IFR German Corporate Funding Roundtable 2016: Part 2
IFR: What about the bond market?
Dominik Buric, LBBW: It’s a question of whether corporates have the relevant funding requirements. When we talk to corporates, they tell us it’s not a question of funding M&A transactions; it’s about finding the right target, one that fits your business model, your strategy. Funding it, through equity or hybrids or bonds, or even with a basic acquisition loan, is no problem today.
For general capex, corporates have improved their balance sheets and working capital management and they are now in a great position to finance working capital through internal sources.
It is indeed an interesting question how German debt markets will develop. Market growth will only come through large acquisitions; this is the only source I can see for 2017. Without it, I expect we will have a disappointing year next year. The question is whether German corporates can find similar targets, like Bayer did with Monsanto. And whether we will see more deals of this size, or whether we will see a broader M&A market with smaller deals.
Ingo Nolden, HSBC: Sometimes I feel there is also a cultural difference between how German corporates fund and how, for example, UK or US clients fund. Anglo-Saxon clients seem to be more open to financial engineering.
Of course we discuss these ideas with clients but we have to accept cultural differences. Some treasurers and CFOs feel that they do not have to do something just because it’s cheap, and sometimes that decision can be right when you look back. I think German treasurers and CFOs are quite disciplined and conservative in that respect.
The Bayer transaction is an interesting case. A lot of people didn’t think such a bold move was going to happen. Will it be a one-off? Or will there be others like it?
There is also the question of FX moves: is it good to go to the US at the moment? Was it good a year ago, with the depreciation of the euro? There are a lot of questions to consider. But definitely the cultural aspect shouldn’t be underestimated.
Michael Schiller, Union Investment: There’s a lot of uncertainty out there. We had the US election, we had Brexit, and we have more European elections coming up next year. If you are responsible for a big corporate and you don’t know what Europe will look like in two years, I would be quite careful before doing big re-leveraging transactions. For me it’s understandable that they’re not as aggressive as some of their US peers.
If you do bigger transactions and leverage up your balance sheet significantly, if you are responsible, you should have a longer-term view about what is going to happen with the economies around you.
A great of example is AT&T, which I asked the same question to, perhaps three or four years ago. They had 1.5 times leverage and now they’re heading to 3.5 times. It’s all working out so far but the risk is if the economy turns, they’re running with €125bn in bonds and at some point they will need to be refinanced. They’ll still have plenty of cashflow but it’s something you need to consider. Times are not always as good as they are right now.
IFR: But from a credit perspective, investment-grade German corporates are under-leveraged compared to historical norms. Are you comfortable with the general state of play? What impact will re-leveraging have on ratings in the short term and medium term?
Matthias Raab, S&P: In general we have seen a slight deleveraging in terms of pure financial leverage. But many German corporations have large pension deficits and, with the low-yield environment, that could cause some problems in the longer term. As a rating agency we include pension deficits in our leverage calculations, and consider it to be a problem, which is actually putting some companies under quite a bit of pressure.
Look at Lufthansa. Its pension deficit increased by €4bn in the first half of this year versus the end of last year. We have assigned it a negative outlook, partly because of some operating under-performance and partly because of the pension deficit. There are examples of corporations where pension deficits have been materially increasing in 2016.
Hence in our view many German corporations are not under-leveraged and large investment-grade companies actually have a similar leverage as other large players in Europe. On the other hand, as far as M&A is concerned, I would agree with earlier comments, that in the traditional industrial sector, German management teams tend to be quite conservative.
If they don’t see a business case, particularly with the uncertainty in how the economy’s growing in the coming years, they would rather not do the deal.
At S&P Global we forecast lower GDP growth in Germany over the next two years compared with 2016. Hence, it could make sense to avoid going all-in with an acquisition in such an uncertain economic environment. There have been some acquisitions where corporations were diversifying their businesses, for example in the chemical industry.
Evonik did a deal that helped them diversify their business, and the Bayer-Monsanto deal is quite a complementary fit in terms of product ranges and geographical footprints. This could improve our business risk profile assessment, and in turn partly offset an increase in leverage.
Evonik also had a bit of headroom in the rating: hence, sometimes companies can digest M&A. Overall I agree the traditional German corporate has been more conservative on the M&A front.
IFR: How much difference do things like pension deficits and turns of corporate leverage make in bond or Schuldschein pricing? Are investors willing to overlook those factors if they can get some yield?
Morris Gutermann, Helaba: Of course we’re aware of all the financial aspects and issuers’ liabilities but this seems to be outweighed by the dynamism and growth of the market, which is creating steady and exuberant demand from investors. Our hand gets bitten off as soon as we offer the paper, and Lufthansa is a case in point.
The bad apples in the Schuldscheine have been mentioned already. We, as a Landesbank, just like my colleagues here from LBBW and BayernLB, have a natural limitation set on us by the savings banks that are part of our organisation and are our co-owners. Everything has to be seen through that prism: is a deal good for savings banks? Can we explain this transaction to those savings banks?
They are very traditional and very conservative in their approach, and that is a natural safeguard. It ensures the Schuldschein market sticks to the investment-grade quality it’s always had. But I think elsewhere many players are postponing problems in Schuldscheine for later on. There are certain aspects that have to be dealt with but they are being ignored for now.
It is similar with the US election. There’s all kinds of negative scenarios that could come to pass but the market has shaken it all off with little more than a hiccup.
As was said earlier, we keep asking how long this bull market can continue. Every year we approach the beginning of the next year with a little bit of trepidation, wondering whether this market will continue. January is an important month, setting the tone for the rest of the year. Right now we feel that this will continue. But we look forward to the day when things settle down and it will be business as usual.
IFR: Let’s move on to another aspect of funding: the cross-border non-euro opportunities that are out there encompassing not just US dollar funding but also markets like Panda and Formosa bonds. Given their conservatism, as we have just been discussing, how willing are German corporates to look at these markets?
Marc Müller, Deutsche Bank: Large corporates are willing to look at different markets and tap liquidity where it is available. Not all the markets are moving in sync, so the US 144A market is certainly an attractive pool for many multinationals. Autos have drawn frequently from the US dollar market.
Also, when they’re looking at acquisitions in the US, the local dollar market ensures currency-matched funding, which aside from potentially more attractive financing costs has a lot of positives.
Formosa bonds offer a phenomenal way of raising US dollars in the Taiwanese market in Reg S format, meaning corporates are less reliant on the Eurodollar market if and when they prefer not to go into the US market directly.
You can effectively use an EMTN programme, add a Taiwanese listing and you have access to the solid dollar pool, especially at the long end of the curve. Many corporates have already raised funds in that market.
Adding other niche markets like renminbi into the mix diversifies funding sources further. This is one of the lessons from the financial crisis: not to substitute a loan with a bond, but to have diversified access to different sources of funding from the institutional investor base. That is increasingly available in various market segments. It also opens up growth opportunities via M&A, which can be financed when a strong capital markets footprint has been established.
There is confidence in German boardrooms. I agree with those who have said there is some conservatism before the button is pressed; there’s a very diligent approach to external moves. But these discussions are happening and I’m confident that 2017 will lead to a number of M&A transactions from German corporates. Those clearly will benefit from this broad access to capital.
Ingo Nolden, HSBC: Who would have thought, last year, that ZF would go and double its size by acquiring TRW? Bayer was another surprise. It shows that a lot is going on in boardrooms, which is not always clear to the outside. I would not be surprised if another really big deal, or a series of big deals, will happen in 2017 again.
In our view there are two sorts of foreign currency issuers. You have the arbitrage funders, such as Deutsche Bahn in Australian dollars or Hong Kong dollars. They don’t have any tracks in Hong Kong or Sydney, so that is arbitrage funding as their final needs are mostly in euros.
Then you have those with operations in different markets, such as the autos. Daimler for example has been doing an onshore Indian rupee deal to expand in India, or an onshore private placement in China if it plans to fund growth in China.
We even saw it in the Schuldschein market, with an Austrian issuer doing deals in US dollars, Polish zloty and Czech koruna. Just think about that: a German product, an Austrian issuer and three non-euro currencies. That’s interesting – not financial engineering, just fit for purpose and offering flexibility for funding international operations.
With the expectation of more FX volatility to come, given the macro-political backdrop, protectionism and currency wars that might be out there, issuers will look for natural hedge funding. They will try to minimise their swap books, which from a regulatory perspective can make it very expensive to get cross-currency lines.
This is where we expect the market will develop. It’s very important to have access to foreign currencies given the export links of our economy.
IFR: To what extent is sub-investment grade on your radar, Michael? Does it offer good value at the moment, and do you expect to see more coming?
Michael Schiller, Union Investment: We, as a traditional house coming more from the investment-grade side, have observed growing interest in high-yield over the last five years. High-yield has gained some incredible momentum among investors. It is linked to the internationalisation debate because investors look for it in US dollars, Australian dollars and other investments.
The second trend is going to subordinated structures, e.g. the hybrid market. We have built up resources in this area and are keen to get new investments. Structures are becoming more difficult than they used to be, but we still want to be invested there.
There’s a lot of competition around deals, you get minor allocations, if any at all. Is it correctly priced? If we assume that economies are healthy and will continue to grow more or less as they have in recent years then pricing is fine. If yields for investment-grade paper stay as low as they are now, then 2.5% to 3.5% for Single B is good yield.
The concern is that when the economy turns this is the market that will be hit most and hit first. People will take a lot of losses on the high-yield side, even when investment grade is still fine. But that’s the environment we are operating in.
IFR: Many less highly rated companies have traditionally been bank customers as opposed to capital market customers. Will we see more German sub-investment grade paper transitioning from the loan market into other forms of capital markets
Dominik Buric, LBBW: I would split sub-investment grade between higher quality Double B crossover area (Single B plus if you are looking at an external rating) and deeply high-yield credits. These are different kinds of companies, with different backgrounds. The lower-rated companies are sometimes the result of leveraged buyout transactions, which is also something different.
Those companies won’t only use the bond market; they will use every source of funding available, particularly with the sponsor behind them. They are looking for the best way to fund the company, and price is important but so is the structure and getting issuer-friendly documentation.
For Double B and crossover corporates it’s not a shift from loans to bonds. They traditionally use syndicated loans, they will compare the Schuldschein market with the bond market. If you have a non-rated company there is always some comparison to be made.
For these credit profiles you have to compare the price because bond markets can be volatile. A treasurer told me that the bond market has to be red hot for him to go to it. It’s different in the Schuldschein market because it has been more robust in 2016 and in past years.
So the company will look at which funding source is most suitable at that particular moment. It is a combination of factors, including access, price and structure.
Dominik Müller, Commerzbank: I don’t think that the main drivers determining whether corporates choose loan or bond financing have changed that much over time. At the end of the day it’s a balance between pricing on one hand and flexibility on the other. These are the main considerations a treasurer and a CFO need to factor in and which determine the right product at the right time.
And of course a big factor is also the relationship between the company and its banks. If a sub-investment grade company solely relies on capital market instruments, it will also consider what happens when times change. Will the old bank partners still be willing to support it in the future? Therefore German companies often take a conservative route, maintaining banking relationships in the loan market as strategic partners.