Underwritten by Barclays, Commerzbank, Crédit Agricole and UniCredit, the deal attracted an order book of €1.1 billion, something of a surprise for a covered bond that is not eligible under Pfandbrief legislation or UCITS compliant and is issued via a standalone special purpose vehicle.
“We were very much aware that using underlying assets that were not known in the covered bond world would raise questions,” says Franz-Josef Kaufmann, managing director and global head of capital markets funding at Commerzbank in Frankfurt. “Discussions were started on this with colleagues from the Mittelstand bank two years ago.
"It was not exactly clear whether it could work or not. We had looked at securitization (and have done a number internal securitizations), but the pricing is always too high.” As the largest SME financier in Germany there was a pressing need to explore new refinancing options. “We needed to look at what we wanted to achieve,” says Kaufmann. “We concluded that we wanted to create an instrument that we could use going forward – one structure, one SPV.”
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Commerzbank's Franz-Josef Kaufmann |
When Euromoney suggests that this sounds rather like a master trust, Kaufmann becomes quite animated. “This is not like a master trust,” he declares. “We need to move away from this securitization terminology. We wanted the pool of assets to breathe like a Pfandbrief pool. We set the parameters of the pool so that assets within certain parameters could go into the pool and all bonds are backed by the same pool.”
The nature of the assets presented some structuring headaches. Principal among these is the desire to avoid the forced sale of assets if the issuer defaults. This was tackled by using more securitization terminology – a pass-through structure. This is unknown in the covered bond world, where transactions normally have either a hard or soft bullet structure.
“The programme switched to a pass-through structure so that they don’t have to deal with selling assets under stress,” explains Eberhard Hackel, senior director at Fitch Ratings, which rated the deal.
“It would be more difficult to trade out of SME loans than typical covered bond collateral, so they had to find a way around it. The saleability of the assets was clearly the biggest problem, which was fully eliminated with the switch to pass-through option. The biggest challenge for the asset analysis was having short-term bullet loans in a structure that should survive on a standalone basis. We had to incorporate into the analysis that these same companies rely on the bank for refinancing.”
As this is essentially a new asset class it required a high degree of investor education. In some ways it falls between two stools – rates investors might not want to buy it because it is not Pfandbrief eligible and typical structured finance investors don’t want to buy bank risk at this price. But the overwhelming appetite for it is a clear illustration of how credit appetite has become far less compartmentalized since the financial crisis. There were over 60 investors in the book, 56% of which are non-German.
“The challenge in marketing this deal was: how do investors see it?” says Joachim Heppe, deputy head DCM bonds and syndicate at Commerzbank. “They saw it as very much close to a Pfandbrief – the pricing underlined that.”
Guidance was 50 to 55 basis points over mid-swaps, but demand was such that the bonds priced at 47bp. This is midway between the bank’s senior unsecured paper at 75bp and Eurohypo Pfandbriefe, which trade at 25bp.
“This is a mix of Pfandbrief components and a classic securitization with an SPV structure,” Heppe says. “The decisive point was when it was labelled a covered bond.”
There was some concern from rates investors that it would go into the traditional Pfandbrief index and they were worried that they would therefore have to buy it to mirror the index. However, both Barclays and Markit have placed it in their structured covered bond indices.
Despite the use of an SPV, this is a funding instrument – it is on-balance-sheet financing.
“The structure of this deal is completely different from other German covered bonds,” says Hackel. “The structure is contractual. We know these assets very well and the challenge was putting the assets in the context of the covered bond structure. From our rating approach it is all about the structure, not necessarily the risk of the assets.”
The deal was analyzed using covered bond methodology as it is dual recourse and a double-A rating was assigned. Hackel reckons that with higher credit protection a triple-A rating would have been achievable.
Commerzbank has €80 billion exposure to SMEs, which explains the desire for a continuing funding vehicle. However, the strict eligibility criteria with tight sector concentration limits of 15% mean that probably only €10 billion of these loans are eligible for the cover pool.
Despite the attention that the deal has garnered, the impetus for it – dire funding conditions for the banks two years ago – has waned and a follow-up could be some time coming. “We are in no rush to do another deal,” says Kaufmann. “We would like to see where the bond will find its place in the credit spectrum. If we are able to open up a new asset class then it would increase the attractiveness of SME lending for investors.”
