A sector apart

To view the digital version of this report, please <a href="http://edition.pagesuite-professional.co.uk/Launch.aspx?EID=07b404cd-fd13-44a8-addc-eb80c03f4868" onclick="window.open(this.href);return false;" onkeypress="window.open(this.href);return false;">click here</a>. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com Politicians preaching to their neighbours have also administered their own austerity medicine at home to maintain a semblance of economic sanity amid the eurozone malaise. Consensus points to the German economy growing 0.2%–0.6% in the first quarter, while full-year GDP could come in at about 1%. The country’s relative economic strength, while much of Europe flounders, is partly due to economic reforms implemented a decade ago. A manufacturing revival and resilient funding instruments such as Pfandbriefe have helped. But Germany cannot continue carrying the continent on its shoulders: the eurozone is its most important trading partner, but a happy ending relies on other parts of Europe sharing the burden. For now there are few alternatives to investing in the Teutonic nation. The search by risk-averse investors for safe berths is expected to bring €27bn into German real estate this year. Fears of a faltering recovery have restrained absolute investment from the dizzy heights of 2007, but the hunt for yield has put a spotlight on property portfolios. The greater success story is that of the automakers, still at the centre of the German corporate bond market. Capital market funding activity has increased as big bond redemptions loom in the not too distant future for the big carmakers. These maturity pressures have led to flexibility in approaching the markets with, for example, nimble Daimler funding in nine currencies this year. Other German industrials have also been active in the bond markets. Even the prospect of a general election later this year has failed to dim demand from investors. But the status of being the only port in the storm is not entirely helpful, as deal-making is held back by lack of confidence in the rest of the eurozone. M&A activity remains focused on refinancing rather than cross-border purchases. Small transactions predominate and bankers have to offer more creative solutions as they look forward to a return of market confidence. One product that is struggling with a lack of supply is Pfandbriefe, as eurozone banks attempt to deleverage their balance sheets. This means demand is overwhelming and pricing tight. With issuance patterns unlikely to change in the coming year and supply so far a third down on last year, the best that bankers are hoping for is a pick-up in the third quarter. That other uniquely German product Schuldscheine is however enjoying a boom after volume more than doubled in 2012. The switch from niche funding tool (so niche banks don’t agree on whether it should be sold to bond or loan investors) to maturing market is best illustrated by French company Neopost selling its issue exclusively in Taiwan. The bitterest of medicine in recent years has been taken by the Landesbanken, but after a process of restructuring the outlook appears to have improved – for those that remain – with the focus now on financial security and restructuring. Their role in lending to the Mittelstand is crucial to maintaining growth. The pleasures and pain of currency union continue to plague Germany, with investors attracted across its borders, but unable to shake off the fear of the periphery’s impact. But as the free-spending southern nations are gradually being brought to heel, Germany may soon stop treading water.

To view the digital version of this report, please click here. For many Germans the pain is keenly felt. This is a country that carries the weight of history – much of it painful and still willingly fresh in the memory – on its shoulders. For decades, Germans – from politicians in Bonn and Berlin to autoworkers in Munich and Wolfsburg – abjured the role of Europe’s “leader”, a role gladly seized by Paris. Yet since the onset first of the financial crisis, then of the eurozone’s ongoing debt crisis, Berlin has been forced to adopt the role of Europe’s financial, political and legislative conductor, a role that requires a judicious mix of the carrot and the stick. Reluctantly at first, more recently with a sense of grim pragmatism, German institutional bodies, from the Bundesbank to the Bundesverfassungsgericht, the federal constitutional court, have led the charge on various austerity-led bailouts and bail-ins.Too little praise, too much resentment Not all were perfectly pitched. Cyprus’s bail-in will go down in history books as a particular stinker. But all were designed to spread the pain without sinking any particular economy, or the eurozone as a whole. And all, ultimately, were well intended and with a single aim in mind: to place all of Europe’s economies, from the lions to the rabbits, back on their feet. Yet Germany’s efforts have often earned too little praise and too much resentment from their European allies. In return for rescuing them from the brink of oblivion, Berlin’s politicians have been the target of a backlash. The eurozone’s intermittently rabid reaction to the pressing need to pare back debt in Europe before pressing ahead with macroeconomic expansion programmes is galling to the Teutonic eye in other ways. Germany may be a relative economic oasis amid the storm: its economy is set to expand by 0.3% this year and 1.5% in 2014, according to Deutsche Bank, while the economies of Italy and Spain continue to contract. France was also likely to see its economy shrink by 0.6% this year, Deutsche said. IMF chief Christine Lagarde recently spoke germanely about the perils of a three-speed global economic recovery; in the same vein, there must be fears of the emergence of a two-speed eurozone economy: on the one hand Germany; on the other, everyone else. Yet Germany is not in this situation as a result of mere happenstance, or plain luck: everything, from a meteor strike to a perfectly delivered pas de deux, is the result of a series of cumulative or creative forces, cosmic or otherwise.Deferred pleasure In this case, Germany’s current commercial strength stems from a sustained period of weakness in the early 2000s that led many to question whether the country’s much-vaunted export-led economic model was dead or merely resting. Labour market reforms imposed between 2003 and 2005 were painful, but Germans, for the most part, accepted deferred pleasure, and while salaries rose steadily in Southern Europe, they stagnated or remained static in Hamburg and Hesse. Indeed, it’s easy to forget how massively Germany has changed over the past decade. Ten years ago the country was running deficits. Outsourcing was hollowing out the country’s Mittelstand, the army of smaller enterprises that keep the German engine ticking over. Yet since then, said Christian Schulz, senior economist at Berenberg Bank, that trend has been “totally reversed. Germany is running big capital account surpluses. Since 2006, it has created 3m jobs. The government is trimming its debt pile every year, and Germany’s economy as a whole is a lot more sustainable than it was”.Ready for the chaos Indeed, it was this set of reforms that prepared Germany for the chaos of recent years. The economy contracted violently in 2009 before rebounding with vigour, thanks to rising demand for competitively priced German-manufactured goods from the emerging economies of China, India and Brazil. That seemingly insuperable strength made a slight contraction at the end of

To view the digital version of this report, please click here. It has been a thin year so far for the covered bond market, one of the hardest in the past decade. The first quarter of the year saw only €36bn covered bond issuance globally, according to Barclays. Thanks to continued attempts by eurozone banks to deleverage their balance sheets the supply simply isn’t there. So much so that at the beginning of April Barclays revised its global supply forecast for 2013 from €175bn to €110bn. The lack of supply has been even more marked in Germany. Predicted issuance this year has been cut by 33%, from €15bn to €10bn, thanks to the long-standing decline of the public sector Pfandbrief market and the gradual deleveraging of the Pfandbrief banks. What has also hit volumes is that covered bonds are being put aside in favour of senior unsecured issuance. “Last year covered bonds were the funding tool of choice, but the shine has come off them slightly in favour of senior unsecured debt,” said Armin Peter, head of covered bonds at UBS in London. Mauricio Noe, head of covered bond origination at Deutsche Bank, agreed. “There is little covered bond supply. Many European banks are well-funded, and where possible they are using senior unsecured.” What the lack of supply means is that demand for any European issues that emerge is overwhelming and pricing is tight. Bear in mind that across the border in France, at the beginning of April, HSBC France sold a €1.25bn 10-year with no new issue premium at mid-swaps plus 22bp, BNP Paribas priced a no-grow €1bn seven-year SFH covered bond at mid-swaps plus 22bp and then Credit Mutuel-CIC Home Loan sold a €1.25bn seven-year at mid-swaps plus 23bp. German issues generally price inside that.Kuroda effect There are fears too that demand will only increase before it declines. Pressure is expected from Japanese investors in what has been called the Kuroda effect. In early April Bank of Japan’s governor Haruhiko Kuroda announced a shift in monetary policy which is likely to see Japanese investors putting their money more broadly into Europe. “We have not seen a lot of Japanese real money yet, but some banks are positioning themselves already in order to attract potential JGB investors,” said Torsten Elling, co-head of rates syndicate at Barclays in London. Another banker mentioned a general change in attitude towards the euro and that the Asian component of books is rising. UniCredit Bank HVB’s €500m seven-year Pfandbrief in late April saw Asian investors take 13% of the paper. With even French issues pricing tightly, no surprise then that in Germany they are pretty much on swap levels. At the beginning of April, market stalwarts Muenchener Hypothekenbank and Bayerische Landesbank priced a €750m eight-year and a €500m 10-year respectively at mid-swaps plus 3bp and mid-swaps plus 11bp. Both of the deals had comfortably large order books and, above all, both deals avoided charges of gouging investors and offered some kind of a pick-up. MunHyp priced at a 4bp premium to its own June 2022 deal, even though this deal matures 14 months earlier. BayernLB looked even more generous with a 5bp premium over the bank’s July 2022s. The pricing on these deals may look incredibly tight, but not only do they offer a pick-up on previous issuance, they also offer something over German government debt. That is the real point here. “Look at recent deals. As a spread over Bunds, the pricing is still attractive. The last seven-year MunHyp deal for example, does give investors a more than 50bp pick-up over Bunds,” said Ralf Grossmann, head of covered bonds at Societe Generale. This is a tight line to tread and there is a danger of pricing too tightly. For issuers who try to see how far investors can be pushed, there is the cautionary tale of Berlin Hyp. For those with longer memories, last summer, it priced one of the tighter covered bonds of the year. A €2.2bn book allowed it to price an €1bn five-year at mid-swaps plus 9bp. In

To view the digital version of this report, please click here. They are out there if you look hard enough – humble celebrities, honest politicians, reflective football players, diamonds-in-the-rough all. Then there’s the most surprising abnormality of the lot, and an institutional one to boot: the investment bank packed to the gills with affable individuals still boyishly eager and filled with intellectual rigour, all acting like the last five years was just a very, very bad dream. To be fair, for Berenberg Bank, a private German lender that traces its origins back to the 16th Century, the past half-decade has been rather good. The financial crisis ripped the heart out of a legion of leveraged banks, but it also stopped Europe’s equity capital markets dead in their tracks. Even when the markets picked up again they were not the same; nor were many of the universal lenders and merchant banks that once lived off and preyed on them. Without the fanfare of Barclays’ ECM buildout, the German bank slips into an apparent void. From early 2010, it starts boosting headcount, adding analysts in London and sales staff, mostly in Europe but with a sprinkling in North America. A defining feature of the bank – and the USP when it comes to ECM – is that it remains a private partnership and holds over €28bn in assets under management. The firepower of a private bank is something established ECM rivals fear, and rightly so. After steadily building a presence, particularly in German issuance, the bank broke through to the top table when it rescued the IPO of Talanx in September. Germany’s third-biggest insurer launched its float into the wake left by the failure of Evonik’s IPO in June, and the turbulence led to the €700m deal’s cancellation on September 12 after failing to reach consensus on pricing with an army of bookrunners, including Citigroup, Deutsche Bank and JP Morgan. Talanx scrapped the deal, then vented ire, blaming its bankers for overestimating the fair listing value. Investors clearly liked the company, it fumed, but their valuation “deviated significantly” from the estimated minimum fair value banks had provided.Private power Then Berenberg, one of the insurer’s oldest banking clients, holding only a co-bookrunner slot on the deal, intervened. Initially it spoke to around 120 investors (the final number was far higher, the bank said) across Europe, the UK and the US. It carefully gauged interest on structure and pricing from institutions of all sizes, from smaller institutions and mid-caps right up to blue chips. It reported back to its client. The pricing, Berenberg reckoned, was wrong: way too high given market conditions. Investors were also fretful of any biggish European flotation: minds were too easily diverted to the €3.5bn IPO of chemical firm Evonik scrapped only three months previously. Vetting a genuine cross-section of the market, said Andy McNally, head of Berenberg Bank UK, “gave us a much better and much more precise idea of how a deeper pool of investors would value the company”. Hendrick Riehmer, a managing partner at the bank, adds to the picture. “If you talk to three accountants in Britain, Benelux, and Scandinavia, they might have different ideas,” he said. “And that creates the opportunity to say, OK, maybe a different price – maybe higher, maybe lower – would be better here.” Rival members of the syndicate perceive the situation somewhat differently. They argue Berenberg used its private bank wealth to present the client with a substantial initial order that would relaunch the deal and secure its promotion by two levels to joint global co-ordinator – and at the same time the demotion of Citigroup and JP Morgan. On September 21, just a week after postponing, Talanx was back, this time with its flotation cut to €500m. Having already done 10 days of marketing and roadshows, the insurer simply relaunched straight into bookbuilding. The book was officially covered on the first day and pricing of 25.5m shares la

To view the digital version of this report, please click here. CVC Capital Partners’ knock-out €3bn bid for German metering business Ista in April has delivered some much-needed cheer to the German loan market. The European private equity firm’s surprise entry into the bidding, backed by a single loan from Deutsche Bank, shows that lending appetite is strong and that for the right deal in the right sector, buyers are keen to execute deals. The question is whether this will translate into a broader recovery at a time when corporate confidence remains febrile across Europe. The CVC deal will ensure that the second quarter will start on a positive note. During the first three months of the year, M&A financings accounted for just 4% of the US$27bn worth of syndicated loans in the German market. Meanwhile, announced deals involving a German company fell by 12% in the first quarter, compared with the equivalent period a year ago. CVC trumped rival BC Partners to buy a 76% stake from co-owner Charterhouse in a €3.1bn deal – Germany’s largest private equity transaction since 2008. “The M&A market is soft across Europe and Germany is no exception. If anything, the M&A market is more depressed because [many German] companies have strong balance sheets and do not need to buy and sell assets to reposition their businesses,” said Wolfgang Fink, head of German investment banking at Goldman Sachs.Sporadic activity There are pockets of activity. Bankers are reporting a rise in dual-track processes, where private equity-backed companies are looking to either sell their businesses or float them on the equity markets. Sources said that German bathroom equipment maker Grohe, which is owned by TPG and Credit Suisse, has taken soundings for a sale that could be worth as much as €2.2bn. The sponsor-backed deals are heavily weighted towards refinancings, rather than providing much-needed fresh loans. “There are a lot of ingredients in place for an improvement in Germany’s M&A market,” said Armin von Falkenhayn, head of corporate finance Germany at Deutsche Bank. “Financial sponsors are starting to look at dual-track processes and with the loan markets at competitive levels, covenants are becoming more comfortable, and that is supporting M&A trade when competing with an equity market exit.” Another source of deals is coming from Asian investors – notably from China – which are looking to snap up high quality assets in the eurozone at low valuations and are targeting Germany as the currency bloc’s safe haven. In January 2012, Sany Heavy Industry agreed to buy Putzmeister Holding, Germany’s largest cement-pump maker, for US$653m, including debt in the biggest takeover by a Chinese firm. The deal was significant because it was one of the first successful sizeable Chinese acquisitions of a company in Germany’s Mittelstand.Sitting on dry powder While there is evidence of a recovery in the transaction range of €1bn to €5bn, there is no sign yet of a return of the sort of big-ticket dealmaking that the loan markets crave. Fink said: “The message from equity investors to the boards of large German companies is that they want to see a very disciplined approach to spending on M&A deals.” The frustration for loans bankers is that company executives are sitting on their hands at a time when there is a glut of firepower, both from private equity firms sitting on dry powder, and from banks willing to extend balance sheet to corporate Germany. “There is a liquidity overhang for financing German corporates,” said Von Falkenhayn. “Although our industry is shrinking the combined balance sheet and selected competitors are participating less in the loan market, we have seen a resurgence in appetite from international banks.” But lenders and potential acquirers alike are being selective as they focus only on high-quality companies with good earnings visibility. Chinese companies are focused on the industrial sector, Von Falkenhayn said, while Deuts

To view the digital version of this report, please click here. With banks nervously keeping an eye on the latest regulatory diktat from Brussels and Basel, there is little surprise that European corporates have increasingly turned to the bond market for funding. No more so than in Germany. Last year the country’s investment-grade companies sold €70bn bonds, a jaw-dropping 96% increase on 2011 and 121% more than in 2010, according to RBS. More to the point, pricing for German corporates has noticeably come in. “We are at low levels now. In January last year the average yield for a five-year was around 3%. Now it is below 2%,” said Marc Mueller, co-head of CMTS Corporates, Germany and Austria, at Deutsche Bank. Much like last year, the flavour of the year has been cars. With their hands on their gearsticks and their feet on the accelerators they have hit the markets. “Since 2006 German automotive companies have increased their capital market funding activity and the market has absorbed the supply well,” said Christoph Seibel, head of corporate debt capital markets Europe at RBC Capital Markets. Little surprise really, Daimler and its financing arms have around €35bn outstanding, BMW has about €27bn outstanding and Volkswagen has almost €50bn outstanding, according to Tradeweb. Significant portions are due in the not too distant future. Daimler has €13bn of bonds maturing in US dollars, sterling and euros by the end of 2015, while VW has €8.5bn maturing by the end of next year. But rather than panic, what has been notable is how flexible this maturing pressure has made the company’s bond funding. Take Daimler, for example. It wasn’t especially fast off the grid this year compared to its rivals, but what it lacked in speed it made up for in style. It hit the euro bond market at the end of February with a €1.5bn two trancher and was able to take full advantage of demand for stable credit in the aftermath of the Italian election. The €1bn three-year priced at mid-swaps plus 37bp while the €500m 10-year went at mid-swaps plus 72bp. A couple of weeks later it was in sterling with a £150m tap of its 1.375% December 2015s. And at the beginning of April it came to market with a US$300m five-year Eurodollar at mid-swaps plus 85bp and €250m two-year FRNs with a coupon of 23bp over three-month Euribor. But the company has also kept up its diversification into other currencies. It has sold paper in Australian and New Zealand dollars as well as a couple in Canadian dollars. In all it has funded in nine currencies this year.Cars not the only movers Although they have dominated, it would be a mistake to think that cars are the only story of the year. Beyond the automotive sector, German industrials have been active too. In top form was Siemens, which in early March sold a €2.25bn two-tranche bond via Bank of America Merrill Lynch and Deutsche Bank, and joint leads HSBC, Morgan Stanley, RBS and UniCredit. On the back of €6bn orders, the €1.25bn eight-year sold at mid-swaps plus 35bp while the €1bn 15-year sold at mid-swaps plus 70bp – both tranches aggressively tight, but an indication of the demand for the name. More recently, at the beginning of April, the world’s largest industrial gas company Linde sold a €650m 10-year at mid-swaps plus 45bp and an €800m five-year at mid-swaps plus 67bp. Corporates have been tempted to dip their toes in the corporate bond market for the first time. In early December, German building services group Bilfinger, rated BBB+, sold its inaugural issue – a €500m seven-year issue via Commerzbank, Deutsche Bank and UniCredit, which priced at mid-swaps plus 115bp. Demand was such that the issue was oversubscribed to the tune of €5.2bn and pricing came in from the mid-swaps plus 135bp area. But the story of success is not just at the highly rated end of the corporate spectrum, it is clear both at the high-yield and ungraded end of the market too. In mid-January, German healthcare company Fresenius, rated Ba1/BB+, sold a

To view the digital version of this report, please click here. The word Zeitgeist is going global, and it is travelling in a German car – for when it comes to corporate issuance, the spirit of the era is definitely Teutonic and the auto giants are setting the pace. A high-octane performance by carmakers Volkswagen, BMW and Daimler reflects the wider activity of German corporates in the debt markets as issuers capitalise on continuing demand to diversify funding. “Demand for corporate credit out of Germany has remained very strong and the renewed uncertainty around Europe – Cyprus, Italy – if anything, has helped to underscore the strong case for German corporate credit among investors,” said Lars Moeller, a director in the corporate DCM team at Credit Suisse. But behind multiple issues by the carmakers is an unrivalled industrial performance as they pull away from competitors mired in a European slump and conquer overseas markets. No better sign of the confidence this is giving them came in January when Volkswagen signalled its ambition by embarking on a €50bn plan to oust Toyota as the world’s top automaker. Germany’s enthusiastic participation in European corporate debt markets reflects how investors are mesmerised by the strong performance of the country’s real economy. Marcus Schulte, head of FIG DCM in Europe at Credit Suisse, said demand for German product was as strong as ever but as banks have reduced their issuance, SSAs and corporates have emerged as the key drivers of growth in the primary market. “The appetite externally and internally for German credit has been as good as ever. Scarcer bank paper is easily absorbed, you have strong appetite for German corporates and, by its safe haven nature, appetite for German sovereign paper remains structurally strong.” Martin Wagenknecht, head of DCM for corporates, Germany, for Societe Generale, said that if some of the exuberance in the market overall had faded after 2012, the performance of the German automakers has nonetheless been exceptional: “2012 was a tremendous year in terms of volume. The numbers for 2012 indicate that the automakers are a steady and good source of bond issuance overall. Daimler did something like €15bn in bond issues, Volkswagen €19bn, and BMW €8.5bn and these are tremendous amounts even if you compare that to how much overall has been issued in the market.”Fuelling debt strategies Success in the debt markets has been accompanied by innovation as the carmakers diversify on the traditional mix of senior financing, ABS, and customer and saver deposits. If companies are still predominately selling euro or Eurodollar debt, greater liquidity has made other investors and currencies more accessible. There is growing enthusiasm for paper in Australian, New Zealand and Canadian dollars, Swiss francs, Mexican peso, Chinese renminbi and even Indian rupee. Another departure was a mandatory convertible by Volkswagen last year although most observers see this as a one-off. So what is fuelling these debt strategies? First, the big three automakers are all cash-generative so need relatively little funding as manufacturers. Volkswagen’s investment plans and M&A activity aside, much of their funding is destined for the ongoing refinancing of debt in support of finance arms that service leasing contracts and lend to other corporates in order to sell the product. As the key differences between cars today boil down to brand cachet and financing, stronger balance sheets allow the Germans to offer consumers better terms – a crucial factor in buying a car. As car financing drives funding needs, the volumes seen in 2012 reflected sales results – a link that means if sales remain strong the sector will continue to be a tremendous source of issuance because of a huge portfolio of debt outstanding that has to be refinanced. Marcus Schroeder, global head of automotive corporate finance for Societe Generale, said: “It is partly a question of size. If you look at a company

To view the digital version of this report, please click here. When WestLB was formally wound up in July 2012, following a series of trading scandals and losses, the future for Landesbanken appeared gloomy, with consolidation seemingly the most likely destiny for the remaining eight banks. A year later the outlook appears to have improved, and talk is now focused on financial security and restructuring rather than wholesale change. “Given the large amount of state support that they received it was natural following the financial crisis that the structure of the Landesbanken should be called into question,” said Tim Brandi, a partner at Hogan Lovells International in Frankfurt, which worked on the WestLB process. “However, with the banks being state-owned there is a lot of political capital at stake, and as the financial situation improves talk of consolidation has faded.” In a sign of the evolving regulatory landscape in Europe, the demise of WestLB was instigated not in Berlin, but Brussels, where the European Commission ordered a change of ownership in response to the billions of euros in state aid and guarantees the lender had received. The Commission had also demanded restructuring at Landesbank Baden-Wuerttemberg, which incurred substantial losses on exposures to Southern European governments and state-related companies (particularly in Greece) and BayernLB, for state aid it received in the financial crisis. “LBBW was traditionally the strongest Landesbank because it had a strong retail franchise but then became overly ambitious with its capital markets business,” said Michael Dawson-Kropf, an analyst at Fitch in Frankfurt. “Now they are in restructuring mode.” In February LBBW said it had largely completed its restructuring, cutting risky assets and raising its Tier 1 capital ratio to 15.3%, as 2012 profit rose to €399m, compared with €86m the previous year. The lender received €5bn in capital and €12.7bn in guarantees at the height of the financial crisis. BayernLB, meanwhile, is paying for ill-fated purchases in Europe; notably the €1.625bn acquisition of a 50.01% share in Austria’s Hypo Group Alpe Adria in 2007, which, following more than US$4bn of losses in the US subprime crisis, was sold back to the Austrian government for one euro. During the crisis, the State of Bavaria provided the bank with a €7bn equity injection and a €3bn silent participation, increasing its indirect shareholding from 50% to 94% and diluting the Association of Bavarian Savings Banks’ stake from 50% to 6%. Another bank to have encountered significant problems is HSH Nordbank, the world’s largest shipping bank, which estimated earlier this year that around half of its €30bn shipping portfolio is struggling to repay loans. HSH Nordbank received a €30bn state-funded bailout in 2011 and in March agreed with its owners, the states of Hamburg and Schleswig-Holstein, a hike in its guarantees to €10bn. “HSH Nordbank is on its way to stabilising but they made a big mistake when they paid back loans too early, when they should have kept the public money invested in the bank,” said Stephan Rabe, a director at the Bundesverband Offentlicher Banken Deutschlands (VOEB), the trade association for the German banking industry.Roots of the problems While the immediate problems of the Landesbanken were caused by the financial crisis, the roots of their difficulties were established in 2005, when the banks lost their explicit state guarantees. As the positive effects of state support lingered in the years before 2008, the banks went on a borrowing spree, gorging on cheap money and spending on risky investments such as US mortgage-backed securities. “After the abolition of state guarantees in 2005 the banks retained good ratings and took up liquidity which they used to expand their global footprint,” Rabe said. “It was unfortunate timing because soon after we had the US housing market collapse and financial crisis, which hurt all the Landesbanken and particula

To view the digital version of this report, please click here. On June 19 2012 it looked as if the ambition to list chemicals company Evonik would never be achieved. The previous day management, banks, and its two main shareholders – RAG-Stiftung and CVC Capital Partners – agreed to cancel the latest in a string of efforts to complete an IPO. Failure, however, was not an option. RAG’s raison d’etre was to list Evonik and sell down its 75% stake through public markets, while CVC was reaching the natural end to any private equity firm’s investment cycle having acquired its 25% stake in 2008. The result was an IPO like no other. Indeed it represented a tiny 2.3% of the company and was completed in one day. This, however, followed a private placement that saw 12.2% of the company sold to institutions and giving a free-float from listing of a healthy 14.2%, rising to 14.5% with the greenshoe. It was just three days after the cancellation in June when bankers from MainFirst Bank met with the company. Carsten Staecker, head of ECM advisory at the firm, remembers it was 2007 when he first met Evonik to discuss the subject of its IPO. Evonik had hoped to float in 2011, when a deal size of €7bn–€8bn was mooted, but uncertainty in the markets was “poison” for an IPO, said RAG chairman and Evonik supervisory board chairman Wilhelm Bonse-Geuking when that plan was abandoned in September 2011. Frustration at the failure of the 2008 IPO plan was moderated by the subsequent sale of 25.01% to CVC. “Shaking the dust off and taking another run at an IPO could have ended with them running into the same brick wall. We suggested they think again and proposed an alternative structure we had been working on,” said Staecker. Each time Evonik considered a listing, it attracted enormous attention, while the significance of the deal and its size ensured that on each occasion there was a large group of bankers and lawyers involved. The June process included five bookrunners and two independent advisers. The theory exists that a billion euro IPO is easier to price than one a tenth of the size as investors do not need to worry about size of allocations, liquidity in the aftermarket, research coverage, the volatility that comes from backing small companies, etc. But when investors are worried about the macroeconomic outlook, lack inflows into their funds and want to know the deal is covered before committing their own orders, a deal size of €3.5bn-plus becomes problematic. MainFirst’s solution was to avoid the spotlight. A private placement process could involve many of the same investors as an IPO but control would be in the hands of the sellers rather than the buyers. Valuation would be affected due to the lack of listing initially, but that may be a small price to pay for certainty. It did not promise too much, but was confident enough to convince the company – at the expense of the existing bank advisers. Confidentiality was crucial so the other banks were excluded – most only knew the process was taking place when it was wrapped up in February. In the event 12.2% of the company was sold by CVC and RAG to over 100 investors, of which Temasek, advised by HSBC, was by far the largest at 4.6%. A further 2%, plus 0.3% greenshoe, was sold by MainFirst and Deutsche Bank in a fixed-price placing the day before Evonik eventually made its debut on April 25. The fixed price of €32.20 valued the company at €15bn, giving an initial free-float of over €2bn. It had taken nine months, but the unorthodox plan worked and the two major shareholders could finally see the exit. Neither seller will risk destabilising the share price by rushing for the exit, but unlike an IPO, no shareholder is locked up after the listing. This additional flexibility surprised rival bankers and it remains to be seen whether the fear of a jumbo placing at short notice – remember an IPO of over €5bn was once the plan – will hinder stock performance compared with benchmarks. Observers remain cau

To view the digital version of this report, please click here. The hunt for alternative sources of yield has turned the Schuldscheindarlehen (SSD) into one of the hottest areas in the credit market. In particular, corporate SSD volumes rocketed in 2012, as issuance more than doubled from 44 deals worth €6.4bn in 2011 to 115 worth €13.8bn, according to Thomson Reuters LPC data. “2012 was the breakthrough year for the growth of the SSD market outside Germany as investors looked for as investors looked for alternatives to loan products which were in short supply,” said Richard Waddington, managing director in Commerzbank’s DCM loans group. Companies from UK retailer J Sainsbury to German carmaker Porsche tapped the market, while German utility and transportation company HGV Hamburger raised a total of €926m from two deals. More borrowers are embracing the format with debut deals this year from French seed supplier Vilmorin which placed a €130m Schuldschein with European and Asian investors in March. The market for SSD loans is benefiting from the macro trends affecting the loan markets globally. As banks cut balance sheets and preserve capital for their biggest and most lucrative clients, smaller and unrated European companies are looking increasingly to private placement markets for financing and find that SSDs provide a flexible format with relatively simple documentation in comparison with the US PP and 144A markets. Meanwhile, bankers are seeing growing supply from Southern European borrowers, particularly Spain and Greece, where banks have been reluctant to increase loan exposure. At the same time, investors are hungry for alternative assets in the credit universe. The spotlight fell on the SSD market in 2008 because it was one of the few funding markets to remain open – it has continued to gain momentum from investors seeking diversification and access to mid-cap companies in which they cannot invest through the bond markets. Evidence of how far the SSD market has come was in September last year when French mail specialist Neopost raised €67m in a four-year Schuldschein facility that was the first deal of its type to be syndicated solely in Taiwan. The Neopost financing, which was arranged by Deutsche Bank met both the company’s need for diversification and that of investors, who would not normally get access to the company’s syndicated loan market, where lending is carved up by a company’s relationship banks. Neopost used the SSD market alongside other PP markets, a bond issue and loans from French insurance companies to meet its financing needs. “Corporate borrowers are viewing Schuldschein as an additional product that completes a variety of funding tools,” said Johannes Maerklin, global head of private placements at Deutsche Bank. “This is a product that fits perfectly for borrowers who have a specific funding need in specific tenors.”Flexibility SSDs can be issued as floating or fixed debt instruments with maturities of two to 10 years in typical volume of €10m–€500m, although deal sizes are increasing. “The SSD product is very flexible in terms of tenor (three, five, seven or 10 years), currency and fixed/floating issues. The deepest liquidity is in the three, five, seven-year segment, but the 10-year segment is developing because institutions are increasingly looking to invest in unrated companies that they cannot access via the bond market,” said Waddington. For many unrated borrowers, tapping the US private placement market in the US or printing a 144A/Reg S deal triggers the need to issue a prospectus, and that means the company will have to apply IFRS accounting. The Schuldschein documentation is straightforward, spanning around 20 pages compared with 10 times that for a bond prospectus, and there is no need for extensive marketing. The Schuldschein investor base has evolved to support the growing supply as investor groups with different needs have emerged. International investors and foreign banks are enteri

To view the digital version of this report, please click here. The impact of the Alternative Investment Fund Managers Directive on Germany will, in some ways, be minimal. Unlike the UK it does not have a thriving hedge or private equity fund industry that would feel the greatest impact from the rules. Yet while most German funds will meet compliance with few problems, the impact will be felt broadly: around 80% of the fund business in Germany will be classed Alternative Investment Funds. For many German funds regulation is nothing new. “Special funds”, marketed to German institutions, were formerly regulated under the Investment Act but are now governed by the AIFMD. Only the remaining 20% of the market, the UCITS funds, will not be considered AIFM. On the straight and narrow Germany has always operated a gold-plated regulatory model: most of the regulations contained in the AIFMD were already in place in Germany, according to Katarina Melvan, managing director at BNY Mellon Service KAG. Indeed, Germany was seen as the model that much of AIFMD sought to emulate. “The effort required to meet compliance is low compared to what Luxembourg or Ireland will go through,” said Melvan. In other jurisdictions, new requirements for cash monitoring will require a significant effort to comply. In Germany all cash payments, even with a third-party bank, are monitored and pre-approved by a depositary. This means clean cash payments are not paid out automatically, interrupting the straight-through process. Cash instructions are reviewed by the depositary oversight team and only released once all controls and checks have been completed, Melvan said. Neither is enforcement an issue in Germany. Where some countries in Europe will enforce the rules via monthly spot checks, German businesses are monitored daily with shadow accounting. But for two types of business in particular, the impact of the AIFMD will be considerable: the closed-ended fund community, a big market in Germany that has until now been completely unregulated; and the depositaries, also known as depot banks, or custodians. That is disregarding the impact on the investor community. “At first sight it might seem investors will be heavily benefited by the AIFMD – but only at first sight,” said Dietmar Roessler, head of the client segment for asset owners at BNP Paribas Securities Services. “Nobody doubts that the AIFMD offers investors significant extra protection. But few investors have asked for it, and they are therefore generally cautious to pay the price for it,” Roessler said. “That is going to be the big challenge for both depositaries and fund managers in Germany and across Europe: explaining to their investors that they will have to bear the burden of these extra protections most of them didn’t ask for.” “Nobody doubts that the AIFMD offers investors significant extra protection. But few investors have asked for it, and they are therefore generally cautious to pay the price for it” That additional cost might equate to anything from 2bp–10bp on top of existing costs, depending on the complexity of the fund, the underlying asset classes and the markets in which the AIFM invests, said Roessler. To give that context, a vanilla equity fund might traditionally have costs of 2bp. Among the buyside community, closed-ended funds will by far be the most severely impacted, said Melvan, in line with their hedge fund colleagues in London and Switzerland. Private equity or real estate funds have traditionally fallen outside the remit of the Banking and Investment Acts that regulated most German funds, because they do not trade in securities or derivatives. But under the new rules they will require an AIFMD licence. It will be difficult and time-consuming for them to meet their new requirements, such as the splitting of the portfolio and risk management functions and the implementation of new reporting procedures. The rules also forbid funds from outsourcing both their risk and portfoli

To view the digital version of this report, please click here. German development bank KfW has established itself as a global capital markets behemoth, in the process acquiring a reputation as an innovative bond issuer, raising €70bn–€80bn of annual funding from Europe, the US and Asia. However, as regulators have sought to bring transparency and security to the over-the-counter derivative markets in the aftermath of the financial crisis, KfW’s extensive usage of swaps has moved into the spotlight, and raised some thorny issues for the agency and its banking counterparties. Of particular concern has been the prospect of regulatory mismatches between the US and Europe, which threaten to derail KfW’s established roster of banking relationships. KfW issues the biggest portion of its paper in euros and dollars, which account for roughly 80% of its funding. The remaining 20% is issued in other currencies, like offshore renminbi, in which it is the largest non-Asian SSA issuer. The agency generally converts proceeds from foreign currency bonds into euros, the core currency of its lending business. It also hedges foreign currency and interest rate risk. The system has worked well, with banks in national jurisdictions always happy to provide KfW with swap facilities following local currency issuance. However, in a recent rule change to European Capital Requirements Regulations policy makers granted banks an exemption to the need to hold capital against KfW counterparty risk, and so handed European banks a distinct advantage. “KfW is a heavy user in particular of cross-currency swaps for its non-euro funding, and the exemption for banks regulated in Europe from holding capital against those swaps is a key advantage,” said Alex Caridia, a director in debt capital markets at Royal Bank of Canada. “It will make the cross-currency business much cheaper for them.” As KfW wrestles with the potential impact of the rule change on its swap counterparty relationships a related issue in the derivatives business is collateral, and the use of credit support annexes. Traditionally, agencies such as KfW, which has an explicit state guarantee, have not posted collateral on their derivatives trades. Since the financial crisis, however, they have come under pressure to do so. While some, such as the European Investment Bank have refused to countenance collateral payments, KfW has been more circumspect, and is reported to be willing to post some collateral in the form of its own bonds to its swaps counterparties. The situation is still far from ideal for dealers, though, with the contracts still heavily weighted in KfW’s favour. The mark-to-market thresholds beyond which KfW has to begin posting collateral against its swaps is understood to be much higher than the level at which its dealer counterparties begin to see margin fly out the door, undermining the benefit of the arrangement for banks. And while dealers may be able to repo KfW paper to lessen the funding burden that accompanies long-dated swaps, receiving these bonds as collateral will do nothing to diminish their counterparty credit risk exposure to the agency. The issue is emotive among bankers, which all post collateral to agencies, and some said they would stop doing business with SSA clients unless two-way CSAs are implemented in full. Bar the extreme example of UBS pulling out of the business, these threats have proved idle so far. KfW for its part declines to discuss its policies. The issue of collateral is important for public sector entities like KfW because they are exempt from clearing in both the US and Europe – which requires daily margin posting against swaps positions as well as an upfront initial margin payment – and are hopeful of escaping the regulatory mandate that has caught a large part of the swaps market. KfW has recently approached the Commodities Futures Trading Commission, and has written to the European Commission to pursue a further exemption from margin requirements