IFR Germany Report 2009

In the first quarter of 2009 German companies signed eight loans for €22.5bn according to Thomson Reuters data. It was a more than respectable showing for a European loan market where volumes have dropped by around a third, making the country the continent's second largest loan market. That said, the amount raised was still modest against the wider capital markets: German entities sold 132 bonds, raising close to €112bn.The figures are indicative of a year where borrowers have focused their fundraising activity in the bond market – and to a lesser extent the equity market. The decision to concentrate efforts outside the loan market has been purely pragmatic: despite the huge injection of taxpayers' money into banks across Europe and the world, lenders remain cautious at best. In Europe, banks have continued to support their key relationship clients but this has been offset by balance sheet pressures. Lenders are therefore extremely circumspect in allocating new capital. It has often led to an element of unpredictability, in terms of what the appetite of a given bank is at any one time: "There has been uncertainty this year as to which banks are willing to lend and at what price," said Matthias Gaab, head of loan capital markets, Frankfurt, at Deutsche Bank.It has also undermined the relative appeal of the loan market for many clients. "Many banks are still funding at a higher rate than some better rated clients can achieve in the capital market. For those clients this means while the loan market can provide certain funds for acquisitions these funds are unlikely ever to be drawn as they are simply too expensive in comparison to alternative funding sources," Gaab explained.Typical of this trend away from bank finance was the way that RWE funded its acquisition of Essent in January. The Essen based power giant opted to bypass a formal syndication in favour of a €9bn loan that bridged directly to the bond market. The decision reflected the type of problems that even the best rated corporates face in raising small amounts through retail syndication in the loan market. Since the collapse of Lehman Brothers last year, lenders have shown little appetite to add assets to their balance sheets. This situation became apparent at the start of the year when lacklustre syndications from top tier borrowers such as EdF showed how unresponsive the market was becoming to well priced debt from premier European borrowers. It became clear that RWE would not be able to raise enough via full syndication to justify its efforts. Rather than expending effort in corralling remaining relationship lenders for limited benefit, the company focused its efforts on the more responsive bond market. Pricing was weighted to encourage a swift take out, with a 150bp base margin increasing by 50bp every six months along with up front fees of 150bp. RWE's actions demonstrated a paradigm shift: the pre-credit crunch standard of one to four relationship banks underwriting a large facility, before taking it out to a senior round of other relationship banks, was over. Banks are willing to underwrite large deals but are not willing to take underwriting risk, a seemingly contradictory position that demands lenders be absolutely confident of achieving sell down before they participate. RWE gave them comfort as an impeccable credit that guaranteed a bond take out. In the absence of a pre-placed club, underwriters would have demanded significantly higher pricing and potentially unlimited flex – something most European borrowers are not yet willing to contemplate. Two underwritings in the US medical sector for pro-forma Double A credits has seen initial pricing increase to as high as 300bp, providing a potentially interesting benchmark for European corporates to follow. Pricing has yet to reach any thing close to these levels in Europe. So far there is considerable scepticism as to whether European corporates would countenance paying such yields. "Large transactions are still

Since the introduction of the German Financial Market Stabilization Act in October 2008, it has become clear that certain amendments are needed if it is to achieve its objective of effectively stabilising German financial market institutions. However, the glut of bad news hitting the markets, and the headlines, over the past months has continued to fuel the debate as to whether Germany needs a comprehensive bank rescue plan. Despite the government’s attempts to avoid a general public debate, the discussion amongst economists, politicians and bankers intensified on an almost daily basis earlier this year. The government, apparently a discussion leader behind closed doors, was expected to unveil its theory on how to stabilise the banking sector in late February - particularly since the world’s leading economies and financial markets apparently cannot agree on a common multilateral approach. However the discussion calmed down in March and early April. It was as though the media, the markets and the government had agreed to take off the heat – which had been unhelpful in shaping the right approach for the biggest challenge that the financial markets and the modern economies have faced in their entire history. Germany, apparently aware of its relative strength compared to other leading economies, certainly does not want to take the lead. It is, unlike the US and the UK, apparently not convinced that massive deficit spending is the right approach. Rather, the German government would like to rely on the markets and its recovery forces. It does not adhere to a “strong government intervention” approach.Since the end of 2008, it has become apparent that Germany’s private banking sector needs a “bad bank”. Today, it seems likely that the Berlin government will indeed introduce such a concept. Yet it remains unclear at the time of writing which “bad bank” concept will, or should, eventually be adopted. What is clear is that it will be the “how” – rather than the “if” – that will be key in determining the success of this project. History holds limited examples of the “bad bank” concept. All the available examples have been responses to particular - often isolated – circumstances. They are, therefore, unsuitable as a generic model for the current worldwide banking crisis. This is particularly true of the US crises in both 1932, with the failed Reconstruction Finance Corporation, and again in 1989, with the successful Resolution Trust Corporation, which was set up to end the US savings and trust crisis. The Swedish banking crisis in the early nineties has probably seen the most innovative and successful “bad bank” concept, but doubts surface as to whether it can be applied to larger economies and a global crisis without modification.In light of the strengths and weaknesses of the various models, it seems likely that Germany will create its own model to respond to the crisis. In doing so, several considerations can be clearly identified. On the one hand, there is the requirement that a bad bank concept must be strong enough to stop the financial market erosion immediately to re-establish confidence in banking institutions. Most importantly, it must restore liquidity by granting credit to private banks. On the other hand, there is a very strong sense in Germany that the taxpayer should not bear the costs of such rescue operations, but should only pay for the ultimately inevitable costs, should all other means of rescue fail.The more the merrierIn order to reconcile those needs and requirements and create a commercially and politically acceptable model, Germany is probably best advised to set up a number of privately held “bad banks”. Under such a “bad bank light” concept, the government would allow individual banks, or groups of banks, to create their own privately held “bad bank”, to which toxic papers could be dispersed. Through the Soffin, state-owned funds established pursuant to the FMStG, the government would give warranties to the bad

With a total outstanding volume of some €800bn, roughly one fifth of the entire German bond market, the importance of Pfandbriefe, Germany’s highly prized covered bond market, cannot be underestimated. But few asset classes have come out unscathed from the crisis, and despite being widely regarded as the strongest of all covered bonds, Pfandbriefe have been no exception. In the first quarter of this year, only €3.25bn of jumbo Pfandbriefe (excluding taps) were publically issued in the market – a staggering 62% less than the same period of 2008. Post-Lehman brothers risk aversion to most bank related debt, and the dramatic rescue of Hypo Real Estate - Germany's second largest issuer of Pfandbriefe - accounts for some of this decline, but it is stiff competition from the newly created government guaranteed bank bonds that has stuck the final nail in the coffin. While jumbo Pfandbrief volumes have been on the decline, issuance of government guaranteed bank debt (currently permitted for maturities of up to three years) during the first three months of 2009 amounted to a sizable €21bn in Germany. As such, it is seriously competing for investors' attention. Worse still, of the three jumbo German covered bonds that have actually been placed since the collapse of Lehman Brothers, all were in a five-year maturity. Demand used to be concentrated in the short-end of the Pfandbrief curve, but since the onset of the GGB market this part of the curve has suffered an erosion of demand. Despite the impact on the Pfandbrief asset class, in mid-February Germany's federal cabinet agreed on a new local law that would extend the Financial Market Stabilisation Act. As part of the move it granted an extension of the maximum maturity for government guaranteed bank bonds to up to five years, putting further pressure on the beleaguered jumbo Pfandbrief. The law is now pending approval of the lower house of the German parliament, and if it goes through, it could finish off what little remaining demand is left between a three and five year maturity. It poses a significant threat to the German model of mortgage financing, which is already on its knees after continued secondary spread widening.The Government’s ‘motives are as clear as they are credible: to align the framework conditions in Germany with those in effect across Europe and prevent distortions of competition. The draft law extends the maximum guarantee term from currently 36 months to 60 months, thus following the EU commission's policy regarding state aid, which permits a term of between three and five years for one third of guarantees.Yet the move flies in the face of a very clear warning from the Association of German Pfandbriefbanks (vdp) that it will further increase competition. "The issuers accept the inevitable distortions that government-guaranteed unsecured bank bonds create in the capital market," said Henning Rasche, vdp president. "But a widening of the scope of such guarantees would result in an unfair disadvantage for Pfandbrief sales." Covered bond analysts at BayernLB have supported this argument since, under the new provision, "not only ailing banks but also ‘healthy banks’, for whom Pfandbriefe are actually an important funding tool, would shift over to the new asset class." On the other hand, Pfandbriefe could benefit from higher returns compared to state-guaranteed bonds, and a steep yield curve will encourage investors to move out of safe havens and into more risky investments like spread products. "We can also expect to see a shift to medium and longer maturities in the medium term," the analysts said. Banks cannot survive forever on short dated funding and Pfandbriefe may well provide the opportunity for banks to lengthen their duration. Private placements prevailThe German Pfandbrief banks have four Pfandbrief types at their disposal: mortgage Pfandbrief, used for the funding of property loans and secured by real estate; public Pfandbriefe, covered by lending's to the f

During the past six months, expectations that new EU-wide disclosure rules for CfDs might be in the pipeline have faded. After Porsche Automobil Holding set in motion plans to raise its stake in Volkswagen and triggered a massive squeeze on short-sellers, industry officials were sure that CfDs would come under greater scrutiny in Germany and elsewhere in Europe. On October 26 2008, Porsche disclosed the extent of its position in VW equity, due to a belief that short positions in the market were greater than assumed. At that point, Porsche held 42.6% of VW ordinary shares and 31.5% through cash-settled options akin to CfDs. This meant the effective free-float had shrunk to single percentage figures. The company reacted by saying that it would seek to take its total exposure above 75% in 2009. Short-sellers reacted quickly and this led to extreme trading as they desperately tried to cover their positions despite the lack of stock. The stock had closed on Friday October 24 at €210.85; by the close on the following Monday, it had reached €520. One day later, it topped €1,000. Then, on October 29, VW declared that it would be taking profits on positions representing 5% of VW to help increase liquidity in the stock. By the end of that tumultuous week, VW shares had eased to about €500.Among EU member states, the UK has taken the lead in introducing a new disclosure regime for CfDs. Just a few weeks before the Volkswagen and Porsche incident, the UK Financial Services Authority published draft rules that, under certain circumstances, require investors to disclose their holdings when they use CfDs to build a position in a company. As a large portion of the UK CFD market involves far smaller stakes, the new rule is not expected to inflict damage on the market. Crafted amid growing concern that CfDs could be used to improperly gain stakes in large companies, the UK’s new rules are intended to reassure the boards of publicly-owned companies of who is trading their shares. The initial disclosure threshold for CfDs is set at just 3% of a company's outstanding stock, the same as the existing disclosure rules for direct equity stakes. The new rules also include an exemption for CfD writers acting in a client-serving capacity, to prevent unnecessary disclosures to the market.In March 2009, the FSA announced that its new disclosure regime for CfDs would take effect on June 1, three months earlier than the planned launch in September. The FSA's move was not entirely unexpected and those active in the CfD market have said that the volatility in the market has had a far greater impact on the CfD market than the prospect of the new disclosure regime, but industry officials will feel under pressure to meet the new deadline due to adjustments required for systems. "A significant shortening of the implementation period as has recently been indicated would severely impact on our members’ ability to meet important planned commitments,” said the International Swaps and Derivatives Association and the London Investment Banking Association, in a comment letter in late January. “As a result of the current crisis, our members are struggling with numerous systems projects which are required to meet regulatory requirements and business exigencies. Thus, meaningful accommodation will be required to ensure that compliance with any new regulations will be a practical possibility," the institutions added.According to the FSA, its new disclosure regime represents a very significant step in improving market transparency and the regulator has brought the implementation date forward to reflect that. "The new rules will resolve some of the concerns raised about the risks of market players devising ways to avoid disclosure or over-disclosing," said Alexander Justham, director of markets at the FSA said when the regulator announced its plan to bring the compliance deadline forward. Upsurge in GermanyThe Committee of European Regulators flagged CfD disclosure as an area

This year promised to be a landmark for German ECM. If all went to plan, it was to start with a high profile privatisation and would be sustained with a steady flow of acquisition-related capital increases. The reality, however, has proved far less impressive. Activity has virtually ground to a halt and some of the regionally-focused German banks are rumoured to be on the point of closing their ECM businesses. In Europe, Germany ranked 10th in terms of issuance volumes during the first quarter of 2009, accounting for US$121.7m from a total of nine deals.This looks pallid compared with the UK, which saw the highest issuance in Europe during the quarter, at US$7.3bn from 93 transactions. Among other leading economies in the region, France came fourth with US$2.6bn from 11 deals, while Swedish companies issued US$2.4bn in four deals.Nevertheless, a handful of transactions and the promise of more activity to come mean that Germany-focused ECM bankers still retain a degree of optimism for the second half of the year.At the end of 2008, hopes were high that the previously cancelled part-privatisation of DB Mobility Logistics, the logistical arm of the German state railways company, could be resuscitated. The planned IPO, tipped for a deal size of up to €8bn, was called off by the German government in autumn 2008 because of ongoing market volatility.Bankers mandated on the transaction were optimistic that continued interest from a number of strategic investors could give enough lift for a relaunch this year. Those hopes came to nothing, however, and the transaction tipped by many as the catalyst for a revival of Germany’s IPO market, faded from the pipeline.Undeterred, German bankers then started to pin their hopes on a trickle of acquisition finance-based deals as healthy companies absorbed their distressed peers. This was regarded as especially likely in sectors where Germany enjoys a competitive advantage as one of the world's greatest exporters, such as capital goods and machinery manufacturers.The trend has yet to materialise in earnest, however, with unrelenting market stress and uncertainty about macroeconomic prospects keeping a lid on issuers' capital raising attempts. German companies have concentrated this year on reducing capacity and cutting costs and are consequently unlikely to turn their attention to acquisitions until this process has run its course."An increase in M&A looked more likely a few months ago but a lack of visibility on economic prospects and outlook is subduing this type of activity," said Klaus Schinkel, head of German ECM at RBS.Indeed, the collapse in global trade volumes has hit German corporates, largely dependent on exports, especially hard. This might be regarded as an opportunity for German companies to boost their balance sheets with capital raisings in readiness for tough times. Companies in troubled sectors such as construction elsewhere in Europe have followed this strategy, with firms such as Lafarge and Saint Gobain in France and British Land in the UK carrying out rights issues.But Germany has not seen a wave of rights issues, neither for strategic reasons nor for the rescue of stretched balance sheets such as that seen in the UK so far this year. And while the tide of recapitalisations is expected to shift away from the UK and towards continental Europe throughout the remainder of this year, few bankers expect Germany to form a significant part of this trend.There are three reasons for this, bankers say. First, German corporates are considerably better financed than their counterparts in the UK. Second, the apparent eagerness of the German government to come to the aid of stricken banks also rules out a source of dealflow that sustained UK ECM volumes late last year and in early 2009.While the UK state took stakes in financial institutions such as Lloyds and RBS, it did so only after ham-fisted attempts to raise equity through rights issues that saw low take-up.The third hindrance to Germ

Like other industrialised economies, Germany faces a higher budget deficit in 2009 than it previously did. It finds itself with a financing requirement of €323bn, of which €60bn is intended specifically for stabilising financial markets. Germany continues to pursue its traditional format to financing, but the ability of the government guaranteed agencies to fund is being tested, just as there are calls for them to assume a more prominent economic role. Similarly, the demand for German assets relative to that of some of the weaker European sovereigns has recently applied pressure to the peripheral market spreads. This has resulted in German finance minister Peer Steinbrueck conceding that support may ultimately have to be offered by the stronger states.Germany needs to raise significantly more in 2009 than the €213bn required to finance the previous year’s budget. The Finanzagentur in its overview for this year, released last December, outlined the means by which this additional financing will be achieved. At the short end of the maturity spectrum, discounted Treasury bills with a maximum 12 month maturity have been added to supplement the six-month bill programme. For the longer part of the curve, quarterly two-year Schatz of up to €15bn will be sold, as well as two new five-year BOBLs of up to €19bn each. Ten-year Bund issuance will be increased by three taps, rather than two, with the current 3.75% January 2019 issue expected to reach as much as €24bn eventually. The outstanding 30-year bond issued in 2008 is expected to reach €8bn in size after a €4bn tap scheduled for June.In keeping with its previous practice, "the Federal Government intends to adhere to the announced issuance calendar to the fullest extent possible in order to provide market participants with a secure basis for their investment decisions," the Finanzagentur said. The other tools at the agency’s disposal – inflation-linked and foreign currency issuance – remain available, should market conditions be favourable. For "its retail business, the Federal Government will sell Federal Treasury financing paper, Federal savings notes and German Government day-bonds as tap issues. The Federal Government reserves the right to extend the range of products for retail customers during 2009". Like other sovereigns, therefore, Germany has increased its supply of conventional debt to offset falling tax revenues resulting from declining economic activity and rising unemployment. January and July are the largest months for coupon repayments and the heaviest months for issuance, often creating a curve steepening bias.Outperformance or underperformance?Germany has generally outperformed all other major Eurozone fixed income markets this year. It was the continuation of an old trend – one that was exacerbated by the deteriorating credit environment, following the failure of Lehman Brothers last year. The widening of spread differentials between some of the weaker members and core Europe, in particular, has been an ongoing theme. Italy, Spain and Greece have all seen dramatic spread widening to Germany since the beginning of 2008, as their domestic economies have weakened. Greece has come under the most pressure, with its 10-year issue yielding as much as 300bp more than Bunds at one point in late February – or, to put it another way, twice as much as Bunds, which were approaching 3% yields at the time. Greece has already issued new three, five and 10-year bonds and is beyond 50% of its €43.7bn funding requirement for the year. Spain has also seen spreads under pressure, with the 10-year Bono trading as much as 125bp over the comparable Bund, compared to just 18bp over at the beginning of June 2008. In January, Standard & Poor's downgraded Spain's Triple A long-term foreign and local currency sovereign credit rating on negative credit outlook to AA+. This was due to the "much weaker potential growth rate over the medium term than that experienced over the past decade. At the sam

German car maker VW had been at the forefront of the European securitisation market last year. It issued several public and privately placed transactions, with the last public placement – Driver 6 – seen just a week before the collapse of Lehman Brothers. In hindsight, the timing of that deal could not have been better for the issuer. At the time, the head of ABS at VW Bank, Stefan Rolf, confirmed that all proceeds of Driver 6 had been placed with third-party investors, with none retained. Loyal German accounts took slightly more than usual, their participation rising from half in Driver 5 to around two-thirds. "German investors are generally more comfortable with German collateral and a well-established programme that they are familiar with," Rolf said at the time. These accounts came in pretty early, bringing momentum to the book from its open, he said. The balance of interest was made up by UK accounts and, more unusually, longer-term French asset managers and funds. There were also a handful of new names, which may have been attracted by the spread levels on offer, which were sumptuous relative to tight pre-crisis levels. The €936m Triple A rated A Class with a 1.92-year WAL priced at one-month Euribor plus 90bp and the A+/A1/A+ rated B Class with a 2.35-year WAL priced at plus 170bp over the same benchmark. In pre-crisis times Triple A debt had offered a spread pick up in the low single digits and Single A debt in the high teens. At the time, Damian Saunders, from the syndicate at lead manager BNP Paribas, said there were still a sizeable number of buyers who were sidelined, awaiting an improvement in market conditions. But that improvement never came. As Driver 6 was pricing, both Renault's RCI Banque and Ford's FCE Bank had been soft marketing their respective auto securitisations. When it became clear liquidity had completely dried up, public placement was no longer a funding option for them. From that point on retained auto securitisations were the order of the day in Germany and across the rest of Europe. RCI Banque had initially planned to place its transaction publicly via Citigroup, and thought it would be able to do so hot on the heels of Driver 6. It returned to the market two months later in November 2008, pricing and retaining Cars Alliance Auto Leases Germany FCT, an ABS backed by German auto leases of up to €1.3bn. At the same time, Ford's FCE Bank priced and retained Globaldrive Auto Receivables 2008-B, Santander Consumer Bank issued and retained SC 2008-2 and VW bank issued and retained its Private Driver 2008-2, 2008-3 and 2008-4 deals, all sized at around €1bn each. In fact, since September 2008, Private VCL 2008-1 has proved to be the only European deal that managed to be even partially placed.Bankers have concluded that, if even the strongest name in the market and the only consistent European issuer since the beginning of the crisis could not bring a deal, the omens were pretty poor for the multitude of other potential issuers. Apart from RCI Banque, which inaugurated its German series with Cars Alliance Auto Germany 2007-1 in October 2007, there was BMW's Group Financial Services bank that last issued in July 2007 with its Bavarian Sky, Daimler Chrysler Bank which had last issued off its Silver Arrow programme at the end of 2006; and Porsche Bank which had been actively issuing off its FACT series, the last being seen in 2006. Broadening funding optionsThe fact that there have been no genuine publicly placed and broadly marketed ABS deals in Europe since September 2008 has driven home the message that the survival of auto makers largely depends on their ability to broadly diversify their funding lines. "In difficult markets it is important to have a well diversified funding basis so you can tap one or the other or a combination, rather than depend exclusively on securitisation or any other instrument," said VW Bank's Rolf. He declined to comment over the bank's 2009 funding need, but confirmed that