German Pfandbrief Banks, gave the new product a qualified welcome. "Structured covered bonds are a positive addition to funding sources for European banks," he said, adding: "It is clear that investors see it as separate from the long-term success story of traditional covered bonds."
However, it will certainly be seen as a closely-related product.
"This is a full-recourse instrument secured on an evergreen pool of assets with various investor protections and a bullet-ish maturity profile," said Richard Kemmish, head of covered bond origination at Credit Suisse. "If something looks like a duck, eats bread and quacks, what are you going to call it?"
He suggests a variety of names, including "Mittelstand-briefe".
Although the deal will price wider than legally backed Pfandbriefe covered bonds, this is likely to help it sell as investors across Europe hunt for yield. Top quality Pfandbriefe are now selling through mid-swaps - a proxy for the risk-free rate in the European debt markets.
Pricing will also reflect the fact that Commerzbank has not structured this deal to Triple A level - the programme is rated Aa2/AA by Moody's and Fitch.
"As an issuer, you need to think about the benefits of Triple A against what is required in over-collateralisation and other structural enhancement," said the Commerzbank spokesman. "We think the rating agencies' prospective ratings do position the instrument well within the covered bond universe." SME ALTERNATIVES
Before the financial crisis, German banks had access to KfW's Promise securitisation programme, which saw the development bank wrap SME loans to make them eligible for public sector Pfandbrief (a well-established bank funding market backing bank debt with public-sector assets). Mezzanine risk in these deals was placed in the market through a synthetic securitisation, while KfW retained the senior risk.
Only one post-crisis deal has been done, Promise Neo 2012-1, which wrapped a portfolio for HSH Nordbank.
Commerzbank does not have an active public sector Pfandbrief programme under its own name, though it is working on one.
Recent SME securitisations have almost exclusively been structured for repo at the ECB. The only European bank to place an SME securitisation since the crisis has been Lloyds, with its UK-backed Sandown deals. (Reporting By Owen Sanderson and Aimee Donnellan, editing by Matthew Davies)