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Wednesday, 23 April 2014

Germany confronts shift from loans to DCM

There is a structural shift taking place in German capital markets, says IFR editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

IFR Editor-at-large Keith Mullin

JUST BACK FROM a jaunt to Frankfurt, where I moderated IFR’s German Corporate Funding Roundtable 2012. Our event in the MesseTurm, the iconic skyscraper in the heart of the trade fair area of the city, happened to coincide with the legendary Frankfurter Buchmesse.

The Frankfurt book fair is the largest of its kind in the world and the city was rammed. There was a great atmosphere and it was all very colourful. The flip-side, of course, was that flight and hotel prices were astronomical. I was spared half of the pain because I flew to and from London on the same day. But hotels jacked up their prices to such an extent that my unfortunate colleague Leonie Welss, on a longer visit, was forced to decamp every day to spend the night in Mannheim, some 87km away.

As for our roundtable, I found it instructive and I got a lot of local insight, the kind you can only ever glean from engaging with market professionals in their own backyard. We convened a fabulous group of senior German bank participants and we discussed where we were in the German corporate funding cycle, how we got here and what the expectations were for 2013.

Of our eight participants, there were four from the DCM side and four from syndicated loans. I had cheekily seated our group in a purposely confrontational manner – bond guys sitting eye-to-eye in a line across the table from loan guys. (Note to self: If this is how I get my kicks, I need to get out more …) I was hoping that this would facilitate a least a bit of disagreement; if not argument or some degree of conflict.

But in that regard, my intentions floundered. If the external perception of how bond and loan originators work is built around rivalry and competition in the quest to make budget, the reality expressed by our roundtable participants was that the two products served different purposes (funded/unfunded; tenor etc) so in fact were complementary and both sides worked in the interests of the client. I guess with me in the room and the tape running, I shouldn’t have expected them to say much else. But it was worth a try.

JOKING ASIDE, there is a structural shift taking place in the German capital markets. If you take the average volume of syndicated loan borrowing by German corporates from 2009 through to 2011 (US$104bn equivalent) and compare it with annualised 2012 data (US$68bn YTD), German corporate syndicated loans are tracking a decline of more than 25%.

The contrast between loans and German corporate DCM couldn’t be starker

Having said that, it’s important to note that the number of facilities is keeping pace, inferring that companies are employing more diversified funding strategies. While they’re not abandoning the loan product as a source of unfunded borrowing, they’re by no means relying on it to the same extent.

The key factor here is that as well as classic bonds or loans, German corporates have access to thriving Schuldschein and private placement markets. The former in particular is a global phenomenon, both on the supply side, where there’s been a wave of foreign issuers tapping the market; and on the demand side, where lenders and institutional investors world-wide, including in Asia, have been active buyers.

The contrast between loans and German corporate DCM couldn’t be starker. Deal volumes have reached US$55bn YTD. Assuming we see continued flow to year-end, that’s likely to lead to an increase in volumes of 80% over 2011 and 70%+ relative to the average of 2010 and 2011 (although they won’t match the bumper 2009 where volumes hit US$86bn). The number of issues has also risen notably. I didn’t de-dupe the data to account for frequent borrowers, but the 120 deals YTD are way in excess of what we’ve seen in the past three years.

CLEARLY, BASEL III and other regulatory factors are making it more expensive for banks to put their own capital to work by extending loans. German banks don’t have any real difficulty accessing capital, but as funding costs rise and banks rework their return on equity models, loan pricing has moved up.

Borrowers are going along with the altered loan market landscape but at the same time, they can’t ignore – and are not ignoring – the fact that technical conditions in the bond market make it an irresistible source of funding. With benchmark bond yields at all-time lows, credit has had a party. Spreads have been compressed and corporates are able to lock in long-dated drawn funds at incredible levels.

The battleground for German corporate mandates is likely to be in the upper-middle quartile of the Mittelstand space. DCM has certainly had a lot of success in getting deals from SMEs, and participants are expecting more debut issuers, unrated issuers and high-yield names in the bond market in 2013.

Loan market professionals will continue to ply the refinancing line. I sensed a little despondency at our roundtable on the loans side about general prospects. Then again, if there is an uptick in event-driven activity in Germany in 2013, syndicated bank finance will stage a comeback. Even though the bond market is able to digest large volumes, acquisition finance remains in the domain of lenders as the first port of call as they work through the bridge-to-bond continuum.

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