Tough sell: Investors question SME-backed covered bond pricing
* Commerzbank new product risks failing to win over investors
* Investors seek triple-digit spread for SME-backed bond
* Structured approach could overshadow upcoming legislative Pfandbrief
By Aimee Donnellan and Owen Sanderson
LONDON, Jan 30 (IFR) - European investors questioned the merits and potential pricing of a planned SME-backed covered bond from Commerzbank at the IFR covered bond conference in Frankfurt this week, potentially stopping this revolutionary new product in its tracks.
If Commerz is too aggressive on pricing and tries to push it too close to the price for Pfandbriefe, this could backfire - hurting development of a European small and medium-sized enterprise (SME) covered bond market and Commerzbank's own plan to return to Pfandbriefe.
Banks across Europe have been looking at SME covered bonds 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.
But the product risks falling between two stools - too risky for rates buyers, the natural investors for legislative Pfandbriefe, and too tight for credit investors, who may be put off by an attempt to match Pfandbrief spreads.
"This is the next natural step in the evolution of the covered bond product," said a DCM banker.
"But in order to make this product appealing to the masses Commerzbank are going to have to pay up, and we're talking about more than double digits here," said a syndicate official.
If Commerzbank is successful, the new bank funding instrument is expected to transform the SME market, which is seen as the driving force in European job creation but has faced scarce financing due to the eurozone crisis and the collapse of securitisation market.
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.
And German Pfandbrief borrowers have benefited hugely from the market's safe-haven status and perceived proximity to Bunds.
Over the past year, Pfandbrief pricing has returned to pre-crisis levels as banks like Aareal, Deutsche Pfandbriefbank and Deutsche Bank regularly offer single-digit spreads to borrow cash over the short to medium term.
The differential between senior unsecured and covered bond funding costs for a credit like Deutsche Pfandbriefbank is currently around 130bp.
Commerzbank faces a number of challenges to price its upcoming bond at the tight end of that differential. Most importantly, investors are lining up to tell the bank that a more securitisation-like structure means the instrument should be priced closer to unsecured German bank debt.
"This should be priced closer to senior unsecured debt than Pfandbriefe because it is not ECB eligible," said a German bank treasury official who is active in the covered bond market.
Henrik Stille, portfolio manager at Nordea Investment Management, shared that view but said that while he would like to see a generous pick-up to senior, he expects it to be priced closer to Pfandbriefe.
"The hope is it will price closer to Pfandbriefe than senior unsecured debt," said Rainer Mastenbroek, head of covered bond funding at Commerzbank.
"But this is not a dilution of the covered bond asset class, which is a well-defined product. We think investors are grown up enough to be able to distinguish between structured covered bonds and Pfandbriefe.
However, syndicate and DCM bankers that spoke to IFR on the sidelines of the conference cautioned the issuer.
"Commerzbank is also planning to sell a legislative Pfandbrief this year, so it's very important for the SME product to be priced right," said one.
Unsurprisingly, Commerzbank is planning to take a more aggressive approach on pricing its new SME product.
"If the SME fails to win support, it could have a negative impact on the bank's cost of funding through the Pfandbrief market, which would be a disaster."
In the wake of an investor roadshow, Commerzbank officials say they are confident the bank will gain the support it needs for the product, but that it is not trying to pull the wool over anyone's eyes by marketing this as a legislative covered bond.
"We expect to get a lot of interest for this product," said Commerzbank's Mastenbroek.
"We went the structured route because SME loans are not included in the German Pfandbrief law. Our client group has been very receptive to the instrument and at the moment we are just digesting feedback from our investor roadshow before we access the market." (Reporting by Aimee Donnellan & Owen Sanderson; Editing Alex Chambers and Philip Wright)