Monday, 20 November 2017

IFR German SME Funding Roundtable 2015: Part 3

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IFR: I wanted to bring in the topic of securitisation. From a policy perspective there’s a huge initiative to kick-start securitisation as a regulatory capital relief tool and as a risk lay-off mechanism for banks. On a related theme, we did see an SME structured covered bond, although the Pfandbrief community was very cautious about it. How do developments in this broad area change the dynamic in terms of SME funding?

Thomas Haas, Bayerische Landesbank: One thing is for sure: running a bank business model is becoming more and more difficult in terms of earning money not least because you have to pay so many people to get to minimum regulatory requirements. Therefore, a lot of debt instruments, including securitisation, have a fair chance of growing on paper.

But the broad market is so competitive and there’s so much liquidity in plain-vanilla lending. On a mid-term perspective, I see covenant-lite lending and business in bonds and Schuldschein continuing to grow. Direct lending funds are not in a position to afford the models to create securitisation programmes.

We are actually growing in this segment because there are still some mid-caps committed to a crossover rating who really want to have a diversified lending base and running securitisation programmes. But at the end it’s very expensive; there’s a very long lead-time and it’s not so flexible, so actually I don’t see it growing rapidly in practice.

Joachim Erdle, Landesbank Baden-Wuerttemberg: From a bank’s perspective it’s a nice product. It depends on whether the corporate is able to establish the structures to deal with the product and the framework. Hence, it’s more like an add-on to a corporate’s established funding base. In most cases it will not provide for the majority of the corporate’s funding needs.

Michael Bures, Raiffeisen Bank International: I agree it’s a very nice product but not right now because everybody is so liquid and plain-vanilla unsecured funding is so cheap. But when times get more difficult – and bond market is already showing signs of getting more difficult – asset-based structures are a very interesting product for clients because they will still be able to get funding at relatively cheap rates when times aren’t so good.

It’s something I think corporate treasurers should seriously consider because it’s a very interesting funding source and it helps them manage their working capital. It might improve one of the other of their ratios. I think it’s a really interesting product. I would say the fact we don’t see more of it currently is collateral damage from quantitative easing.

Thomas Haas, Bayerische Landesbank: We did see a couple of borrowing-base financings in the syndicated world. A couple of years ago, we thought this might be a new trend but what we found was it’s very difficult to build a bridge to the asset from a banking perspective because what do you as a bank do with these kinds of assets?

The customer you are serving has the best business model to make money from their assets. Our experience also was that banks were not in a position to save equity by financing such structures; it’s too expensive to create the rating tools that give you as a bank the opportunity to build a portfolio that is then driven by a broad base that your auditor qualifies you for.

So I don’t think it will happen. What we will see more and more is ABS structures combined with commercial paper, for example, or with bonds that you bring to the market. But this is actually very rare with SMEs, because if you’re talking a €500m revenue, you’re talking about a very small balance sheet that limits the asset base dramatically and we struggle to do this even with blue-chips.

Also what you have to bear in mind is that once a Schuldschein or a bilateral financing is out there, you’re restricted in doing these kind of things, so there is also a big hurdle.

Reinhard Haas, Commerzbank: I agree with Thomas. The borrowing base financings had lot of hopes pinned on them a few years back. The logic behind thinking that client assets could be worth something and could provide credit enhancement is absolutely valid.

The problem we encountered, what you described as the difficult risk appraisal process: was giving a fungible value to the assets we appraised. That’s why you’ve seen borrowing-base financings so much out of raw material-driven trading companies. That’s where it works because there is a quote for the assets that you have as underlying security.

If you don’t have that, there’ll be a very diverse view on what the underlying asset may be worth. If banks in general, or investors on a broader scale, don’t agree on the value of the asset that’s the underlying security, then you won’t have a harmonised view on the financing. That makes it limited in scope. As long as you have an asset that is viewed by everybody …

Sven Janssen, Oddo Seydler Bank: as being fungible …

Reinhard Haas, Commerzbank: – as fungible and has the same value to everyone, then it can be capital alleviating and then it’s worth it.

Stefan Bund, Scope Ratings: On the broad issue of SME funding, there is always strong political will to support it but there are two angles to that. One is ABS lending at the corporate level – there, of course, liquidity is competing with other structured products and why would a corporate go for a structured product which is more expensive than unsecured funding?

The other element is that the political incentive to support SME lending is that banks recycle their balance sheets to do more lending to SMEs. But that’s not really the issue; it’s not lack of liquidity that requires recycling of SME loans into structured products but it’s a question of the equity. The market is awash with liquidity but you can release equity with SME securitisation? That’s not the case any more.

Therefore, and it’s also one of the reasons why I think, for instance, the SME covered bond wasn’t very well received. Why should you resort to such a complex structure when you can get cheaper funding via unsecured bank funding?

Sven Janssen, Oddo Seydler Bank: Speaking from the perspective of a bank that doesn’t have a balance sheet – with all the pros and cons implied by that – our focus is on institutional investors. There are roughly 100 insurance companies in Germany, mainly mutuals. They live a very quiet existence but one that is challenged in that day-to-day, minute-to-minute, they’re confronted by asset-liability mismatches.

They have no interest and no capacity whatsoever to invest in mid-sized companies, let alone small companies, principally because they don’t have the capabilities to deal with issuance of, let’s say, €75m or €100m. So they focus on the large blue-chips, even knowing that they’ve locked in something which will eventually be a major challenge to managing asset-liability matching.

So we’ve got this extreme scenario: a fragmented SME market, with potential issuers that constitute the backbone of the German economy, and a huge yield-seeking insurance sector where the two sides simply aren’t coming together. This is something Berlin should address. It’s very difficult; we are all market actors around the table and the problem is we are all pursuing our own interests. But the problem represents an important macroeconomic dimension which has to be handled by a more neutral institution, and I think that neutral institution is the State, I’m afraid.

I’m open to ideas and suggestions as to bridging the challenges of the insurance companies and the financing need of SME companies. At the moment, the SMEs are fine because they are well financed primarily from the Landesbanken, savings banks and co-operative banks. The challenge will come once interest rates will go up.

Marion Schiller, UniCredit: But don’t you think as soon as liquidity shrinks from the banking side that they will find their way together?

Sven Janssen, Oddo Seydler Bank: No. Why?

Marion Schiller, UniCredit: Because if liquidity from the banking side is no longer available, maybe they will take steps towards each other.

Sven Janssen, Oddo Seydler Bank: The problem is not with the issuers; the problem is with the investors. It goes back to standardisation, actually.

Reinhard Haas, Commerzbank: Indeed, having infrastructure in place to suit smaller insurers and mutuals. They don’t have such a thing and it will be too expensive for them [to go it alone] so the equivalent of the NAIC in Europe will be crucial. And not just on a German scale but on a European scale.

Once you have [credit] appraisal by a rating agency or an agency of the insurance industry in Europe and that is seen as a reliable source of risk appraisal for capital, then it becomes much easier for smaller investors to trust and invest in SME paper. I think that’s when you start to have a liquid market.

Ingo Nolden, HSBC: To that point, the SVO as an institution is financed by insurance companies. The analysts employed by the SVO are treated more or less like civil servants so they are in some way the neutral body Sven mentioned.

As a market participant, you can’t approach them. I really like this kind of structure. Coming back to Sven’s point: yes, we need the government of course but that’s easy to say. Plus we already have a lot of analytics at the domestic level; we’ve got the Bundesbank; we’ve got the Banque de France; we’ve got the OeNB. Of course, we can all question what these ratings are worth in the end. I’m not the biggest friend of always calling for Big Daddy to come in and manage this.

Sven Janssen, Oddo Seydler Bank: Neither am I; that’s why I was so hesitant.

Ingo Nolden, HSBC: But it is a political question to use what is there in a neutral way. Of course, we have the private sector rating agencies but I feel that in the light of CMU this is a starting point that could somehow standardise the way market participants look at risk – and in a way that people will actually buy this credibility.

Of course, you always have the issue of credibility but at least from a German perspective I don’t think analysts would question the credibility of a Bundesbank rating or an OeNB rating. Of course, there is always room for improvement, but I think it’s a starting point.

Thomas Haas, Bayerische Landesbank: What market players learned in the financial crisis was not to trust a single rating from a rating agency. I think it’s key to assess the quality of an investment by yourself.

Ingo Nolden, HSBC: I agree.

Sven Janssen, Oddo Seydler Bank: But that’s precisely my point: it ties up resources. It means you have to review and you have to think. People are too lazy to do either; that’s the point. Or they simply don’t have the resources.

Thomas Haas, Bayerische Landesbank: Yes, but who is coming into the market? It’s the big players, the really big funds with billions of capacity. They can afford to do their assessments and these guys decline on average 90% of the deals they’re shown. They’re very selective because they cannot afford a single default.

Ingo Nolden, HSBC: But to Reinhard’s point and just coming back to the USPP, the SVO and the NAIC designations are only done after the deal, giving guidance on the capital buffers for each and every investment. Investors do their own credit work. It’s harmonised to the extent that everyone knows what capital buffers they have to put on the balance sheet but it’s not a question of: “OK it’s NAIC 2 I’ll just buy it blindly”. It doesn’t work like that.

Reinhard Haas, Commerzbank: No. What Thomas said is true: you need to have a certain capacity to have your own appraisal. But even though the NAIC of SVO appraisal happens in the aftermath of the deal, it comes back to us as banks: we guide issuers through what the structure should be so it will correspond to SVP or NAIC appraisals.

If we had a European version of that and we know what the investment criteria will be to have investment risk categorised as one, two, or three, then you have a situation where you can create a product with deep liquidity because everybody will be familiar with the relevant standard.

I think banks are well qualified to accompany clients in that process; we just don’t have the infrastructure available where you have a unified view on the issues.

IFR: I wanted to touch on something that was mentioned earlier, which is the notion of cross-sell or ancillary business and how that works in a mid-cap environment. If you’re talking about BMW or Volkswagen, clearly their ability to offer cross-sell is tremendous. At mid-cap level it’s a bit more limited. Martijn, how does that narrative play out in the mid-cap space given the more limited scope for cross-sell?

Martijn Kamps, ING: First of all, in the mid-cap area banking groups are much smaller. Roughly speaking, if we’re talking about €500m-turnover companies, you’re most probably, under normal circumstances and under normal Ebitda margins, discussing maybe deal sizes of €100m, which means banking groups of max five to six banks.

In that context, there should be enough wallet, especially when companies are diversified in the international space. In Germany we see a lot of export-driven companies so there’s a lot of cross-border activity as well. If you pick your banking group carefully and make sure that everybody has their own niche where it’s stronger than the others, it’s easier to share across the wallet and enough space to make everybody happy.

Marion Schiller, UniCredit: It’s a valid question because the cake is much smaller than for large caps or multinational clients. I think we’re clearly seeing a trend especially with smaller companies to further reduce their banking groups because everybody is telling them: “I need cross-sell” and the cake is available just once.

For €500m and below, five or six banks is already a big number. I think three to four is sufficient. SMEs tend to do club deals; they don’t want broad syndication processes because they want to select their banks and offer cross sell to them all.

Martijn Kamps, ING: And these companies have existing relationships that have lasted for a long time, through cycles and crisis so it’s a reliable relationship from both sides. I think banks to a certain extent also take the view that although it may not be worthwhile today, it may become worthwhile again, and revenues and ancillary business will pick up.

Reinhard Haas, Commerzbank: In the end, it’s a simple mechanic. If there is not enough cross-sell to be distributed, that will weigh on the pricing of the debt product. If there’s sufficient cross-selling available for the number of providers of liquidity, you can talk about the pricing having a relationship discount. If that doesn’t exist, the discount will disappear.

IFR: Are banks more disciplined around that now?

Reinhard Haas, Commerzbank: Competition obviously brings new players into a situation where they need to live without the assurance of getting cross-sell in the immediate term, but there is a belief that over time that’s going to happen. This is how the industry works and that’s what’s driving your strategy as a new entrant in the market. That’s always the case; that’s why you see banks moving in and out new markets because it either pays off or it doesn’t.

Marion Schiller, UniCredit: We always try to price it in. If we’re talking about the small and mid-cap companies, we know the banking group and we know the wallet they have and you really try to price that in. It normally works.

Joachim Erdle, Landesbank Baden-Wuerttemberg: A very important aspect of this is that clients in the small and mid-cap market are getting more and more professional in terms of how to deal with cross-sell and how to organise banking groups. That’s not only in the €500m-plus revenue area; it’s also in the range below €500m revenues.

This makes it much easier as an existing bank to discuss wallet with a client and the share of wallet you are looking for; it also makes it much more challenging for new banks to enter the market and to initiate such discussions with the client.

Marion Schiller, UniCredit: And the good thing is clients have long memories. If you support clients in a crisis, they will stick with you. Being a bank that has been in the German market for years really helps us because some banks are in and out and clients don’t forget.

Thomas Haas, Bayerische Landesbank: If you ask a mid-cap CFO what his ancillary business is, he would say: “I have none”. And that’s sometimes true, but what you can recognise is that deals below €100m in size attract much higher pricing, especially margins, because of the lack of ancillary business.

IFR: As we move to our conclusion, I wanted to go around the table. What are the challenges out there? Where are the opportunities? What keeps you awake at night? If the monetary environment changes, how does that change the financing landscape?

Michael Bures, Raiffeisen Bank International: We are in a borrower’s market but this will not last forever because there will be an end to quantitative easing. I think it’s time for us and our clients to think about alternatives, diversify and look ahead and towards alternative products.

I also think that in the short term it can get quite interesting with the volatility we’re seeing in long-term rates. We might see some unexpected developments there. Otherwise I think the competition is really tough among banks and I don’t expect this to change significantly any time soon.

Ingo Nolden, HSBC: What is keeping me awake at night is that we are seeing a lot of stress in DCM at the moment. There are so many black swans and so much volatility. The liquidity situation has painted and over-painted some of the structural problems in the funding and banking markets overall. And not just in Germany: I think it’s European wide.

Given the macroeconomic picture around Europe, I wonder whether we’ll have another round, another round and another round. In the end there will certainly be an end-game and all these nitty-gritty discussions will disappear in a flash. My point is whether the market is under such severe stress that liquidity doesn’t help any more.

Nobody has a crystal ball. I don’t think that the decision-makers know the outcome of what they are deciding on. I think the last four to six weeks have shown that big volatility is back on the agenda. I think we might have some very turbulent times coming.

Marion Schiller, UniCredit: We have a highly liquid market, and the SME sector especially is driven by bank liquidity. I’m very interested in seeing what happens in the future. When will there be a market for institutional investors? When will issuer and institutional investor needs converge?

It will be interesting to see given the high liquidity in the institutional market when and if institutional investors lower their pricing requirements and, on the structural side, when and if institutional investors lower their standards to where they can be accepted by SME clients.

Sven Janssen, Oddo Seydler Bank: What keeps me awake at night? It’s the macroeconomic environment and its spill-over effects. Related to mid-sized companies, what strikes me is that the risk management in a lot of these companies – even relatively large corporates which, in many cases are the clients of the other banks around the table rather than mine because I tend to deal with smaller companies – is quite shocking.

They’re not adequately prepared for exogenous shocks, be it on the operational or on the financial side. So what I’m concerned about comes from the macroeconomic dimension and the impact that has on financing.

Joachim Erdle, Landesbank Baden-Wuerttemberg: What is key for us at the moment is to intensify our strategic dialogue with clients because it helps us in multiple ways. In the current environment, we can come up with more custom-made solutions.

The German Mittelstand is very well prepared and learned their lessons after the last crisis because they established more flexible cost structures, optimised their value chain and we are facing better educated management teams. Hence, companies are much better prepared.

I think we all agree that we are on the top of a cycle, so being in an intensive dialogue with the client helps to come up the right decisions in a more challenging environment. As long as we feel as a bank that we are close to the client, we understand its market and its needs, I will sleep well in the future.

Thomas Haas, Bayerische Landesbank: The biggest challenge is to define where we are in the credit cycle and to make sure that you have a high credit-quality portfolio as a bank. That creates the challenge of needing to decline deals where you think credit risk and pricing are in imbalance. For a relationship bank, this is a challenge because you know you’ll be out of the relationship for a couple of years.

On the other hand, we have great opportunities and I think the competition and the very liquid markets around my product are a great opportunity because it gives us the flexibility to structure deals in a tailor-made manner and to do large M&A financings. It’s great that you have liquid markets; it’s always good for a syndications banker because you can do underwritings.

And that is what helps me wake up in the morning. What we must not forget is that the SMEs are unique and very special companies that are interesting to follow and to analyse.

Martijn Kamps, ING: In terms of what helps me sleep at night, it’s that under current circumstances you can be very comfortable with the liquidity situation, your underwriting appetite and confidence. There will be a turn somewhere in the cycle and from a professional point of view, that’s one of the most difficult things that we need to judge: when are we on top of the cycle and when will it turn?

That is what keeps me awake. I don’t think we’ve seen signs of over-heating yet but all that liquidity isn’t going into new investments; it’s going to existing assets. And it can only go in one direction; to drive asset prices up. But I think that as long as we keep thinking sensibly and reminding ourselves that we are financing cash flows and not assets, hopefully we should be OK or at least we can see trouble coming.

Stefan Bund, Scope Ratings: Monetary policy conducted under the label of financing the economy, which in effect is driven by financing sovereigns, isn’t necessarily healthy for the stability of the corporate finance sector per se. The liquidity which is being pumped into the market doesn’t necessarily strengthen standards in the financing sector. Once the liquidity that was meant to support the stability of this sector dries up, it will be in trouble if it doesn’t learn the lessons from the past.

Reinhard Haas, Commerzbank: We have a responsibility towards our clients. Pricing is one thing, but the structures and the financing solutions we offer to them need to be viable over the cycle and [we need to guard against] pushing clients into situations where loose structures may lead to accidents for them in the future and to anaphylactic shocks in the down-cycle.

We need to counsel them on structures that are viable but which represent both spheres of interest: the banks but also the clients. I would furthermore call out to the lawyers who are always trying to see where they can carve out new structures, to act responsibly. Not every structure is suitable in every case. That’s something I constantly have on my mind.

Obviously there is a tension between that responsibility and the will to offer the best solution. And then there is always the competition that drives you into situations where you have to live up to the challenges of what’s out there in the market.

IFR: Ladies and gentlemen: thank You for a fabulous discussion.

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