A debut SME loan-backed structured covered bond yesterday (Thursday) provided Commerzbank with significant savings versus senior unsecured, an official at the German bank told The CBR, noting ample demand for the new product, even if not everyone was won over.

The issuer sold a Eu500m no-grow five year issue at 47bp over mid-swaps, the tight end of pricing that kicked off with initial price thoughts of the mid-50s over before moving to guidance of 50bp-55bp over and then the 50bp over area. Joint leads Barclays, Commerzbank, Crédit Agricole and UniCredit collected more than Eu1bn of orders.

Rainer Mastenbroek, head of covered bond funding at Commerzbank, said that the issuer achieved what it set out to.

“We proved that the product is accepted by the market,” he said. “Not by all investors, but that was not to be expected when introducing a new instrument.

“After the programme became public knowledge in December we said that we were not in a rush, and that we were doing this with a purpose, namely to establish a further secured funding source to enable us to generate additional funding at a competitive cost for our core SME franchise.”

This also informed the issuer’s approach to pricing, and its decision whether to go ahead with a transaction, according to Mastenbroek.

The issue marks a break with the mortgage and public sector assets that have traditionally been collateral for covered bonds, while other features of the structure was also considered notable, such as the cover assets being shorter dated than the maturity of the covered bonds, and the covered bonds reverting to pass-through in the event of an issuer default. Yesterday’s issue was therefore seen as being atypical of covered bonds, with some market participants even having questioned whether it should be considered part of the asset class.

All this, and more, provided fuel for discussions about where the deal should be priced within the Pfandbrief-senior unsecured spectrum, with bankers seeing the pricing of yesterday’s issue skewed towards senior unsecured, albeit not to such an extent that should be considered a disappointing result. An analyst, for example, said that Commerzbank’s SME backed issue seemed fairly priced given its structure and collateral, although others said that the final pricing was wide of levels that had initially been floated.

Commerzbank’s Mastenbroek said that the issuer had clearly communicated to investors that it was targeting pricing in the middle of covered bond and senior unsecured spreads, and that it achieved its goal.

“We are happy with the pricing, otherwise we wouldn’t have done it,” he said. “The pricing is significantly below our senior unsecured costs and therefore makes sense for us.”

The decision to cap the deal at Eu500m reflects the contained ambitions for Commerzbank’s programme, according to Mastenbroek.

“It is meant to refinance only a limited part of our SME lending book,” he said. “It’s a Eu5bn programme that is intended to provide for issuance over several years.”

Yesterday’s deal comes over a month after Commerzbank roadshowed its programme, with Mastenbroek noting that the issuer needed to give investors time to explore the new product and that softer market conditions and a blackout period also prevented the issuer from launching a deal sooner.

There has been plenty of ink spilt over Commerzbank’s innovative programme – the first backed by SME assets outside Turkey and the first major structured German covered bond programme – and this week was no exception, with a Bloomberg article titled “BlackRock sounds covered bond collateral alarm” published on Monday quoting investors expressing concern about the new product, for example.

“We have a huge investor base out there and it turns out, as this product shows, that many investors are looking at covered bonds and that we do not have to convince everyone,” said Mastenbroek. “Concerns raised in the press we were already aware of from our meetings with investors, but those discussions also told us that there is enough demand and that is what we concentrated on.”

Media reports referring to the inclusion of “junk” assets in the cover pool also miss many important aspects of assessing the credit risk inherent in the SME loan portfolio, according to Mastenbroek, such as the closely regulated internal rating system that Commerzbank uses for its SME loans, and the requirement that any weaker or non-performing loans uncovered by monthly reviews be replaced in the cover pool.

He added that the rating agencies generally do not assess the SME pool on a loan by loan basis, but rather have a benchmark approach on a portfolio level, which is why it looks as if most loans are sub-investment grade. Commerzbank, which is the largest lender to German SMEs, has a long track record of superior performance in SMEs, the backbone of the German economy, he said.

Different investors participated in the transaction for different reasons, said Mastenbroek.

“Some will have seen it as a good means of diversifying their exposure to German secured debt,” he said, “because it is not so easy these days to get hold of Pfandbriefe, which are also very tightly priced.

“Others, especially foreign investors, are interested in gaining exposure to the German Mittelstand, which is well known as a successful business segment in Germany, and others may simply have a mandate for secured debt to fulfil.”

In contrast to the typical distribution of German Pfandbriefe, foreign demand drove Commerzbank’s SME-backed transaction, which is a positive, added Mastenbroek.

“The large share of foreign investors is important to us because our senior unsecured funding is primarily sourced via private placements in our home market,” he said, “so this is a good means of diversifying internationally.”

Banks took a smaller share of the bonds than is typically the case in German Pfandbriefe, he added.