IFR German Corporate Funding Roundtable 2017: Part 2

Keith Mullin, KM Capital Markets: Markus you’re on the other side of the fence. You’ve had to live with low and negative yields. The narrative that gets thrown out there is that where investors were investment-grade focused they’ve felt a compulsion to buy lower-rated or unrated paper or look at alternatives amid a sense of panic to generate some kind of positive return. Can you talk about that? Has it been tough for people in the buyside?

Markus Wiedemann, Deutsche Asset Management: Yes and no. I think it depends on your mandate. A lot of the money we manage is benchmarked against indices so you only have to take the decision to be either long or short. It’s much more challenging if you run portfolios which have an absolute-return investment objective. Then you’ll probably look much more at valuations.

On index mandates, we get a big inflows from institutional clients as well as retail and wealth management etc. They want to be in the market and they like to get alpha from what we do. We look at every issuer that’s coming to the market and we do our fundamental and relative-value analysis to see whether it has the chance of outperforming the index, just as any equity investor would do.

Overall, since the view on overall market conditions – and I can agree with all the points that have been mentioned here – are very favourable, particularly since October 26 [the date of the ECB’s decision about the future of its asset purchase programme], we maintain a constructive view on corporate credit.

When we talk to other people in the organisation, there are warning signs on the loan side as well as on the high-yield side, particularly around looser covenants. Everyone can come to the market today to refinance so it’s not for now but this topic is something maybe for, say, 2019 or whenever the economic cycle returns. I guess it’s much easier for momentum players at the moment and for people who only look at value.

Keith Mullin, KM Capital Markets: Dominik, this point about loose loan documentation keeps coming up. How have you seen developments this year?

Dominik Müller, Commerzbank: I can echo what Markus is saying in relation to the loan market. Documentation is softening; that’s a fact particularly in the leveraged space where most transactions these days are covenant-lite. But in the investment-grade loan market too there was a tendency to further relaxation but this now appears to be coming to an end.

What is more interesting to observe in the long run is how documentation standards today compare with 2008 to 2009. Then prevailing documentation allowed banks to liaise with companies and to agree on how to go forward. If a comparable scenario were to occur over the next few years, banks would not necessarily be in a position on the basis of today’s documentation to have that kind of dialogue with borrowers.

At the end of the day, there is a lot of competition but there is also a degree of caution. Most of the players around the table want to do business with their clients on the basis of a fair balance of interests.

In the Schuldschein area, there is a tendency to launch transactions for corporates in the sub investment-grade area. Despite this trend the market perceives this as an investment-grade product and should be restricted to companies with predictable and solid credit stories.

Keith Mullin, KM Capital Markets: On that particular point, Ingo, traditional Schuldschein players have seen the emergence of unrated and low-rated borrowers as something of a travesty. And as the market has become less private over the last two or three years and international issues and investors started to participate, the SSD market has started to morph, it seems to me. Can you talk about where we are today?

Ingo Nolden, HSBC: It’s a €30bn market, it’s starting to generate some noise; it is a German product but people are speculating about whether it could get a Brexit boost. But let’s keep it in perspective: it doesn’t really move the needle vis-à-vis the bigger picture.

We have all learned that our reputation in the market and for the market itself is very important so there is some self-discipline. Whether that really is the case for all loan financing is a question. But the TLB trend is not driven by the banks, it’s more the institutional non-bank money that is driving it.

On documentation, it’s becoming really difficult but we all need to make money and write new business. In January 2018, business plans will be out there and we will start all over again. We are all sitting in the same boat and cannot really escape the market situation, which, once again, is driven by excess liquidity.

There are banks out there that still cannot get away from their TLTRO funding. They still have money lying around on their balance sheets and they need to put it to work. And they’re using more or less decently priced broadly decent risk to get the money employed. This will continue. It’s still in the system.

Anthony Bryson, BNP Paribas: On the covenant discussion, what’s been interesting is some clients who were very conservative, whether they’re rated or unrated have come and said: “we are definitely going to stick to a rating of solid investment-grade or implied but could you guys please give us a debt capacity analysis?”

“The problem we’re having is that we know there are going to be opportunities we have to seriously look at, which are transformational. We cannot fail to look at them but we need to explain to our board, stakeholders and shareholders why we would, sometimes materially, deviate from what we have been giving as leverage guidance or ratings guidance in the last years.”

Some of it has happened, most of it hasn’t. The very fact that some people who have been, by their good German nature, leverage-averse, have been saying: “let’s theoretically assume we were to do something larger. How do we communicate leverage guidance? How can we explain this to the rating agencies? How are bondholders going to see it because we’ve been telling them for a long time we were going to remain within a certain ratings band, implied or explicit?”.

That’s been interesting but challenging. There are sometimes covenant discussions where there’s a three times net leverage covenant in some of the documentation and companies have said: “actually we need to go to four times for an 18-month period. We can deleverage fast over x months but how can we manage this for the overall transaction?”.

I’ve learned a lot from that process. It’s new but of course it’s logical: we’re getting cheap financing which is boosting asset prices ie, you can get cheap financing but your downpayment for whatever you’re looking at financing has gone up. I call it squeezing the balloon.

Dominik Müller, Commerzbank: What I’ve been observing is a general awareness, both on the client side and bank side. There are a lot of banks and market participants running around offering terms and conditions that are incredibly attractive from a company perspective. On the other hand, there are a lot of market participants, both on the client and the banking side, who know that attractive conditions are as important as working with reliable partners.

I’m pretty sure that companies, irrespective of their size, are in a position to differentiate between banks who are reliable and take a more sincere view and come up with the best possible financing proposals compared to others with a short-term view.

This will also be valid for 2018 because opting for the cheapest financing with the softest documentation isn’t necessarily the best solution for a client. Particularly if things get more complicated, it will become really important to sit around the table with solution-driven financing partners.

Keith Mullin, KM Capital Markets: From your perspective Henryk, I imagine a lot of people come to you and say they are reliable partners or want to be reliable partners. Do you always look for the cheapest source of financing? Do you analyse some of the softer aspects of the relationships with your financing providers?

Henryk Wuppermann, E.ON: Bank relationship management is very important for corporates. We have very long-standing relationships with our banks. The difficulty we have, and I’m being very open here, is that there has been no consolidation in the bank market which we need to see. This year we redid our syndicated loan, which defined our banking group. We actually needed to take hard decisions and asked ourselves which banks we want to continue to have in our banking group. It’s not a nice decision to take because you have to exclude partners which you’ve had as reliable partners for a long time.

It is not so much, at least as a large corporate, an issue that you work with people who are unreliable in terms of banking group because you know your banking group very well.

Keith Mullin, KM Capital Markets: What’s driving the consolidation story?

Henryk Wuppermann, E.ON: In our specific case it was our Uniper spin-off, which meant the company has shrunk so the banking business we can offer is reduced. Still, given how the market is, every bank wants to stay in the group. That’s the way it is. So we need to take difficult decisions on which bank we believe is more reliable or is better placed to serve us in respect of certain products and others.

Ingo Nolden, HSBC: What I see talking to treasurers is that while on the surface you can say there is no consolidation taking place because the number of players hasn’t really diminished, there has been what I would call consolidation behind the scenes.

I can definitely confirm the trend Henryk described, where corporates are really asking what type of bank they want to partner with through the cycle and what type of products they need. The reality is that funding and liquidity are no longer differentiators for any institution in the market.

It is: how well do they know me, how good will they be if I need their help? Can they provide solutions? Do they still have the product set? For example we have seen players exiting the commodity space. Depending on the company, I can imagine that for their trading businesses this is something that might be of interest.

It is something where clients look and say: “what type of products do they still offer, in what region and what do I need?”. Then it’s more like putting together a puzzle and is much more professional than it used to be. In the past, it was “give me the money and we’ll find something”. At the moment it’s: “OK, the money is there regardless and I will choose my toolbox on the basis of what is good for me, where I see the company developing and what I foresee I might need in the future”.

Christian Reusch, UniCredit: It’s also because more and more products that banks typically offer and which clients use are becoming more and more commoditised and margins have shrunk. And competition is so strong that there is hardly any differentiating factor except maybe counterparty risk, which obviously clients need to balance when they look at their banking relationships. At the end of the day it’s also what banks joining your club can bring to the table in order to satisfy the overall relationship,

Keith Mullin, KM Capital Markets: This is a very interesting point but let’s be clear, consolidation is taking place on both sides. Banks are also consolidating their own client bases for slightly different reasons perhaps from the corporates but still it’s a process that’s ongoing.

Dominik Buric, LBBW: It’s an interesting topic but I disagree with some of the points made. We do have consolidation of a sort; not on the bank-client side but if you look around the table here, most of the banks have a debt platform or a corporate finance platform. That’s pretty similar to consolidation insofar as you are bringing more efficient service to clients by keeping products you formerly split up into one group to create solutions for your client. This is a sort of consolidation. The driver behind it, from my perspective, is of course more transactions done by the same capacity you have as a bank with lower margins or lower income possibilities.

So efficiency is a big topic here and this trend of debt platforms, or the corporate finance approach is our solution right now which I consider as the most value-adding approach for our clients and us as it is more holistic than a product-selling approach, I think the partnership between the banks and clients – and it’s not only the borrower/issuer side it’s also the investor side – becomes much more future-oriented than anything we did before.

Keith Mullin, KM Capital Markets: Markus, to Dominik’s point, consolidation is not just issuer-bank, it’s clearly an investor-bank issue as well. Can you talk about the relationship management aspects from the perspective of a very large buyside shop in terms of how you figure out who your dealing counterparties need to be or what you expect from them?

Markus Wiedemann, Deutsche Asset Management: We also favour long-term relationships with our counterparties because it’s not only the execution side of the business; research also becomes more interesting under MiFID II and we see unbundling too on the fixed-income side. I think it also comes with all the technology that’s coming into the market.

We have a limited number of counterparties on the trading side. Everyone is talking about liquidity being bad, which comes from a long memory from before the financial crisis. I think it’s actually good and has maybe improved over the last eight or nine years. Transparency is better and anecdotally we are also hearing that banks are increasing their balance sheets. So it’s actually quite positive for 2018. At the moment I don’t see consolidation taking place on the sellside in terms of being an execution partner.

Keith Mullin, KM Capital Markets: Have your requirements been upgraded with regard to regulatory changes, be it MiFID II, be it Market Abuse?

Markus Wiedemann, Deutsche Asset Management: Controls have clearly increased and for our people on the execution side, there are obviously larger requirements from 2018 with documentation etc. That’s on the sellside as well as on the buyside. Actually, we are much more involved on the portfolio management and research side of the business in having separate contracts for research providers because of the issue of inducement.

Keith Mullin, KM Capital Markets: Christian, I wanted to touch on the issue of how banks deal with their institutional clients in a new-issue context. This has come under a lot of scrutiny. The Market Abuse Regulation and MiFID II have created more rules around the syndication process and how banks allocate deals. There’s a lot more transparency required as well as democratisation of access to information. Is this a game-changer?

Christian Reusch, UniCredit: Whether it’s a game-changer is yet to be seen. Certainly, life will be different starting from January 3 with MiFID II, preparations for which are in full swing. That will certainly have an impact and we will need to accommodate to the new normal. You’re already seeing that on allocation calls and other things where first measures are applied to dry-run the new status quo and figure out how things are going to work starting in January.

Nobody in the market is against transparency. [The new rules] will probably spread more transparency through the equation and make life a bit more predictable in some ways. Market participants think all the measures being put in place on a stand-alone basis are OK. But the combination and, let’s say, their magnitude and their timing maybe could have been better. The fact that there are so many things coming into play more or less at the same time is creating some stress to the system.

Bringing some of the actions together at the same time seems to be a little complicated. On a stand-alone basis, things sound perfectly good; bringing them into balance is more difficult.

That’s the challenge we will see over the next couple of months. Discussions in the industry are, I think, going in the right direction. Would I say everything is already in a perfect world? No, because there is a lot of room for interpretation. And there are other discussions currently going back and forth which do not necessarily make things easier. Brexit, for example, also weighs on some of the industry body discussions because people in the UK see things slightly differently. There’s a variety of things to be balanced.

Anthony Bryson, BNP Paribas: One of the challenges we have on the DCM side is if you happen to work for an institution that cares about immediate primary market support of a deal, or secondary trading or credit research, we take our pitch books to clients and, of course, no bank, be they large or small, is going to say: “we don’t care about secondary trading levels or bid-offer spreads”, or “why don’t you get your research from the market-leading national bank on this sector?”.

The challenge is to take that message and get a reward for it. Corporates, especially after Lehman, have been under a lot of pressure to pay back lending relationships for those banks that remained loyal. But you often have a situation where banks are not being rewarded for doing things that other market participants can simply free-ride on.

Banks, under the new regulatory environment, obviously have to pay more attention to what we can tell clients. We’ve got a lot more data but it’s a lot stricter – and for good reasons. That is the challenge I’ve had. We’ve often had our syndicate colleagues remind us to convey to corporate clients: “please make sure the client is aware that we do care about our primary franchise”, but there’s not always been a correlation in terms of recognition.

European corporates have strongly deleveraged in recent years, so when we do the financial models we quite often go to corporates and say: “look, you’re going to be net debt-free in two years”. Be they listed or not, that puts a lot of pressure on corporates to do something because, if you project that forward three or four years, you cannot have shareholders and stakeholders ask: “what are you going to do now?”.

Of course, having deleveraged, corporates have the challenge of not needing so many banking partners and not having so much wallet to share out. It’s clearly a very challenging thing to then form a long-term relationship and say: “actually we’re downsizing, do you mind if we don’t invite you into our refi?”. I don’t envy corporates that task.

Henryk Wuppermann, E.ON: As an issuer, you really wonder how asset managers deal with less and less corporate credit coverage. I don’t know what your impression is but if you are seeking alpha you need to evaluate the credit but I see less and less coverage from the banks.

Markus Wiedemann, Deutsche Asset Management: For us it’s never been a big issue because we have a network of more than 60 analysts in New York, Asia and obviously Frankfurt who look at credit. We do our one-on-ones, we do the analysis on investment-grade as well as on high-yield and on emerging market corporates, and we do our credit assessment so the portfolio managers can look at relative value when it comes to pricing.

Obviously it’s always good to have third parties to discuss issuer profiles and your fundamental view on the company but you’re right, there are fewer and fewer banks who engage.

Christian Reusch, UniCredit: While shops like yourselves have a 60-strong credit research team, a lot of small and medium-sized asset managers and banks certainly do not have internal research capacities. It also depends on which market you’re talking about: in the UK or France it’s much more consolidated from an investor perspective. Looking at Germany, yes you can say on the big fund management side it’s also not very difficult to diversify.

But if you want to diversify even further, you have lots of small and medium-sized investors, which, if you want to touch them, certainly with those services as you’d already described, they will take them as a support mechanism to reach conclusions.

In today’s market where everything is bright, everything is perfect where if you invested at the beginning of the year and did nothing you’d have had a great year-to-date performance, that’s a perfect scenario. But there will be also times where there’ll be more volatility and things will become more challenging. Then secondary market coverage and research coverage will come into play.

This is, from a borrower’s perspective, where I think you say, when you compose your group: “does my counterparty bring this to the table, yes or no? Do I weigh this as important, yes or no?”.

Henryk Wuppermann, E.ON: As an asset manager, if you want to diversity into smaller names, essentially you will never hear from them again unless they default or pay back. It’s obviously more difficult; I can’t see 60 people cover 2,000 names.

Markus Wiedemann, Deutsche Asset Management: Obviously there are limitations and also for us it’s about efficiency and where you allocate resources. So if an issuer wants to come to the market, there’s always an incentive to establish a bondholder track record. I can only encourage issuers to engage in this dialogue or have quarterly or semi-annual updates. On the other hand, we have quite a large equity business here in Germany and they get many more company meetings than we do on the bond side. We take every chance to participate in those meetings.

But when it comes to smaller issuers, when we talk about, let’s say, our emerging market credit business, then you really have to have partners.

Ingo Nolden, HSBC: You said you search for alpha but how can you create it? We have all seen the unrated market or the hybrid market where issuers have said to us: “of course, I’m happy to pay up for features I cannot bring to the table. I am not rated, I am not as big as E.ON or I might be less well known but I’m happy to provide the transparency investors need”.

We very often have situations where we go out with issuers that are outside the norm and end up with a lot of declines, especially from the large funds who say: “listen, it’s not in this portfolio, it’s not in that portfolio, I’m a benchmark tracker etc”.

I sometimes ask myself whether tracking a benchmark is really a differentiator for you. And of course your business has been under big pressure from ETFs. How do you cope with this demand? We can bring more names to the market. Of course, there’s a limit; some issuers shouldn’t be in the capital market because they are not professional enough and it’s our job to take those out and not put them in front of you.

What I wonder is why can’t we have a bit more flexibility? Of course, it depends on your mandates but to your end-clients who complain every year asking where the alpha is, why can’t you sell them a package and say: “guys, we can do this, but it will cost more money because we need to track this issuer more intensively and of course it comes with more risk”?

How is that conversation going on your side? I always wonder why you don’t take up the 50bp or 100bp the market is offering you or the syndicates are pricing in. We have this discussion all the time. Your originators come to you and say: “listen, it’s a nice story. It has some hair but they will pay for it”.

The unrated market is a decent market; a niche market but it’s there. At one point, people would look at the hybrid market and ask who would buy this stuff. It’s a boom product in some ways of course but it’s established. I think the only way to really create alpha is going above something. The question is, where’s the border? Everybody needs to find it. How do you deal with creating extra yield for your clients?

Markus Wiedemann, Deutsche Asset Management: We’re covering around 92%-93% of market value in European investment-grade so there are obviously enough opportunities for us to create alpha. We look at first-time or infrequent issuers as long as they at least have benchmark size, €500m, to offer. To be honest, we don’t look at unrated most of the time because many of our institutional guidelines don’t allow us to invest in non-rated paper.

Ingo Nolden, HSBC: Benchmark size is some kind of approximation for liquidity?

Markus Wiedemann, Deutsche Asset Management: It’s an approximation.

Ingo Nolden, HSBC: Which has changed over time …

Christian Reusch, UniCredit: The unrated market is a niche market so we shouldn’t over-exaggerate but people are looking at it and €300m seems to be the mark; €500m is a stretch for many so €300m is healthier and still gives a feel that it might be providing enough liquidity.

Ingo Nolden, HSBC: You can ask even with all the regulation taking place and with the consolidation on the trading side whether a €500m bond is really liquid now.

Anthony Bryson, BNP Paribas: There is competition from our own balance sheet too. We are continuing in Europe to finance in a very competitive market landscape at very attractive levels, which is also good for the economy and for what is required of banking and financial institutions, these days. We’re often competitive compared to outside investors.