Commerzbank has become the first major European bank to set up an SME-backed covered bond programme, doing so in structured format, and a spokesperson for the bank said the instrument would offer it funding flexibility and could prove interesting to investors.

Rumours that Commerzbank, and one or two of its peers, would launch SME-backed structured covered bonds have been circulating for around a year, and official confirmation came yesterday (Thursday) when the programme was assigned provisional ratings by Fitch and Moody’s of AA and Aa2, respectively.

Before the financial crisis the German banking community, led by the Association of German Pfandbrief Banks (vdp) had been the staunchest defenders of legislative covered bonds – although Landesbank Berlin set up the first structured covered bond programme in the country as long ago as early 2007.

However, with the changed funding environment for banks and investor preference for secured instruments, German banks have been exploring covered bond programmes outside the strictures of the Pfandbrief Act, which only allows for issuance backed by residential and commercial mortgages, public sector assets, and aircraft and ship backed loans. Deutsche Pfandbriefbank, for example, revealed in September 2011 that it was considering issuing structured covered bonds.

A spokesperson for Commerzbank told The Covered Bond Report that the bank is very well funded and that it has not been decided when a deal will be launched, but that the bank has set up the programme to add another funding source to its options.

“Looking at funding more strategically, we thought it would be good to have an additional covered programme in place to add to our long term funding flexibility,” he said.

“While SME loans are not cover pool eligible under the German Pfandbrief law, Commerzbank is a big lender to the German Mittelstand and we think that it would be attractive to investors to get the opportunity to invest into SME assets in a secured way.”

The only SME-backed covered bonds to date have come from Turkey, where they are permitted under covered bond legislation. Elsewhere, Austria has been working on amending its covered bond legislation to allow for SME-backed issuance and in Germany HSH Nordbank is able to include SME loans in its cover pool but only after they have gained a guarantee from Germany government agency KFW.

The Commerzbank group is one of the largest covered bond issuers in terms of outstanding through Hypothekenbank Frankfurt, the former Eurohypo, while Commerzbank itself is expected to issue Pfandbriefe.

While proponents of the Pfandbrief have in the past raised concerns about structured products weakening the standing of covered bonds, the Commerzbank spokesperson said that given the importance of Pfandbriefe to the group it would not do anything to damage the German legislative product and that the clear distinction between the two instruments would safeguard this.

Assigning its provisional rating, Fitch said the first covered bonds are expected to be issued with a fixed coupon and a maturity of five years.