IFR German Corporate Funding Roundtable 2016: Part 1
IFR: Good afternoon, thank you for attending our fifth annual roundtable on German corporate funding. We have seen a lot of volatility and uncertainty this year, in part fuelled by monetary policy divergence between the US, Japan and the eurozone. We have negative bond yields in Europe even for new issues; a new US president-elect not to mention geopolitical conflict. How has the market held up to all this pressure?
Ingo Nolden, HSBC: We’ve all scratched our heads at times, wondering how the market has been so resilient. We saw a very weak start to the year, before Mario Draghi helped to stabilise things. Some might argue he has prolonged the party.
Putting this into perspective, the overriding issue here is how central bank liquidity is helping the markets. Whether that will prove the right choice in the long run remains to be seen but for now it has ensured markets have been resilient in the face of these shocks and the volatility. Corporate, financial and public sector issuers have been very nimble in navigating this volatility, which is quite remarkable.
The question now is what is the future for this central bank liquidity? We have seen tremendous steps taken by the ECB and the Bank of England, but what or who else can step in now to continue to provide that stability?
IFR: Do people become immune to this sustained volatility?
Dominik Müller, Commerzbank: Looking at the loan market, our clients are less exposed to volatility as banks take a long-term approach compared to capital markets. Furthermore, our clients are conservatively and long-term financed and therefore less affected by short-term developments.
IFR: The narrative, in terms of funding, seems to be that banks are withdrawing commitments they had towards clients in the past, for all sorts of reasons: regulation, the cost of capital, a new approach to relationships and the phenomenally good rates available in the bond market. In the German market specifically, are corporates going where they can get the best price? And is that a sensible approach?
Marc Müller, Deutsche Bank: The positive side of the ECB CSPP [corporate sector purchase programme] has been the liquidity that QE has put into the primary bond market. We’ve seen a phenomenal environment for corporate funding in both bond and loan markets. There’s excess cash available to fund corporate growth.
This is not all down to the attractiveness of the bond market. The loan market has also seen a positive impact. There are certain funding requirements where a revolving credit facility will be most appropriate and indispensable, and there are others where the mid and longer-term options available in the bond market are better suited.
On the liabilities side, the corporate environment has been particularly attractive for German borrowers this year. Corporate concerns are more on the cash and cash-equivalent or pensions side.
IFR: I’ve heard it said that corporates in Germany can fund at such tight levels that they can raise cash in the bond market more cheaply than the commitment fee on an undrawn loan facility.
Dominik Buric, LBBW: Companies use the loan and bond markets in different ways. They use bonds for term funding whereas the bank facility is normally a base facility, a revolving credit facility, usually built around relationship banks. We’ve spoken to a lot of companies and they don’t typically think about which of the two markets is more attractive. They think of it as a solution-driven decision.
IFR: The loan market is now offering extendable facilities? Is that getting into bond market territory?
Dominik Buric, LBBW: While I do not anticipate extendable structures to become a topic in the Schuldschein or bond markets for the foreseeable future, there is certainly a positive spill-over as extendable structures provide a treasurer with more flexibility. However, a loan facility is usually not drawn and for back-up purposes. In practice a stable funding source through the bank market can be considered as a pre-requisite for corporates wanting to tap the Schuldschein or the bond markets.
IFR: Given the optimal funding conditions, how do corporates view the landscape? Do they use the loan market for these undrawn core facilities and then switch to the bond market for drawn facilities? I’m curious to pursue this notion that corporate treasurers are going for the best price option over worrying about their funding structure.
Heiko Möhringer, BayernLB: What we’re seeing in the market for bonds and Schuldscheine is tremendous new volumes being raised this year. Companies tell us the money is being raised in particular for acquisitions and for new investments, especially in the Schuldschein market.
IFR: The Schuldschein market has got some very positive press in the last two years even if in absolute terms SSD volumes are relatively modest compared with the debt capital markets or loan market. We consistently hear that corporates, especially in Germany but also elsewhere, can get better execution in the Schuldschein market.
The issuer base is internationalising and issuers can achieve huge size and very long-dated maturities. Do recent developments risk altering the nature of the Schuldschein market to its detriment?
Morris Gutermann, Helaba: We’ve been very busy but we still have time to read the papers and there has been some negative press about the Schuldschein product itself. We’re used to this being a securely investment-grade market with a self-selected group of issuers and banks that serve them.
There has been no need for issuers to gain an external rating because it has been understood that they can place paper into the market without covenants and at investment-grade pricing. But things are starting to change.
The growth we have seen in this market is huge. In absolute terms, the growth of around €20bn we have seen this year and last may be a drop in the ocean if you compare it to the loan and the bond markets but in our market it’s very significant. Companies that previously would have been marginal propositions at best are now suddenly interested in the Schuldschein market.
We have to be careful how we manage that. We must not bring issuers that are not ready, that do not have the pre-requisites for the Schuldschein market, and assume it will be fine just because there is so much more volume. That could undermine the Schuldschein market in the longer term by ruining its reputation and casting a shadow over some of the successes this market has had.
IFR: Morris mentioned credit ratings. One of the interesting things we have seen in Germany from a credit perspective is the widening of the spread between rated and unrated issuers. The indications are that a lot of German corporates are increasingly incentivised to get an external rating. Yet banks say they don’t particularly bother about external ratings as they conduct their own internal credit assessments.
Crossover and unrated issuers are looking at Schuldscheine where the market is not traditionally a market for crossover or sub-investment grade issuers. What is going on here?
Matthias Raab, S&P: Typically, if a company gets a rating we see its spreads tightening. We just gave a rating to Heidelberg Cement and observed a price increase of about two cash points for its outstanding bonds. There are many other examples, which suggest there’s some value in the rating for investors.
Many Schuldschein issuers don’t have a rating. As a rating agency we have some concerns that, given documentation is quite loose and often there are no covenants, investors may not be well informed. If investors don’t have access to good information from the issuers or an independent assessment of the credit quality in the form of a rating, there’s a risk we might see bad apples coming into the market.
This could ultimately hamper the growth of this market. That should be a concern for the whole market, given the importance of this market to German corporates, and the diversity of funding it provides.
IFR: I’d like to bring in Michael Schiller, our investor panellist now. Investors have been confronted with negative yields or at best meagre returns. What can you do in such an environment? And another point: how concerned are you about covenant dilution? Is the environment forcing you to look at things you wouldn’t normally touch?
Michael Schiller, Union Investment: We’re trying to avoid that but that trend is definitely emerging. People keep accumulating more and more risk, with less and less protection. But our clients continue to buy risk and we’ve got a great substitution, driven by the corporate sector purchase programme, from the covered bond market to investment-grade markets. There are people who never previously invested in high-yield who are now going down the credit structure.
It is important to be careful in credit analysis. Do not buy risk you don’t want on your balance sheet when the ECB stops buying. Since the CSPP started people have forgotten how thin liquidity has been in credit markets relative to what it was before the financial crisis. It’s not going to improve.
I’m not that concerned about covenants. We all know what will happen if the economy takes a downturn and credits turn sour. Investors have to decide for themselves whether or not they are willing to take the risk.
Ingo Nolden, HSBC: The point is we’re in the seventh year of ECB expansion so the cycle has already been running for quite a long time. We have had these same conversations with clients and among ourselves for the last three years, debating whether the situation can continue. All we can do – and this is what the financial crisis taught us – is ensure we are ready for when the market turns. Because when the boundaries are pushed too far, it eventually will.
We are talking about institutional investors here. There are some products that are going into retail that probably shouldn’t, as we saw with the problems in the Mittelstand bond market. But when you are dealing with an institution like Union Invest for example, you can talk openly about the limitations of a product and its inherent risks. In the end they decide; they are professional enough to decide whether they like the price for a given credit risk or not.
That brings us back to the Schuldschein market. It has received a lot of attention which has perhaps been a bit over the top at times. I think there are investors out there that are riding the wave of cheap money and are expanding into this new market. But it is a professional market and we must understand there is a pull effect: investors are looking for more yield, and that drives them to look down the credit curve, or at new structures.
So yes, we should remain disciplined, but we must also do our job, which is to originate deals and then present these opportunities to investors. The market is professional enough to sort it out.
Marc Müller, Deutsche Bank: I would like to be more positive about the Schuldschein market. It is an instrument that is available to the Mittelstand in smaller sizes, with transactions of €25m or €30m. This is a very efficient path to the capital markets, to reach into the pockets of banks and real-money accounts, which probably wouldn’t justify getting an external rating as with a public bond offering.
It’s on the banks arranging the Schuldscheine to ensure that there are proper covenants in there, to ensure it is a sensible transaction for both sides. But it’s a very valuable way for the Mittelstand to tap capital markets funding.
For the bond market it is of course valuable to have a rated transaction, but there are questions about the size and frequency of deals. If an issuer is only planning to visit the market once every five years, many corporates are questioning whether it is worth getting a rating.
When Union Investment looks at an unrated versus a rated bond, it is doing its credit analysis for both, and that is the same for insurance and bank investors. So it’s more about which investors can purchase unrated instruments.
IFR: Even though funding volumes have gone up year-on-year, and German banks are very liquid, why haven’t corporates raised more? After all, they’re unlikely to see these levels again, given we may be coming to the end of the ECB asset-purchase programme. M&A presents a fantastic opportunity for growth, for example. Are corporates being too conservative?
Dominik Müller, Commerzbank: As far as the loan market is concerned I would agree. We had a very slow start into the year in the German loan market: German volumes represented just 5% of total EMEA volume, compared with around 10% to 15% historically.
Meanwhile we have seen a lot of acquisitions that have been financed first through the loan market and then refinanced quickly by capital market take-outs. The market was dominated particularly by one deal, the Bayer-Monsanto transaction, which accounts for almost 50% of German volume.
The German market currently accounts for €120bn loan volume, with UK and France following. So I think this year has been quite normal in respect of regional distribution.
However, general corporate purpose facilities were mainly entered into in 2011/12 and many of them were extended in 2014, so facilities will mostly mature only in 2019-21. That is why there has been less activity in Germany. But it underlines that corporates are long-term orientated in their financing strategy and hence are taking a conservative approach in not being required to approach the market every year.
Heiko Möhringer, BayernLB: As was said earlier, this year was a brilliant one for the Schuldschein market. Our investor base is growing but there is still a limit to investor capacity. I’m not sure issuers could have raised much more than around €23bn to €25bn this year. I’m not sure the market would be able to absorb much more than the volume and the number of transactions we saw this year.