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Sunday, 19 November 2017

IFR German Corporate Funding Roundtable: Part 2

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IFR: What about the issue of rating, Christian? It’s always a big talking point among corporates, particularly first-time corporates. We have seen, as you mentioned earlier, demand for unrated issuance. Would you advise borrowers always to go for a rating? Or do you think it’s not so essential these days?

 

Christian Reusch, UniCredit: Obviously having options is a matter of luxury here, put it that way. In a bull market, or in a market like this, it might be beneficial but not necessarily needed. I think it’s also a question of which target audience you want to reach.

In unrated format, you will most likely reach a much more domestic audience than an international one even though you might have a strong brand name, which everybody around the investor community recognises.

Ratings play a role in markets that can be a bit more challenging. We have seen a similar picture with respect to Schuldschein, where some of the long-term buyers especially have been requesting a rating. So from that perspective, a rating is nice, but not essential where demand is high and economic conditions are very favourable.

 

Ulrich Hoeck, Commerzbank: I fully agree but I think the unrated tag that is very much associated with Germany. The biggest unrated bond market is France. In terms of number of issues, total volume, number of issuers, that’s a much bigger market. We also have a strong Italian component.

It’s much more feasible for unrated issuance to be attached to domestic markets, as Christian said. If you do not need to have a rating in order to get it done – call it hype, which is the other side of the coin – you can do that.

We recently established a debt issuance programme for private placements for an issuer without a rating – the German retailer Otto – and we’ve done deals, which shows me that there is a market, that is, let’s say, the next logical step in development behind Schuldschein into the bond market.

I think if we look forward, if we solve more and more problems in certain areas of Europe and elsewhere in the world, I think we will have a continuous flight of unrated issues into Schuldschein because the parties at the table are getting more and more used to this, especially when they see it working in strong markets.

We only touched on this very briefly but I think the key element will be simply how quickly the market will come back to what banks and portfolio managers think are healthy spreads. I think in the past we always said: “OK, if the market turns it will be a very quick thing. It takes us six years to go down, it takes us six months to be back on top on the peak”.

I think that has changed completely with the continuous injection of political demand into the market. We will not see this immediate return hence Henner and other corporates’ attitude to wait and see. Having time and patience is absolutely prudent and maximises shareholder value.

 

Matthias Gaab, Deutsche Bank: What hasn’t changed over the last three or four years is that it’s advisable for companies to diversify their funding base among all the products in the lending business and the various capital market instruments. Not just to diversify the sources of funding but also with respect to the volumes you can raise, as well as the tenors which are available in the various sectors.

Especially in the current environment where we talk about pretty low coupons and spreads over mid-swaps in the debt capital markets, that should certainly, in principle and in theory, be much easier than it would have been, say two years ago or so, for example.

 

Roland Boehm, Commerzbank: I agree with you but I would even go further Matthias. In spite of the good market conditions, we haven’t seen a lot of borrowers acting opportunistically because I think most of them have realised that the world is a more volatile place than it used to be, and it probably will continue to be.

As a result, diversifying your investor base and diversifying your optionality in issuance is key, and this is a trend that I can only encourage. The result of that are stronger capital markets in Europe. Europe is never going to be the US, but we can do this our way, and I think that’s actually what’s happening.

 

Henner Boettcher, HeidelbergCement: That’s probably also the reason that more and more corporates are establishing debt issuance programmes and not stand-alone documentation. HeidelbergCement has had a debt issuance programme for ages and I get constant calls from treasurers of smaller companies asking me whether it’s a big step to take. I always tell them it’s not and you have full optionality.

 

Ulrich Hoeck, Commerzbank: I think you see much more opportunism on the corporate finance side. You may have spoken at your last roundtable about acquisition finance and if I look through what I have seen in the market, we’ve seen little to no acquisition finance; in fact it’s only picked up in the last month or two. It certainly wasn’t there at the start of the year.

We hope that this will kick in much more. The US is way ahead of us in this regard, referring to Verizon. If you talk about what’s on the horizon, that’s the next big opportunistic thing. Whatever the internal hurdle rate of how costly debt is these days from a macroeconomic perspective, it may be far too low. We may make completely wrong investment decisions given the low hurdle rate. But that’s for the generation after us to find out.

We have some rare opportunities on the acquisition front: a superb environment, the banks are strong, the markets are strong and what the Verizon case tells me is that you need a little bit of loans in order to get a lot of bonds done. So these two things work nicely together.

 

IFR: Keeping on the theme of the acquisition environment, wherever you are in the world, there is always an expectation about an acquisition wave about to hit but we have seen relatively unexciting volumes. I’m curious to find out whether the panel thinks the big deals we’ve seen this year are episodic or are they setting the scene for M&A growth?

 

Roland Boehm, Commerzbank: Well, asset prices have remained stubbornly high, and that’s the reason many corporates – and again I would be very interested in what Henner has to say — have rightly been very cautious about bolting ahead with very large acquisitions that lead to a lot of leverage. Let’s not forget that Verizon, in spite of its spectacular size, was actually the buy-out of a minority shareholder.

It’s a bit of a unique story and it’s a great story because it illustrates the capacity that’s available in the market. Verizon could be duplicated in Europe with similar volumes and a similar take-out story. It demonstrated market capacity but it’s a relatively simple deal. Before corporates really re-leverage in a volatile environment, they are going to think about it very carefully.

I am not going to presage an acquisition finance boom, but deals will happen. Particularly in Germany, as I said before we have global market-leading companies and franchises. In spite of the market crisis, globalisation is going to continue and as a result of that, we are going to see deals happen.

Finally, you’ve got to stop measuring acquisition finance activities against developments that we saw in 2004 to 2006. That was a one-off. The activity we are seeing now is normal and it will increase over time. I think we are going to see some fantastic deals come out of Europe over the next 12 months.

 

Matthias Gaab, Deutsche Bank: The merit of the Verizon transaction is people have now seen the volume that is possible on the loan as well as the bond side. If people wondered whether we could raise that kind of size in the markets, it’s no longer a question. Twelve months ago, all of us on the bond and loan side would have said that under current market circumstances you can raise a very significant amount of money but clients would probably have doubted that.

That doubt has gone away and the financing issue has been sidelined as an issue; it’s no longer the bottleneck. The bottleneck remains: is there a target? Is the asset too expensive and what’s the overall process?

People remain cautious with respect to the long timeline between announcement and closing, in particular in light of volatility which will remain high.

 

Roland Boehm, Commerzbank: But again, because we are all product people, we tend to focus on things the wrong way around. If we look at it from the corporate side, I think acquisitions and incurring that amount of debt need to make sense economically over the lifetime. In a volatile market, that’s what is holding a lot of people back.

 

Christian Reusch, UniCredit: But I think you have a variety of aspects which play into why you should do it. But as you rightly said, at the end of the day it has to make economic sense, it has to make sense strategically and not just be an acquisition for the sake of it.

 

Henner Boettcher, HeidelbergCement: There is M&A activity and there is pick-up in capex but right now it’s brown-fielding, it’s green-fielding, it’s buying out of minorities, that’s it. That is what we see across the industry. In this volatile environment it’s just not the right time to do mega-deals.

 

IFR: One of the drivers of M&A is consolidating into fast growing markets, typically emerging markets. We’ve seen a slowdown in China and most of the major emerging markets. So, if the expectation is that EM growth is slowing, does that put a lid on potential M&A?

 

Henner Boettcher, HeidelbergCement:  It makes it harder to justify.

 

Roland Boehm, Commerzbank: But where is the growth going to come from over the medium to long term? It will continue to come from many of these countries that I actually have trouble referring to as emerging markets; they’ve emerged. That’s where the growth is going to come in the medium to long term, so we will see continued activity.

I just don’t think we need to rush the discussion on things like acquisition finance, or purchases into emerging markets, it will come. I am very, very confident that we will see quite a lot of activity over the next 12 to 24 months.

 

Joachim Erdle, LBBW: Just to add to what Roland and Henner said. I think borrowers are prepared for this. Either they’ve already built up strategic equity on the balance sheet, or they are sure they have access to loan finance and capital markets. So I would say corporates are prepared to make strategic acquisitions, but clearly driven by the fact that it has to make strategic sense.

 

Roland Boehm, Commerzbank: The discussions that we as a bank are having with clients – and I believe many of you around the table as well – demonstrate that interest in underwriting has picked up significantly over the last three to four months. This is a leading early indicator. Companies are seriously looking at deals and opportunities.

 

Ulrich Hoeck, Commerzbank: I want to address this topic of where growth is going to come from. From my perspective the growth of loan markets is clearly in the Schuldschein product. At least this is the quality dimension, it’s not the quantity dimension, it’s the quality dimension in that it attracts a lot of eye-catching momentum.

I think the growth of the bond market is most likely in the hybrid product. We have always had these things, but we had, let’s say, multiple regimes from the rating agencies and accountants. The dust is settling and issuance is being funnelled into fewer structures, which is why we are able to do much bigger transactions.

You saw the VW dual-tranche perpetuals, which I think was a truly landmark deal and tells you what is possible, if you are in a special situation. It’s then up, obviously, to the corporate to decide whether it wants to go that route or whether it goes to equity stakeholders and address it with them.

But I think that is a kind of quality dimension which we have. In the current environment, where we all say, “the DAX should continue to go up and up and up” and “debt spreads are at a low level” I continue to say: “hybrid debt is the cheapest equity”. If nothing else, it’s an enrichment of the corporate treasurer’s menu card.

Some corporates are taking that route; ditto mandatory convertibles. So far, this is a product that has been used in special cases only, such as acquisition finance situations, but I think corporate treasurers have a truly enriched toolbox. We bankers have to deliver and clients have to use the whole menu in order to be in the best position.

 

IFR: On the corporate hybrids, there has been a lot of activity but from the debt investors’ perspective. Christian, is this purely a yield play? Because as Ulrich said, it’s cheap equity.

 

Christian Reusch, UniCredit: I share part of the enthusiasm Ulrich has. However, I think it is also very much driven exactly by the low coupons on offer relative to senior debt. That’s why it makes economically a lot of sense, from a corporate treasurer’s perspective.

But the product matches investors’ interests as well in that they will get a much higher yield, and that certainly plays a significant part of the investment decision. But I’m a bit more sceptical; this is not an instrument that is there for everybody. Some smaller companies have struggled a little bit in this market and not all issues have sold like hot cakes.

It’s a good sign that we’ve seen a cyclical company enter the fray, after the telcos and the utilities, which have been using this market for a very long time. As long as yields remain low, this instrument will play a significant role but as the cycle turns, we will see people quickly disappearing and investors will quickly offload risk at that part of the capital structure.

 

Ulrich Hoeck, Commerzbank: But one component you may not have reflected yet, due to the new policies of the rating agencies is we have fewer structures and more standardisation. That helps the market to grow. I’d also like to raise the question of what will happen with 30 year deals in 10 years’ time if yields are 8%.

 

Henner Boettcher, HeidelbergCement: For strong investment-grade corporates, it’s a very nice addition to the pools of capital you have. For a crossover name, though, it’s less interesting.

 

IFR: I wanted to talk a bit about liquidity, both in the loan and the bond market. Investors have been used to lots of inventory on dealers’ desks but because of capital constraints, dealers are carrying much less. If investors want liquidity, should they now have to pay for it? What’s the bond market view?

 

Christian Reusch, UniCredit:  I laugh because this liquidity discussion has been around forever, even in the bull market. At the end of the day, if I am an investor and I am long an asset, and I would like to get rid of it, for whatever reason, liquidity is defined as: (a) is there a bid out? b) is the bid out in the size I need?

I may or may not like the bid but anything beyond that enters the realm of a more esoteric discussion. I would cut this long story very short. If you want to offload risk, then you can offload it, you’re fine. If you cannot offload, you have a problem, as simple as that.

 

Ulrich Hoeck, Commerzbank: I think the banks are doing a lot to provide liquidity. There are more and more e-platforms and I think they have become smart. Years ago we had these discussions about stock exchange-driven things, etc and I think all that dust has settled. I think the regulators have put some stress on holding positions and that needs to be reflected.

You cannot force somebody into holding positions against the regulator’s wish and at the same time have the lowest cost of getting rid of your paper. That needs to be taken into account. I think it’s a very simplistic mathematical approach, you have to make the math correct, that’s it.

 

IFR: How does this discussion play out in the loan market?

 

Joachim Erdle, LBBW: I think we are desperately looking for pieces in the secondary market for various reasons. But to be honest, while there is liquidity at the stressed and distressed end, in healthy or performing debt, liquidity is very difficult to find.

 

Roland Boehm, Commerzbank: The market is open for business but you have a severe imbalance between supply and demand. Currently there is a lot of demand but relatively little supply. I certainly have lots of buyers on the secondary desk but it’s very hard to find the sellers.

But what you need to always underscore in the loan market is that you essentially have two very different markets. The market for corporate revolvers is very clearly a bank market, and corporates think long and hard who they want in their banking group. This is really a play on the total wallet that banks have with corporates, rather than an indication of liquidity and pricing in that market, and usually the assets are undrawn anyway.

The other part of the market is the market for drawn assets, and we simply haven’t seen a lot of supply on the corporate side. It’s picking up on the leveraged side. I think that’s also a healthy development. Here the market would like to see more. So there is currently a bit of an imbalance, but on the positive side, it shows that the market is there, and that we can get things done.

 

Matthias Gaab, Deutsche Bank: Well, on the secondary side there is little activity because by far the vast majority of the deals which we have seen are corporate deals, and as a bank you just don’t sell out of those, because as Henner confirmed, that’s your entry card. You only see it if a bank – and we have seen this occasionally in Germany, over the last three to four years – changes its strategy towards certain clients.

But any supply that comes out is easily picked up by competitors, mainly because in the initial primary transaction, especially in the current environment, they have been reduced so significantly from their initial commitment, that they probably still have room to pick up more paper. But otherwise we don’t see much.

On drawn assets, on the leveraged side, it depends. There is relatively little LBO activity. On the other hand, looking at the numbers, on the high yield side for German borrowers, the numbers are twice as high as last year in percentage points.

From that perspective, a lot of liquidity has morphed into the high-yield bond market from the leveraged market. And you have this question between whether on the leveraged side, it’s a bank market or whether it’s an institutional market.

Under the current circumstances, with significantly reduced coupons and spreads on the high-yield side, that is an attraction which is squeezing what the banks and institutions would be willing to offer. We have seen a couple of transactions where the volume on the high-yield side has, as a result, reduced the availability for the other sectors.

 

IFR: How do you see activity in the leveraged market in Germany?

 

Roland Boehm, Commerzbank: Again we need to avoid focusing on the short-term trend so that we don´t miss what is going on in the medium to long term. You continue to have, in Germany, a market with a substantial number of Mittelstand companies. Many of them are still privately owned and some of these are going to look to transition ownership over the course of the next few years.

As a result this remains a highly interesting market for leveraged players and for private equity houses. I expect to see, in the medium term, a very lively market from Germany into that space. I think some of those issues will go directly to US distribution. Others will stay here.

But we are going to have a very lively market. I am very much looking forward to seeing how the high-yield bond product can play a larger role in that. I think that’s a sign of a healthy market and I am glad to see it grow.

 

Ulrich Hoeck, Commerzbank: The high-yield market is, from experience, always the market which switches off first when it comes to some stress, and what we saw in late summer was that, due to desperation on the investor side and the good quality packed into these transactions, we saw some positive developments.

Whether decision-makers decide to use the bond market route or go to the loan market, they will be opportunistic. We have strength from the markets’ side that can easily deliver and I think the comments about the pick-up in opportunities in the leveraged finance market are spot on. The same is true for the high-yield market. We are ready; corporates have to come up with ideas as does private equity.

Partners have to think about what they would like to do next, because they should benefit from the current environment. Banks are no longer shedding assets, but taking assets on board, and investors are looking for opportunities as long as the coupon is two plus.

To continue reading this roundtable, click the relevant section. Introduction - Participants - Part 1 - Part 2 - Part 3

 

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