IFR German Corporate Funding Roundtable 2014: Part 1

IFR: Good afternoon and welcome to IFR’s 2014 roundtable on German Corporate Funding. We have a whole host of themes to discuss here today: the broad funding drivers in Germany in 2015 for SMEs and large caps; what is the 2015 funding requirement? How are financing conditions set to evolve? Will M&A evolve as a big new-money theme in 2015? How are German banks positioned in terms of their ability and willingness to lend to corporates? How is the competitive landscape shaping up? Roland: is Germany Inc in a good place?

Roland Boehm, Commerzbank: The short answer to your question is definitely yes. When we sat here last year, Germany was already doing well but markets have moved on and from the point of view of our clients have become even better.

So great markets, great performance but very strong competition too. Germany Inc continues to make great products that the world wants. We need to remember that we should not look at the world in isolation or from the point of view of a particular issue or crisis. Globalisation continues and German companies have been able to take advantage of that. So I think yes, Germany is in a good place.

IFR: Joachim, do German companies need to raise money in 2015? Do we have redemptions? Are we going to be exposed to another cycle of re-financing? When are we going to see new money coming in, for capital investment or for acquisitions?

Joachim Erdle, LBBW: From a funding perspective, 2015 will be very challenging at least for the banks active in Germany, given that most of the refinancings have happened; so all of the syndicated loans of larger companies were either refinanced last year or this year. From that perspective I don’t think we can expect to see lot of new business in the next 12 to 18 months. What we are looking for are event-driven deals, i.e. result of M&A transactions or expansion activities, where corporates definitely need to raise new money.

IFR: OK so who is going to finance Germany’s growth?

Joachim Erdle, LBBW: Well most corporates have taken care of that in the last 12 to 18 months as well. They’ve been piling liquidity onto their balance sheets. Hence, the growth that comes from an organic point of view, I think that is all done, at least with the large caps.

In the small and mid cap area, I would say it is a slightly different story and we do see some funding need for smaller companies. But all the banks are prepared to take care of the financing needs of that growth if necessary, as will capital markets, which means the competition we’re currently facing will definitely remain in place.

Roland Boehm, Commerzbank: To add on to what Joachim was saying, we are starting to see growth already. If we compare year-on-year numbers, volumes are up 23%, while the number of transactions is down by 8%. That tells me two things: firstly, transactions are getting bigger and secondly they are getting more exciting. I think the M&A wave that we talked about last year has arrived.

IFR: Matthias, I’m curious as to whether we’re at the level of the economic cycle where German corporates start to raise funds for capital investment, for plant expansion, for international expansion.

Matthias Gaab, Deutsche Bank: Well, a very large proportion of German corporates already have plant at home and abroad so it’s not just an investment in Germany, you’re talking about investments in China and throughout the world. In that connection there are probably two things. Number one, you have local financing which brings with it specific issues of how to deal with local regulations etc and how this fits into companies’ overall cash management positions.

Second, overall credit quality, a result of strong cashflow over the last couple of years, has significantly improved. From that perspective there is little reason for corporates to be worried about their ability to raise required funds. Especially not in light of the fact that especially in Germany, we enjoy pretty strong competition from banks all over the world.

On that specific point, the banks are in a difficult position; it’s a difficult business. On the other hand, looking at this positively, it feels to me like we’re close to an efficient market, which for the overall economy is certainly good news.

IFR: Christian: banks and corporates are very liquid and funding conditions are better than they have been. Every time we come to this event, everyone says: “we’ve reached the floor, funding can’t go any lower” and every year it carries on getting lower. Why haven’t more German companies taken advantage of these incredible funding conditions? Or is it back to Joachim’s point, they just are so cash rich they don’t need to. I’m curious about the dynamic at play here.

Christian Reusch, UniCredit: Having options is a matter of luxury. I think that is priority number one. Second, from a debt capital markets perspective, I kept telling clients: “credit spreads and yields are so low yields, it’s time to go”. Unfortunately it’s taken me three years to more or less find the bottom, and I still don’t know yet whether we have reached the bottom.

With Bund yields at 0.85% in early September, we went back to levels above 1% and [in late October] we’re down again to levels south of 0.90%. Where is it headed? Some issuers rushed into the market when Bunds hit those lows, not so much from Germany but from elsewhere. The point is a lot of funding has already been done. Issuers have been stringent in fulfilling their funding plans. I think cashflow generation, as Matthias mentioned, is excellent. So from this perspective, if there is nothing new to be done, from an investment perspective or other things, there is hardly any need.

As Matthias already mentioned, we have a more or less efficient market. We don’t just have the banks; we have this disintermediation story going on. Institutional investors are increasingly standing in line for assets, directly interfacing with some of the large corporates and telling them what funding they can offer. And extending maturity is no problem. I think there are a variety of options in play here. In some respects, it’s too good to be true for some issuers.

Ingo Nolden, HSBC: I agree. It’s the best of all worlds for corporates. Banks are chasing new clients and business opportunities so we’re seeing new entrants coming to the market. The loan market is very liquid and the bond market is seeing new institutional investors looking for diversification and new ways to put their money to work, leading to a very abundant and liquid market for corporates, especially German corporates as they’re among the winners in the globalisation stakes so far.

The status quo is a dream from the German corporate treasurer’s perspective. The question is whether it’s gone too far. We’re seeing some initial signs of overheating.

IFR: How is overheating manifesting itself? Was the development of the Mittelstandsanleihe SME bond market with its high default rate a sign of that? Roland, what does overheating mean for you? Does it mean that you are compelled to do things that you wouldn’t normally do because of the situation and because of the competition?

Roland Boehm, Commerzbank: Well, I would contest this notion of overheating. I think we are going in that direction but I am not sure we are there yet. I think there is lots of liquidity in the market but by the same token refinancing rates for banks have gone down. Clients have been able to benefit from that. Competition is, in my view, a good thing for markets. Structures were tightened considerably during the financial crisis. They are coming back to normal levels.

The good news is that the products we are offering our clients are becoming more attractive to them and they are starting to make use of them. If I look at some of the larger M&A deals that we have seen this year, be it Symrise [which acquired Diana Ingredients for US$1.8bn] Bayer [which acquired the consumer care business of Merck & Co for US$14.2bn], or be it Infineon [which bought International Rectifier Corp for US$2.6bn], clients are seeing deals in action again and not just hearing banks talking about it.

That is extraordinarily good news. We have certainly got to watch what is happening, and individual banks need to take a view on what they are willing to do, but I do not think we are in an overheating scenario yet.

Joachim Erdle, LBBW: I would say there is a certain level of overheating visible in the market. The reason I say that is, if you look at deals with covenant-lite structures that we typically see on DAX companies, we are seeing them more often in Mittelstand transactions too.

That is a clear sign, at least to me, that we’re in a phase where overheating is becoming an issue. If you look at the leveraged market, you can definitely see the same. You don’t have to go to the US to see more covenant-lite deals than typical covenanted structured deals, you can see it in Germany too.

So I would say yes, there are some signs of overheating. You can also go further and look at margins and fees. With the margins currently offered in the market, no bank is earning money so everybody is focusing on ancillary business.

IFR: This is an interesting point. Matthias: you have to make money as lenders and service providers. Where do you stand on the overheating debate? But more to the point, what can you do about it in this environment?

Matthias Gaab, Deutsche Bank: I would divide the market into two parts: large caps (however you define them) and small and mid-cap companies. In the large cap space, by far the largest portion of the lending business is back-up facilities. By definition you are not going to make money on those so to Joachim’s point, you need to rely on ancillary business.

The bank market, not only in Germany but especially in Germany, has a long history of getting accustomed to this and telling itself that this is a good idea. You might have a different view on that.

On top of that, you have event-driven transactions and coming back to the question on overheating, I think each competitor needs to define and explore the merits of each transaction, whether or not this is the right deal to support in terms of leverage, in terms of take-out risk, in terms of overall strategy for the client and whether it makes sense or whether it is something you should question.

At the moment, given the level of competition, you need to realise that if you decline such opportunities when they pop up, in at least 80% of the cases or probably even more, the client will be able to find competitors to do the deal.

Whether that will ultimately be successful for the respective institutions is another question. But in the first instance, for the client and from a client’s perspective – clients who by the way will be convinced it’s the right thing for them to do and that they need the transaction for their strategies – as long as they find a group of reputable banks to support them, they will go for it and if one bank has a different opinion then so be it, but that’s not going to have an impact on the market.

IFR: Christian: where does the status quo in the bank market leave the debt capital markets? You’ve already talked about the fact that it’s not just the banks you are competing with for DCM business, you are also competing with direct lending by institutional investors. How do you see the complexion of DCM evolving over the next year or so? Do you foresee more of the same? What competitive advantages does DCM have versus the alternatives?

Christian Reusch, UniCredit: In the aftermath of the crisis, banks started preaching disintermediation. It’s now starting to take place so we certainly can’t start complaining now about Pandora’s Box having being opened. It’s not Pandora’s Box; DCM is an additional avenue of funding and we’ll see when the cycle turns if it continues to be a valid one. Some investors will understand that entering a credit relationship is different to what they might have experienced in the past, and you will have to live with cycles. That’s the first thing.

Second, long tenors can usually only be offered through the capital markets or through institutional investors. That is certainly an advantage, so why not take advantage of the very low yield and spread environment and lock in low levels over a long tenor? I think that is a very compelling argument

Banks will always have a function and from this perspective, yes competition is high and yes this may be a little painful. But you will have to adapt, you will have to react and you will have to probably push other products or other ideas forward. But that’s the good thing about financing institutions, whether from the loan or capital markets perspective. We’re probably a little quicker in adaptation and innovation than a lot of the institutions, even the very big bulge-bracket buyside firms.

I wouldn’t see competition as anything to be frightened of. I see it as a positive because it offers a strong impulse to offer new ideas to the market. But you do need to be creative. As long as you are creative and innovative, as long as you are fast and as long as you can open up your balance sheet in case of need, I think you will still find good business.

I totally agree with what Matthias said, that you will have to make your calculations on your own, whether the overall package is suitable to your needs or not. At the end of the day, this is the decision everyone has to make. It’s probably more pronounced than in the past, but I think that is the situation.

Roland Boehm, Commerzbank: I would underscore what you say, Christian. We are seeing a world which is becoming ever more inter-connected in all kinds of ways. Why shouldn’t that apply to financial markets as well? We tend to think in product categories but clients want solutions and they will expect to be able to turn to their providers for help and form partnerships with them. They want us to provide solutions across a variety of different products and they want us to provide solutions that harmonise and work.

So in all of this, the advisory angle becomes much more important. For this reason, banks are very hard to substitute out of the equation because at the end of the day what we do is something very few other firms can do. Certain players can be good at certain things, very few players can be good across the board, and I think our solutions capability is something that banks are good at and need to focus on.

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