IFR German Corporate Funding Roundtable 2015: Part 1

IFR: Good afternoon and a warm welcome to IFR’s German Corporate Funding Roundtable. As the title suggests, I’m eager to explore how the landscape is changing, both from the sell-side perspective and – since we have some leading corporates around the table – from the borrowers’ perspective too.

We hear a lot about the changing landscape on the lending side, given the issues the

banks are facing around capital, liquidity, leverage and resolution. We also have a challenging external economic environment, which could potentially become more challenging in 2016. I wanted to talk too about the bond/loan interplay, especially in an environment in which the expectation is for constrained bank lending to corporates. Will the debt capital markets and other sources of non-bank finance come in to take the place of any gap?

Roland, if I may, I’ll start with you. I’m curious about the place of syndicated loans in today’s changing world. Can you talk about that, both from your perspective as a banker and the client relationship angle but also how or whether your corporate clients are adopting slightly diverging or different views? Is bank finance still the base financing product of choice for corporates?

Roland Boehm, Commerzbank: Absolutely. The syndicated loan is very much a core element of what banks provide to clients. The syndicated form provides a lot of advantages: unified documentation, an agency concept with majority lending; transparency; it ensures that borrowers are able to manage their relationship group. As a result of that, the syndicated loan does indeed remain the anchor product for the relationship.

The further advantage to the syndicated loan – which is hard to duplicate in other parts of the capital markets – is its flexibility, its discretion and speed, and the fact that most banks have known their clients over a long period of time. As a result, I’m very confident about the role that the product plays.

IFR: So why I am hearing so much chatter about the fact that the loan market is changing? From what you’re saying, it sounds like the story hasn’t changed much.

Roland Boehm, Commerzbank: The fascinating part of the story is that the dialogue is broadening. This isn’t a loans phenomenon; it’s something we’re seeing more broadly in the capital markets space. One of the trends since the crisis is that corporate treasuries have become much more sophisticated in their knowledge of the capital markets and how they access capital markets.

They are willing to try new and different things if there are advantages to them. We see both the bond product and the loan product diversifying. The second trend, which is very important in today’s environment in a world which is inherently more volatile, is that it’s very important for sophisticated borrowers to broaden their investor groups, to have access to different markets.

And that necessarily means that a dominant product like the syndicated loan will be broadened out to include other products like Schuldscheine or Private Placements. But that’s an opportunity as well as a threat.

IFR: Ingo, so if syndicated loans haven’t morphed from their role as anchor corporate debt funding albeit in a world of expanding options and clients’ knowledge about the range of financing products, can you talk about the evolution of bonds as a corporate funding option and how that may have changed in the recent past?

Ingo Nolden, HSBC: First of all, let me just mirror what Roland just said. Bond and loan markets will be complementary. Our investors in the bond market want to see stable core banking groups. It’s very clear that you want to have a very stable basis for funding. And I think the syndicated loan market serves this purpose.

What we have observed over the last couple of years, especially after 2008, is a further internationalisation of the bond market. We see issuers interested in diversifying on the bond side, going on roadshows and initiating direct contact with investors.

We also see much more institutional investor activity in the space. If you look back at 2008, about 20% of the investor base was institutional. Now it’s roughly 50%. This is clearly telling the story. The bond market is no longer a shadow bank market; it is developing into a real institutional market and institutional investors are driving its development.

For example, we’re seeing more and more Asian institutional investors looking at European corporates, especially German corporates. We also see a lot more interest from US investors. On the issuer side, borrowers want to go international. They don’t want to rely on the same pool of investors any more.

IFR: We’ll come back to the challenging external environment and how volatility and a normalising yield curve might impact the attitude to bond markets. I’d like to come to our three corporates. Steffen, could you explain a little bit about your current funding mix? And how you see the market evolving in terms of your own financing?

Steffen Diel, SAP: Very pleased to. SAP is a great example of having a combination of debt capital market-driven debt and bank loans. Our last major acquisition – of Concur Technologies, Inc. – was financed with a €4bn bridge facility that was taken out in the European debt capital markets. An additional €3bn piece was left with the banks as a term loan. And that fitted our strategy very nicely: to pay down additional debt very quickly to return to more moderate debt levels.

I can only mirror what our bank partners have said, that there needs to be a combination. The bank loan, the bank financing, remains a very flexible form of financing, especially when it comes to M&A scenarios where you need to come up with a major financing document within a couple of weeks.

And it provides the possibility for us to pay down additional debt as our free cash flow kicks in. So it’s a very flexible arrangement, and that’s why we chose that combination. When you look at the overall debt portfolio, we have some US private placements. We started out with US PP when we had no rating. We also have quite a few Eurobonds outstanding. And now we have the bank loan, which is left from our last major acquisition.

We talk a lot about disintermediation and it’s on its way. It’s continuing. Companies are turning to the debt capital markets more than in the past. But we still need flexible bank financing. Not only in M&A scenarios; if you look at pure cash facilities, you need such flexible financing that you can tap into when it’s needed to bridge gaps in your cash flow structure. So as I said, a combination is really needed for us as a corporate. And that’s a strong combination.

IFR: Excluding event-driven transactions, what’s your broad annual financing requirement these days?

Steffen Diel, SAP: Well in that respect, SAP is a very strange animal because when you deduct our financing needs for M&A transactions, there’s nothing left. We have such a strong cash flow that we don’t need any recurring financing. It’s just driven by M&A activity.

Peter Zirwes, Daimler: We are comparable to SAP. We are also in a net cash position on the industrial side. But – and it’s a big but – we have a captive finance arm, and that really drives our funding requirements so we have a totally different approach in that regard. M&A is not a topic for us.

In the developed markets, we rely on the capital markets to a significant extent but we also have a syndicated credit facility more as a back-up. But then when we go into other markets, we have to rely locally on the support from the banks.

In some markets, you are even not allowed to do inter-company funding from abroad so you have to rely on the ground on the funding which is there. And quite often, we are in countries where the capital markets are not yet as developed as they should be. So it depends really on the country.

Take for example, the US, the most developed capital market out there. There, we rely purely (aside from, let’s say, some small lines that we need for cash pooling) on capital markets and we do our funding via CP, ABS and on the bond market.

There are other extremes: China, also an important market for us where for quite a long time, it was dominated by pure funding via banks. So we had to rely on bank funding. It’s really dependent on the sophistication of the local bond markets. Over time we have developed some of these markets, and shifted from bank funding into a mix of capital markets and bank financing.

IFR: If you’re depending on banks on the ground, would you expect to receive coverage and support from your house banks in those locations? Or do you play into local liquidity as well?

Peter Zirwes, Daimler: What we had in the past – and this is also a reflection of how the banking landscape in general is changing – was banks who really tried to be big global banks. That has narrowed, and some of them are taking a careful approach as to where they want to be. We definitely want some of our global partners going with us into the markets where we are on the ground. But at the same time, we have to work together with local banks.

Peter Müller, Bayer: I agree that we need both, the debt capital markets and the loan market. For us, the most important piece of our financing is our syndicated back-up line. This is our backbone and defines our banking group. And it’s also the back-up for our CP funding, which covers our short-term funding needs.

The second important aspect around bank financing is M&A, the same as with SAP or Daimler. We need bridge financing for large M&A projects. And in this context, we have kept part of the bridge financing which we did last year intentionally as term loan in place because it is much easier to pay back under that facility with our operational cash flows rather than fund through a bond and have later no flexibility in repayment.

Emerging markets are also very important to us, so we look for bank support and to get funding on the ground there. In summary, it’s similar to SAP and Daimler.

IFR: As it’s quite recent, can you talk about the spin off you did?

Peter Müller, Bayer: Sure. We listed 31% of our Material Science business in a partial IPO. We targeted a leverage of €4bn, including pension liabilities. This was structured it in a way that we over-leveraged the company before the IPO, and used the €1.5bn IPO proceeds to pay back inter-company loans.

The new company plans to issue bonds next year, the proceeds of which will allow it to pay down all remaining inter-company debt to Bayer. We needed bridge financing for that and we did it the classic way: we hosted a bankers’ day where we invited our relationship banks, explained the Covestro business and provided them with draft documentation and term sheet. Almost all banks we contacted wanted to participate. It was a highly over-subscribed syndication and it was in place shortly before we did the IPO.

IFR: It all seems to have gone very smoothly.

Peter Müller, Bayer: Yes. So far, so good.

IFR: Let me come to you, Caroline. How have you seen the development of the European corporate funding landscape from the buy-side perspective?

Caroline Brugere, Allianz Global Investors: As an investor in bonds and in private placements, we have definitely seen a shift since 2008 by large corporates in particular from a higher share of bank funding to a higher share of bonds. If I look at the financing mix of [large] industrial companies, bonds represent in many cases between 70% and 90% of gross debt.

As an investor, we like to see diversification and to see companies not being too reliant on banks, which is contrary to what we saw pre-2008 for some of them.

On the other hand, I agree that the syndicated loan remains a key tool. Not only in bank financing but in particular from the investor side, in liquidity assessment. It is really key.

The question I have is whether syndicated loans are being drawn as much as they used to be a few years ago, because what we see for most corporates is that syndicated loans are mainly used as back-up lines and drawn down more for things like M&A.

IFR: Roland, do you want to pick up that point about drawn facilities?

Roland Boehm, Commerzbank: In the context of larger companies the core funding instrument is indeed more of a back-up line. But it’s an important element of the funding mix. We’ve heard from all three corporates here today on that. When we go down a little in the scale of clients, you’ll see more of a lively mix between term debt and revolvers. And if you look at the broader loan space, we’ve seen instruments like Schuldschein also out there to take up the slack.

Certainly for larger corporates, the bond market offers volume, tenor, and size so that’s the natural funding channel for them. But the sophistication in corporate treasuries shows in that corporates have contact to all major investor groups to make sure that they have access to markets at all times and to all products. The bond is and will remain the main funding instrument for companies like the ones around the table today. That’s a good and very sensible approach for everyone, including banks.

IFR: One of the criticisms levelled at the bond market is that it does succumb to bouts of volatility and the emergence of window markets that can render market access difficult, even for companies that are quite well known. Is this a genuine downside of the bond market, Ingo?

Ingo Nolden, HSBC: The bond market is a traded capital market just like the equity market and thus it is exposed to external shocks and to volatility. But the more professional issuers that look very regularly at the markets know how to cope with that. Their attitude is: “OK, I cannot change the market so I’ll live with it and of course, I can pick my windows of opportunity”.

But if they have recurring funding demand and need to go to the market regularly, it’s a question of averaging out. In the long run, everybody wants to be smart and pick the right window but if bonds are a permanent funding tool or portion of your funding mix, you cannot escape the external environment.

And neither can your competitors. It will feed through to product pricing but it’s something that most professional issuers are quite realistic about. Having said that, the banking sector should, from a wider perspective, still act as a buffer in times of stress.

Of course, we can talk about the flow of regulation coming into play. I wonder if there should be some kind of moratorium on bank regulation because it is getting difficult for banks to play the buffering role in the economy that they used to play. This is a question that needs to be addressed at some level, because it’s giving rise to pricing increases, which drives more volatility. If we look at liquidity in the bond market, it’s a very worrying topic.

Roland Boehm, Commerzbank: That’s a very important point. The role of banks and bankers is changing insofar as we are not just here as representatives of a product – a syndicated loan or a bond. The role is morphing more into providing solutions for issuers’ funding needs.

So I think rather than just being ‘the bond guy’ or ‘the loan guy’, I think intelligent banking today is about providing solutions across the board, which assist sophisticated treasuries in issuing at any time.

Let’s not forget, it’s not just volatility in the market. It’s also blackout periods, which are an element that need to be considered. There need to be products that can bridge that.

Peter Zirwes, Daimler: This is a big issue. The markets are not functioning properly any more because the banks, due to the regulation (which is there for good reasons) cannot play the role they did before to the same extent. That’s not only an issue from the borrower side, it’s also true from the investor side; investors are quite concerned about the topic.

But even though we talk about this and people hear about it on the political side and on the regulatory side, we’re getting even more regulation on top of what’s already out there. I would ask them to think twice as to whether that’s the right way to go or whether we can manage it in a slightly different way and give back some flexibility in order for the banks to fulfil that very important role in the markets.

IFR: It sounds like you’re quite sympathetic to the predicament the banks find themselves in around regulatory overload.

Peter Zirwes, Daimler: It certain areas.

IFR: But in terms of your corporate experience in dealing with the banks, have the changes that have been forced on them acted at all as a detriment to your day-to-day ability to do your job?

Peter Zirwes, Daimler: Not directly but liquidity in clearly deteriorating. How much can you rely in today’s world on secondary trading? What is the price of a bond at this very moment in the market? There is so little liquidity that you can move price a lot with little money.

There is something wrong and it needs to be tackled. The way forward is not to put even more of a burden on other elements in the market. We really should think of ways to take the market back to the way it worked before.

IFR: Steffen, do you broadly agree with that view and that regulatory rollback is the way forward? What’s your perspective and on the buffer function that Ingo talked about?

Steffen Diel, SAP: I have pretty much the same impression as Peter. When it comes to us as corporates, we do not see the impacts on a daily basis. In some scenarios when you look at M&A transactions, it’s things like contingent hedging instruments that might not be available but were a few years ago. Or long-term foreign exchange hedging, which is much more onerous than before.

But in certain cases, including in project finance, these instruments are needed so the regulatory changes really impact corporates in their operating risk profiles. If this is the outcome of regulatory developments, it’s not what should be intended. The real economy needs to work.

Decent risk-management policies should be supported by all market participants but it’s much more difficult for the banks. I fully agree that there were good reasons for regulatory developments. But it’s overshooting in some areas, and it’s forcing the banks to focus on regulatory issues. If you look at the financial services sector as a whole, they should be thinking about defining their sustainable business models rather than only focusing on their regulatory compliance. But that is hard these days.

IFR: So if products like long-dated cross-currency swaps now attract heavy capital charges on the banks and there’s a clear regulatory intent to squeeze such products out of the toolkit, the question that springs to mind is: are you as end-users prepared to pay up to get those products? Everything is available for a price but what price is too much of a price?

Peter Zirwes, Daimler: Regulation has taken us from one extreme to the other so we have to find some reasonable ground again. If you look at our long-term hedging, there is always an operational underlying behind it; it’s not speculative so how much risk is involved and how much capital do you have to attach to it?

As for price, it’s difficult to say when it becomes too expensive but there is still so much competition among banks. We always hear them complaining they’re not earning their cost of capital but they are very keen on competing.

So maybe there is still a bit of over-banking, especially in Europe, which makes banks – especially for larger corporates – calculate very small profit margins in order to get additional business on the investment banking side.

IFR: On this point of lack of liquidity, Caroline, the people really suffering are not necessarily the issuers; it’s investors who are at the sharp end. What’s your reaction to this and is there a solution? Is it about charging a new-issue premium?

Caroline Brugere, Allianz Global Investors: We definitely like to see new issue premiums. Contrary to what Steffen was saying, we definitely do suffer from the lack of liquidity every day, especially at the end of a quarter. It was very harsh in September.

So it does impact us. For new issues and to answer your question, in some sectors this can limit our appetite. And because we have to take into account the fact that liquidity might be restricted if we want to turn the position around in the not too distant future, it definitely has to come with a premium.

IFR: Might the liquidity situation force changes in how bonds get allocated, Ingo?

Ingo Nolden, HSBC: After all the incidents around benchmark setting, it’s a logical step for regulators to look into other price discovery mechanisms and allocation procedures. What I can say from my observations is first of all if we’re talking about investment-grade bonds – and I think all three corporates around the table will agree on this – we (not just HSBC but all banks) will ask issuers to sign off the final allocation and thus strive to ensure a transparent process.

We sometimes get challenged by issuers about it: “why is this investor getting a relatively high allocation and not that investor”, and we have to lay out our rationale, which we’re happy to do. It’s the bond of the issuer, not of the bookrunning banks. The issuer should be in control and say what they prefer.

The banks should advise issuers to their best ability. If you are a less frequent issuer, you need to rely more on your banks. If you’re like Peter Zirwes at Daimler, you are in the market almost every week so you know your investors and the market very well. There might be some niche markets, such as high-yield, where the allocation processes might be open to more scrutiny but in general the allocation process is very transparent between issuers and syndicate banks.

On top of that, you see also larger groups of banks bringing bonds – especially in the euro market – so it’s a group-wide discussion. There can be a lot of internal discussions before we present to the issuer. But the process as it is feels to be a good one. Of course, there are buy-side investors who would like more say, but I’m not sure whether that is in the best interests of issuers.