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Derivatives

Commerzbank makes a covered bond comeback

Commerzbank bought an investment bank two weeks before Lehman Brothers collapsed, and now counts the German government as a major shareholder. But despite its drawn-out recovery meaning less frequent visits, Commerzbank is now creating funding markets all of its own, writes Tom Porter.

Commerzbank is unrecognisable from the institution it was in September 2008. 

It has gained an investment bank, for one, through its €9.8bn acquisition of Dresdner Kleinwort. Not to mention a major new investor in the shape of the German government, after an €18.2bn bail-out in 2010 left the state holding 17% of the bank’s shares.

Amid all the changes, the one that will stand out for FIG investors is the big reduction in funding activity from Germany’s second largest bank.

“We have reduced the overall funding for the bank quite substantially over the last few years,” says Franz-Josef Kaufmann, head of capital markets funding at Commerzbank. “The balance sheet has been develeraged, non-core assets have been reduced. That’s why we virtually stopped issuing Pfandbriefe out of Hypothekenbank Frankfurt. It was a major part of our funding previously but has now fallen away completely. We have also reduced substantially our unsecured funding.”

But just because Commerzbank’s name is popping up on investors’ new issue screens more rarely these days, does not mean it can’t make a splash when it does. 

Controversial innovation

In February the bank unveiled its long-awaited — and much debated — SME structured covered bond. On the face of it, it was an odd choice of asset to use. The product does not comply with the capital requirements directive and is not eligible under Ucits. SME loans have low recovery, they are not included in the iBoxx covered bond index and transparency on the revolving pool assets is not good enough for some.

But despite many market participants being unhappy that Commerzbank was allowed to call the deal a covered bond at all, joint leads Barclays, Commerzbank, Crédit Agricole CIB and UniCredit found more than €1bn of demand on February 21. They priced the €500m five year at 47bp over mid-swaps, roughly midway between the borrower’s senior unsecured five year and its covered bonds issued under the Hypothekenbank Frankfurt brand name.

The structure has since gained some support from Moody’s, which said in June it was gaining ground as a funding tool for European banks and could soon become a feature in Italy, Spain and France. The agency said one reason for this was a paucity of SME financing from banks.

No SME saviour

Bankers have been trying to find capital markets solutions to insufficient SME funding, which politicians label as one of the biggest drags on European economies.

But Jo Heppe, head of syndicate at Commerzbank, does not see the new product as the saviour of SMEs. For him, it was a simple case of supply and demand.

“The beauty of the product is investors can get exposure to the SME sector, which is at the core of the economy and still doing pretty well, especially in Germany where the SMEs are not particularly active in bond funding or other markets,” he says.

“It would be wrong to say that this will be the saviour of the SME sector in Europe. They are actually pretty well funded, they are deleveraged, and they have sound financials. They will ultimately profit from the fact that banks have better means to refinance their loans, but in my view the short term effect is more for the investors that can gain exposure to the segment.”

Heppe is equally cautious about the potential future size of the market Commerzbank single-handedly created.

“We have talked to other banks about the SME product, and we’ve used our own experience for to market it,” he says. “There are a number of banks concretely looking at doing SME covered bonds but you need time to develop the infrastructure for this sort of trade. The attraction is clearly there for banks to refinance their portfolios in that way, but we don’t expect it to be a huge segment where we see constant issuance.” 

Secured options

Commerzbank plans to use its new product regularly, but it has also been busy making sure it has other options for secured funding. The bank priced the inaugural Pfandbrief from its new public sector programme in June, a €500m five year and the first since the wind-down of Hypothekenbank Frankfurt began late last year.

The bank plans to be a regular issuer through the programme both on the public and private markets, while it is also working on a new mortgage-backed programme backed by assets originated through its private client customer business. 

“The SME covered bond programme and our public sector Pfandbriefe give us two channels to source funding below levels we would have to pay for senior unsecured funding, so we can optimise our overall funding for the bank.”  

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