Needed: a strategy for uncertain times

April marks a surprising anniversary – 10 years since KfW sold any shares in Deutsche Telekom. Since 1997, the development bank has been in charge of selling the German state’s shares in Deutsche Telekom and Deutsche Post. Yet even as equity markets have gained ground in recent years, the jumbo equity sales for which KfW is known have been absent. As an entity independent of the state it has been able to focus on providing the best return for the taxpayer, free from political pressure to sell at certain junctures. This has led to extended periods of inactivity – notably following the two companies’ IPOs in 2000. KfW’s first post-IPO sale in Post was in December 2003, while it waited until October 2004 to sell any more of Telekom. KfW did in fact try to sell some more of Telekom through an exchangeable bond issued in 2008. However, the bond failed to convert by maturity in June 2013, with shares trading below the €13.4366 conversion price. This begs the question as to why KfW has not been keen to sell with shares now trading €2 above that conversion price. While exchangeable bonds have failed as part of the privatisation process for DT – the 2013 bonds were to refinance an earlier bond that had not converted – they have been more successful for Post, where KfW has clearly been happier with the valuation, selling far more recently. Equity was sold in September 2012, while outstanding bonds exchanged into stock in 2013. However, the €750m exchangeable that matured in 2014 failed to convert. Yet the inactivity is surprising considering the performance of both stocks. KfW last sold Deutsche Post shares in September 2012, raising over €900m. The deal was not a clear success, with pricing revised during the evening bookbuild from a minimum €15.70 to final pricing of €15.40. The stock has traded above this level since late 2012 and doubled by April 2015 to a close of €31.08. Shares have been volatile in 2016 but now trade above €25. The last sale in Deutsche Telekom in 2006 was not a capital markets transaction but a private sale to Blackstone raising €2.68bn. The hope was that this may lead to private equity interest in the state’s holdings, but within the year, shares fell to €10 from an investment at €14 per share. They eventually recovered, though not before Blackstone had reduced its stake, and are now holding above €16. At present levels, KfW’s 17.5% holding in Deutsche Post is valued at €12.7bn, but a further 14.3% is held directly by the republic (shares are transferred to KfW prior to sale), taking the entire stake up to around €23bn. KfW holds all of the state’s Post shares and its 21% stake is worth €6.5bn. Bankers are hesitant to talk publicly about KfW for fear of upsetting the agency, while KfW itself declined to comment on equity sales at this point in time. However, bankers privately suggest that a major reason for the inactivity is that KfW has a major funding programme. Bankers all point to KfW’s extremely heavy financing requirement at nearly €80bn in 2015 as a reason not to focus on the few billion that can be raised, with a little more fuss, through equity markets. An official at another state-owned entity echoed this view, adding that if there is not the political imperative then there are unlikely to be sales. In 2015, KfW raised €62.6bn through international debt issuance at a rate of more than three bonds per week in 14 currencies. Its target for 2016 will be even more exhausting at €70bn–€75bn. Nonetheless, all parties are cautious about predicting future behaviour, knowing that the phone could ring without any notice. But elections mean action may be limited. One originator felt that the local elections this year would stop deals launching, but another said national elections would be a block next year, so local elections could be ignored. Without the need, then, bankers may have to get through another year in the absence of their biggest client. Which makes the speculation of one senior banker particularly

Of all the problems presently facing Germany, it is unlikely that a stuttering equity capital market is getting much attention versus the challenges of welcoming hundreds of thousands of refugees. Yet it is a worry that Europe’s largest economy is struggling to support companies’ growth through transition from the private to public market. Just one company has completed an IPO of over US$50m on the German exchange in 2016 – wind turbine company Senvion. And it was not an easy path to pricing, with the deal cancelling at the end of bookbuilding, only to be restructured as a far smaller trade and revived within days. The float was to allow private equity owners Centerbridge and Arpwood to sell down their stakes, raising up to €611m in the process. In order to get the deal done, it was relaunched with a lower valuation for the company and minimal selling by the owners for a deal of €255.9m. Of course, too much attention should not be paid to a single deal – and no part of the EMEA region could claim to have had a successful first quarter as issuance volumes collapsed and IPOs were postponed more often than priced. If only Senvion was a one-off. In fact, it marked the fourth consecutive German IPO to be significantly downsized in order to be completed. That record is exceptional in EMEA. But is it a cause for concern? Worrying trend Senvion followed Covestro, Schaeffler and Hapag Lloyd – all in October 2015 – in cutting its IPO to fit demand. Also in October, Xella cancelled its €200m-plus IPO. Across the four downsized deals, target proceeds dropped by over €3bn. This pattern is unique in Europe, though the reality is that in other nations in the fourth quarter deals were instead postponed. “In the fourth quarter last year, deals across the region were collapsing and many cancelled, but in Germany sellers restructured deals,” said one head of Germany, Austria and Switzerland ECM. “Rather than being a disappointment, the achievement was getting those done. It highlights the need to be flexible and doing what you can to optimise a deal.” Jens Voss, head of equity capital markets at Commerzbank, echoed that point. “All these IPOs in a row modified after launch show that investors are not willing to pay high multiples,” he said. ”Covestro traded up significantly, showing this is a buyers’ market. But the deals all got done when others cancelled. So there are positive and negative signs, it is a really complex situation.” While that run of deals spoiled the end to the year, October also witnessed the €1bn IPO of digital marketplace Scout24, which suffered none of the problems of the other deals. By year-end, IPO proceeds in Germany reached US$7.7bn, more than double 2014 and the highest level since 2007. While acknowledging the difficulties, Armin Heuberger, head of German ECM at UBS, said there had been a real renaissance in the IPO market, citing the completion of a number of corporate deals, including Covestro, Schaeffler and Hapag-Lloyd’s IPO – a transaction that was first attempted over 10 years earlier. Each of the deals could easily have cancelled, yet the issuers chose not to waste the time invested in the process and adapted to survive. It was the right choice, as shown by the Schaeffler family six months later being able to sell all the shares that were cut from the IPO. Covestro traded strongly from the start and the shares now trade in the upper part of the IPO price range. By contrast, those that cancelled IPOs, including Xella and food delivery company HelloFresh in November, are not coming back any time soon. Scared off Nonetheless, the impact was clear in the first quarter as issuers shied away from coming to market. That held true even for smaller offerings, with the €30m IPO of Brain the only other new issue and one that was strongly supported by existing shareholders. “IPOs are a tough sale right now, so most corporates have postponed their listings and done another round of financing before an IPO,” said Verena Kro

Corporate Schuldschein volume in the first quarter reached €7.7bn, the third highest quarterly volume ever, according to Thomson Reuters LPC data. The total is already well on its way to top the €20bn seen in 2015. “The acceptance of the product by both issuers and investors has increased, with an increase in clients using Schuldschein to take out M&A debt, while there has been a window of opportunity where often even rated issuers can get more attractive pricing compared to other capital markets,” said Raoul Hessling, Schuldschein specialist at BNP Paribas in Frankfurt. For borrowers, Schuldschein also compares favourably compared with other debt instruments. “The main reason for the strong volumes we’re seeing is that pricing, relative to other capital markets, remains very attractive to borrowers,” said Richard Waddington, head of Schuldschein and loan sales at Commerzbank, Corporates & Markets. The perception of the Schuldschein market has changed from an old-style domestic instrument into a truly international product attracting both international issuers and investors. While the French Euro Private Placement (Euro PP) remains an almost exclusively domestic product, the Schuldschein has expanded across geographies, offers access to relatively deep pools of liquidity and is more akin to the US private placement market. International investors have been attracted to the Schuldschein product because of the optionality if offers in terms of maturities. “One aspect that it is increasingly important to take account of is the flexibility this product offers to investors when it comes to tranching. A multi-tranche SSD offers an arbitrage between pricing and maturity that a corporate bond does not,” said Reinhard Haas, head of DCM loans at Commerzbank. Larger and greener In addition to keeping pricing low, the influx of international investors into the market has also seen an increase in the number of bigger deals. “This used to be a solely domestic market, mainly funded by the German savings banks, now investors from outside Germany have come in, this includes some large commercial banks, and they are providing much bigger clip sizes,” Waddington said. In 2014, there was only one Schuldschein of over €500m, in 2015 there were seven, including a record €2.2bn deal for automotive supplier ZF Friedrichshafen. There have been six already in 2016. “For a transaction of over €500m, you need a good mix of domestic and international investors,” Hessling said. For example, in February, independent telecoms provider Freenet placed a €560m Schuldschein, an increase from the launch amount of €300m. The issue comprised five-year, seven-year and 10-year tranches. BayernLB, Commerzbank, LBBW and UniCredit arranged the financing, which was placed with a widely spread group of institutional investors in Germany and abroad. A jumbo Schuldschein totalling more than €1.1bn for sports car maker Porsche was placed at the beginning of March 2016 – increased from a launch amount of just €200m. The financing, which was arranged by LBBW and UniCredit Bank, was split between three-year, five-year and seven-year maturities. The financing was placed with over 150 institutional investors, including banks, pension funds and insurance companies. Non-German investors contributed 45% of the total facilities. Another major factor in the recent growth of the Schuldschein market has been companies using the product to finance or refinance acquisitions, so much so that it is regularly discussed in early stages of acquisitions, bankers said. In January, HeidelbergCement tapped the market for a €625m seven-year Schuldschein via LBBW, Helaba and Raiffeisen Bank International. The financing was used to reduce a bridge loan that had been arranged in 2015 to back the acquisition of Italcementi and help pre-fund the acquisition initial stake purchase. Wind turbine maker Nordex placed the first ever “green” Schuldschein in late March, raising €550m from investors. Th

Germany took the market by surprise when it raced ahead last year with a proposal to subordinate senior unsecured debt in the insolvency of its banks. For all its simplicity, other countries have not followed suit, creating a patchwork of different bail-in regimes across Europe that is proving a nightmare for investors wanting to invest in the region’s bank debt. Germany passed the Resolution Mechanism Act in November 2015, subordinating senior unsecured bonds to deposits and derivatives but keeping them senior to contractually subordinated debt, such as Tier 2 capital. The new law, which will be retroactive when it takes effect on January 1 2017, ensures that institutional investors rather than the taxpayer shoulder the losses in future banking crises. “It is clearly one of the simplest and clearest solutions, to clarify the ranking of senior unsecured bonds versus other excluded liabilities,” said Christoph Hittmair, head of European FIG DCM at HSBC. It sets out a bail-in hierarchy that should provide clarity and legal certainty in insolvency. Furthermore, by being applicable retroactively, it has effectively removed the need for German banks to raise billions of euros of additional loss-absorbing debt to meet European and global regulatory requirements. Globally systemic banks such as Deutsche Bank must have 18% of their risk weighted assets in so-called Total Loss Absorbing Capacity (TLAC) debt by 2022. That debt needs to be either structurally, statutory or contractually subordinated. Thanks to the German proposal, Deutsche Bank was able to report more than €110bn of TLAC in a recent presentation to investors, €26bn above the 2019 TLAC requirements, while banks in some other countries are still waiting for regulatory clarity. Divisive However, Germany’s solution is not without its problems. The legislation is seen as one of the most aggressive in Europe towards senior debtholders, who complain that their senior unsecured holdings, originally sold to rank pari passu with other senior instruments, were suddenly bumped into the subordinated category. “The subordination of senior unsecured debt instruments will increase the loss severity for senior debt instruments, offering lower protection for senior bondholders,” Moody’s analysts wrote as the agency downgraded seven German banks by a notch in January. The solution is said to have divided the opinion of German banks, with some warming to its simplicity and others objecting to the increased funding costs. “The German frontrunning in terms of BRRD implementation has had a strongly disturbing effect not only on secondary markets for German FIG senior but also for the primary markets,” said Thomas Cohrs, head of syndicate and origination at Nord/LB. It is hard to quantify the impact the proposal has had on German spreads, given they are impacted by any number of factors, although most agree the market has widened. A €1.5bn March 2025 senior bond issued by Deutsche Bank widened by around 75bp between March and June last year, before retracing some of those losses. Landesbanken, however, benefit from state support and have widened less than Deutsche Bank or Commerzbank. Still, Cohrs argues that the widening has made it particularly difficult for new issuers, such as Nord/LB, trying to establish benchmark curves. “In order to attract more foreign investors, we had to bridge not only the expected spread gap between domestic and non-domestic investors but also expect them to swallow a statutory subordination that not even most German investors fully comprehend,” he said. Crossroads Since Germany’s proposal, a number of other countries have set out changes to their own bail-in regimes. No jurisdiction has replicated Germany’s approach, although Italy has come the closest. Whereas Germany opted to subordinate senior unsecured debt, Italy instead proposed to elevate the ranking of large corporate customer deposits above other senior claims. Theoretically, that should leave a thicker tr

With Europe’s economy wallowing in a prolonged low growth, low inflation cycle, it was no major surprise to bond market practitioners when the European Central Bank announced in March another round of attempts to stimulate the eurozone towards its 2% inflation target. What was more of a surprise, however, was the extension of the central bank’s Asset Purchase Programme (APP) to include corporate bonds. On March 10, the ECB announced that it was lowering deposit rates further into negative territory and, as of April 1, expanding the combined monthly purchases under the APP to €80bn from €60bn. For the first time, however, the remit of the APP would be widened to incorporate euro-denominated bonds from Europe’s corporates in a Corporate Sector Purchase Programme (CSPP). “Investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area will be included in the list of assets eligible for regular purchases,” said the ECB in a press release at the launch of the programme. “The CSPP will further strengthen the pass-through of the Eurosystem’s asset purchases to the financing of the real economy.”  There was very little other information for the market to digest other than that the buying would commence towards the end of the second quarter. Nonetheless, the prospect of another major investor joining the demand side for European corporate bonds – a price-insensitive one at that – had an immediate impact on the market. “It’s a game-changer,” said Martin Wagenknecht, head of DCM origination for Germany, Austria and Switzerland at Societe Generale CIB. At the beginning of 2016, European credit markets were suffering from the volatility associated with fears for the China economy and a precipitous fall in oil prices. The situation had begun to improve leading up to the ECB meeting in March as oil started to recover and Japan soothed the markets by adopting negative interest rates. That change in sentiment created a fertile backdrop against which the ECB announced its own monetary-accommodative plans. Investors quickly stepped back into the market in the belief that credit was the place to be – for the foreseeable future, at least. “Overall investor demand is resilient,” said Christoph Rieger, head of rates and credit strategy at Commerzbank. “Even on risk-off days, the cash market often continues to tighten.” The strength in demand is reflected in the performance of the iBoxx Triple B index. In mid-January, it was trading around the 190bp level, but by March 10, it was closer to 150bp and was 115bp by mid-April. “Not all of that tightening is purely due to the ECB’s announcement, but it clearly impacted it and demonstrates the underlying strength of demand for credit,” said Marc Mueller, head of DCM origination for Germany, Austria and Switzerland at Deutsche Bank. The strong performance in Triple B names has been closely replicated throughout the credit markets, with even debt not expected to be included in the scheme, such as corporate hybrids and bank bonds, also benefiting from the dramatic increase in demand. Securities from issuers more likely to make an appearance on the ECB’s buy list have outperformed the rest of the field by some 7bp, according to calculations made by Commerzbank. The immediate reaction to the ECB’s announcement comes in advance of full disclosure as to the workings of the programme and has left the market speculating as to what it will look like. “Will they be restricted to size, will they follow the indices, will they include private placements and, if so, how will they go about the credit assessment?” asked Wagenknecht. But with an outstanding universe of likely eligible bonds estimated at somewhere between €550bn and €650bn, the additional €20bn of monthly asset purchases is not expected to all be targeted at corporate bonds. “I’d be surprised if they communicated ex ante the share of corporate bonds to be purchased as part of the overall allocation,” said Rieger. “I doubt

For Volkswagen, the full implications of the NOx emissions scandal, which broke in September 2015, are yet to be fully ascertained. The US is still calculating its fine, while the manufacturer is still developing its software fix. Recent figures show VW Europe’s quarterly market share has hit a five-year low. Yet observers point out things could be considerably worse. Christian Stadler, a professor of strategic management at Warwick Business School, said: “That the VW brand has been hit more than others is no surprise but, considering the furore of ‘dieselgate’, we have definitely not witnessed the demise of the Volkswagen Group that some expected.” For its competitors, things look a little clearer. Some have questioned whether VW’s practises might be the industry norm, but for now no other manufacturer has been implicated. Before the scandal, German auto manufacturers were popular issuers among investors and had no trouble securing financing in normal market conditions. In January 2015, VW had priced a 15 year bond at mid-swaps plus 60bp. The spread had widened in the following months as part of a broader market shift in sentiment. But once the details of the emissions scandal were public the spread ballooned to around 240bp. In the early days of the scandal, this panic-widening proved contagious, with similar issuers such as Daimler seeing similar, if slightly less aggressive moves. But for issuers other than VW, the reaction was relatively short-lived and they had recovered their poise before the ECB announced in March it would include corporate bonds in its QE programme. Daimler, for example, was among the first European corporates to the bond market in 2016, issuing a €1.25bn three-year floater at Euribor plus 53bp, a €1bn five-year fixed-rate at mid-swaps plus 65bp and a €1bn eight-year fixed at mid-swaps plus 77bp – all tighter than guidance. In February, BMW sold a dual-tranche euro benchmark. A €500m floater was priced at Euribor plus 65bp, while a €750m fixed-rate tranche came at swaps plus 85bp. The deal was relatively small for this issuer – its last euro deal came in November at €1.25bn, and its last dual-trancher last September for an aggregate €1.5bn – but the price shows there was no sense of crisis around the issuer. The ECB’s announcement saw spreads for auto manufacturers tighten further, along with other large credits. The move creates a buyer of last resort for the issuers and has clearly had a positive impact on spreads – even VW’s. On the eve of the ECB’s pronouncement, VW’s 15 year had come back to 180bp over mid-swaps, further narrowing to 145bp by April. There was similar tightening on other German credits: Daimler issued a 10-year bond in March at swaps plus 105bp, which in April was trading at 53bp – a tightening of around 50bp in response to the ECB’s statement. Yet the ECB has also drawn criticism that it could undermine secondary market liquidity. Some estimate the ECB could end up acquiring between 30% and 50% of new issuance, as well as some secondary market paper, which will then be held to maturity. Some issuers are also concerned that ECB purchases could be perceived as implying they needed government assistance and there has been talk of syndicate desks limiting allocations to the central bank, though this would probably result in greater acquisitions in the secondary market. Ultimately, only time will reveal the true impact on liquidity. New strategies The year has also seen both Daimler and BMW adapt their longer term funding strategies. BMW has traditionally avoided the public US institutional market, preferring to rely on private placements. Its core market has always been in euros, supplemented with deals in sterling, Australian and Hong Kong dollars and some others. But this year it has been active in US dollars. Daimler, on the other hand, has been a regular issuer in dollars. But this year it has been unusually active elsewhere, particularly in the euro market, where it had raised €

German banks should be in a sweet spot right now: funding costs are at an all-time low, and the home market – the world’s third largest economy – is growing at a decent clip; demand for exports has pushed the trade surplus to a record high, helping generate jobs and push unemployment to the lowest since reunification; consumers are spending again, and the property market in many of the country’s biggest cities is booming. But, despite the strong macroeconomic backdrop, and almost eight years on since the global financial crisis, much of the German banking system is struggling. Consolidation, predicted for many years, has been underwhelming. Almost 1,800 banks – more than double the number in any other eurozone country – are still locked in competition for a slice of the same lending, advisory or underwriting business. The result has been thin margins and disappointing profitability: return-on-equity at German banks has averaged around 6% over the past few years, according to Bundesbank figures, even as the country’s economic engine has hummed along nicely. The last few years in particular have been painful – current annual profits of around €35bn are down almost a fifth since 2010, and are now down to levels seen in the late 1990s. “This is the strongest economy in Europe, yet its banking system has an antiquated look,” said Sam Theodore, a managing director and team leader for financial institutions coverage at ratings upstart Scope. “The country still has too many banks and profitability is very low, a problem that is more acute that ever before because of the low-rate environment.” According to Theodore, the German banking system’s resilience has in some ways been its biggest enemy. “Other banking systems have been through consolidation and reform – normally as a result of crises – but Germany’s banks did not experience a major crisis, therefore there has been no real incentive to reform,” he said. “Added to that, there is a lot of political interest in maintaining the status quo, especially on the public banking side.” Low demand But poor returns are not only due to overcapacity; demand for banks’ products – and in particular loans – has also been weak over the past few years. The German economy has grown by 23% in absolute terms since the 2009 post-crisis nadir. By contrast, the amount of credit extended by German banks has flat-lined at around €4.6trn for much of those six years. Economic growth has just not translated into increased credit demand. Subdued appetite for loans during times of economic growth is all the more surprising given the fact that the cost of borrowing has plummeted during that time. The European Central Bank has cut interest rates to zero and deposit rates into negative territory, while also launching numerous liquidity injections that have flooded banks with cheap funding. Rates charged on loans have come down to record lows. “Germany is a mature market, but it is a very conservative and risk-averse market,” said Jan Schildbach, team head for banking, financial markets, regulation at Deutsche Bank in Frankfurt. “Even with the most favourable conditions you could ever get, companies are reluctant to borrow and invest. And on the retail side, conservatism prevails too: loan-to-value ratios are usually low, and most mortgages are fixed-rate.” In bond markets, while other eurozone corporates have been enjoying the party, issuing heavily into a market where demand has been high and yields low, German corporates have been more cautious. Outstanding eurozone corporate bonds stocks have grown by around 40% to €1.1trn since 2010, but the German component has remained relatively flat during that time, rising only marginally to €258bn from €251bn. “Corporates have been using up their cash buffers rather than borrow, and that’s a trend that is only likely to intensify as the impact of negative rates feeds through,” said Roman Schmidt, head of corporate finance at Commerzbank, Germany’s second largest bank. “T

Overcoming hurdles: With attention more often than not focused on other parts of the eurozone and the problems faced by countries mainly in the southern part of the region, it is easy to forget that Germany is not without issues of its own. Its much-vaunted auto industry, for example, was rocked by the Volkswagen emissions scandal that broke in September 2015. The sector has long since been a mainstay of the country’s corporate world, so the revelations and their consequences cut deep into national pride. That the credit has been partially rehabilitated and that the ABS market provided an avenue to funding in the interim have both been greeted as positives, although the road to redemption looks to be a long one. ECB initiatives to include corporate debt in its bond-buying programme have added a further spring to the sector’s step, although previous experience in the Pfandbrief market shows that such action can be a double-edged sword, impacting liquidity and contracting spreads to such an extent that the traditional buyer base no longer finds the product so attractive. Germany’s corporate borrowers have not historically encountered problems as far as market access is concerned – VW notwithstanding – so whether the negatives will outweigh the positives is a moot point. On the other hand, those further down the food chain could benefit from an investor community looking for incremental returns in a low-rate environment. In fact, it looks as if it is the equity rather than debt market that could do with a helping hand as far as corporates are concerned, with just one IPO bigger than US$50m pricing so far in 2016. That deal, from wind turbine company Senvion, was initially cancelled after bookbuilding, only to be resurrected as a restructured but far smaller trade in fairly short order. But it is this very willingness and ability to adapt to the conditions that leads bankers to believe that all in ECM is not necessarily lost in spite of a lacklustre DAX and heightened volatility. The previous three German IPOs were also downsized in order to get them over the finishing line, and this Realpolitik paid off inasmuch as their subsequent performance was commendable. By contrast, those that chose to cancel rather than tailor their aspirations to the conditions have little chance of trying their luck again any time soon. The story is similar in the financials world, where close on 1,800 banks are fighting it out to attract business, giving one of Europe’s most advanced nations a rather antiquated feel. Consolidation – which some would deem the natural manner in which to adapt to the circumstances – has been slow. A reduction of 200 since the financial crisis might sound material in isolation, although it is not nearly so remarkable when starting from such a high base. Returns are low and aggregate profits are down to levels seen last century. Lending is stagnant – exacerbated by the conservative nature of those on both sides of the equation – with the lack of any domestic crisis prolonging this inertia. But perhaps as other countries move to address their predicaments, this will change. There is, however, one area in which the German banking industry stole a march on its rivals – although not all are agreed it was in a good way, investors in particular. In November 2015, the Resolution Mechanism Act was passed, subordinating senior unsecured bonds to deposits and derivatives. This aggressive bail-in approach removes the need for German banks to raise billions of euros of additional loss-absorbing debt to meet European and global regulatory requirements, given that it will be retroactive when it takes effect in January 2017. However, there are concerns about the senior debt market becoming a minefield for investors, with the regime likely to be just one of a patchwork of approaches across countries. For all that is going on in the financial markets, there is one subject that is more talked about than any other – immigration. But even here