Covered bond to test risk appetite Germany's Commerzbank is poised to test market appetite for a new style of covered bond backed by loans from small and medium-sized enterprises rather than mortgages or public sector loans. If successful, the issue could provide a blueprint for other banks, a number of which are understood to be looking at similar models as they try to diversify their funding options and reorganise their balance sheets to meet new Basel III regulatory requirements. The format being discussed by Germany's second-largest bank by assets will sit somewhere between classic covered bonds - in that it will stay on the bank's balance sheet, with a defined asset pool that is clearly earmarked for investors - and other securitisation products. German law currently only allows covered bonds to be backed by pools of mortgage, public sector or ship and aircraft loans, prompting some to say the Commerzbank bond cannot really be defined as a bond of that type. Classic covered bonds - over-collateralised debt which is ringfenced for investors even in bankruptcy - receive more favourable regulatory treatment than many equivalent securitisation products. Some investors have shied away from securitisation instruments since the subprime crisis, although market sentiment is beginning to change. Advocates of the securitisation model argue it is still an efficient way for banks to fund themselves. Commerzbank's euro-denominated, structured covered bond is expected to price between senior unsecured debt and conventional covered bonds. The German bank has already held meetings with European investors about the SME bond and is expected to come to market in the next few weeks.