KEITH MULLIN, KM CAPITAL MARKETS (MODERATOR): WELCOME TO THIS IFR VIDEO CALL ON THE PROSPECTS OF GERMAN MITTELSTAND FINANCING. WE’RE DEFINING OUR DEMOGRAPHIC HERE AS COMPANIES WITH TURNOVER OF BETWEEN €125M AND €1BN, AND OUR MARKET PREDOMINANTLY AS THE LOAN MARKET.
I’D LIKE TO GET A SENSE FIRST OF ALL OF WHERE WE WERE AT THE END OF 2019 AND INTO EARLY 2020, HOW THE MARKET CHANGED AS MUCH OF EUROPE WENT INTO LOCKDOWN, THEN MOVE TO FOCUS ON THE MARKET TODAY, INCLUDING THE PROVENANCE OF TRANSACTIONS AND STRUCTURAL FEATURES.
FINALLY, WE’LL HAVE A STAB AT MAKING SOME PREDICTIONS ABOUT WHAT MIGHT HAPPEN IN THE COMING MONTHS, WHICH I SUSPECT IS MORE DIFFICULT THIS YEAR THAN IT HAS BEEN FOR SOME CONSIDERABLE NUMBER OF YEARS. REINHARD, CAN I ASK YOU TO KICK US OFF WITH SOME THOUGHTS?
Reinhard Haas, Commerzbank: When you think about how 2019 turned out, it was actually very constructive. We had a very liquid market and a lot of activity. We were back to a situation where we were seeing a fair share of M&A financing. That swept over into the New Year and it stayed that way until it became clear that the pandemic would engulf pretty much every country in the world. Clearly, the way it developed, the speed with which it developed and what a pandemic of such magnitude would mean for modern economies caught everybody off guard.
You had certain industries that from one day to another went to zero turnover; people couldn’t go to work; and a manufacturing industry where plants had to be shut down entirely. That situation was unprecedented and wholly different to anything we’d seen before. This was in no way triggered by industry and didn’t start out as a liquidity crisis of any kind. We did have warning signs coming from China, but governments had no experience of how to deal it.
For Mittelstand companies, it was especially menacing taking into account the fact that the German economy is very export-oriented. The supply chains for a lot of these companies simply broke down. It wasn’t only that they had difficulties in producing the goods, it was also that their offtakers and clients were in trouble as well. That was, I think, the situation that a lot of companies found themselves in.
Their first reaction was to ensure they had sufficient liquidity to keep going even though there wasn’t a lot of economic activity. So they reverted to their reserve lines, which were not really designed for this purpose, as permanent drawings. It was not a liquidity crisis but by-and-large where back-up lines could be drawn, they were fully drawn.
But that was only a transitory solution and what you saw then was a lot of discussions between companies and the financial industry on how to solve the problem for the longer term. That’s when we eased into the second quarter when that question was being resolved little by little.
KEITH MULLIN, KM CAPITAL MARKETS: ULRICH, HOW DID YOU READ THE IMPACTS AND WHAT ROLE DID KfW’S SUPPORT PROGRAMMES PLAY, PARTICULARLY IN THE EARLY COVID PHASE?
Ulrich Kittmann, DZ Bank: Well, loan tenors have clearly shortened. At the beginning of March and into April and May, we stopped seeing five-year tenors. Tenors shortened to three-plus-one-plus-one. We also saw an impact on utilisation fees, which went up from 7.5bp/15bp/30bp to 10bp/20bp/40bp. Companies that had liquidity needs due to a lack of revenues had options, and used those options.
On one hand, as you mentioned, there were the KfW programmes. Here we saw two programmes that were mostly relevant in this context: the 037 Entrepreneur Loan programme for smaller clients, and the 855 programme for syndicated financings for the Lufthansas, TUIs and Adidas of this world. What is really attractive for the banks with regard to KfW programmes is we only have a 20% share of risk; it’s 80% state risk. That made it a little easier for banks to support these KfW loans; they’re attractive as long as the companies survive.
We also saw third category: companies that wanted to avoid KfW because one of the impacts of KfW programmes is that companies aren’t allowed to pay dividends, so some companies said: “OK we haven’t experienced a direct impact due to coronavirus and we want to be able to pay dividends”. These companies drew down standby credit facilities.
KEITH MULLIN, KM CAPITAL MARKETS: JUERGEN, COMING FROM THE PERSPECTIVE OF A PRIVATE LENDER AS OPPOSED TO A BANK, COULD YOU TALK ABOUT YOUR EXPERIENCES? THE NON-BANK DIRECT LENDING BUSINESS IS RELATIVELY NEW AND HADN’T REALLY EXPERIENCED THESE SORTS OF CONDITIONS BEFORE.
Juergen Breuer, Pemberton: I remember sitting in February with a couple of our portfolio companies presiding over record performance before it changed quite dramatically. It was an interesting experience and it took all of us – most importantly the management teams of the companies – a while to figure out what it really meant for their business models. The experience was quite different for each and every one of them.
Internally it was similar to the way the banks were reporting to their internal bodies about what was going on. We did that too but we also reported to our investor base. Our investors were extremely curious to find out how the portfolio was developing. We went about things in as systematic a way as we could, coming up with a traffic light system that looked at a number of factors aimed at giving investors a very good view about what was happening.
There were dramatic differences in the speed with which businesses were hit. Some weren’t hit at all; some were hit quickly but recovered quickly. There were very different trajectories. In terms of dealing with it, direct lending is typically a bilateral situation between lender and borrower, with sponsors frequently involved (or, in the case of corporate lending situations, other banks as well). But to the extent that there were things we had to do, they were largely dealt with by the company, ourselves and the sponsor.
After the pandemic emerged, risk premiums shot up. There was a sense that we were probably looking at a fundamental repricing of risk in the same way we did 11 years ago. We were thinking: “Great, the world has gotten a lot better. We’ll be doing deals at lower leverage and getting higher margins and tighter terms”. But that was a fairly short-lived experience. On new deals, we reflected the more conservative terms, but not many deals happened and the few that did happen tended to be in pretty solid sectors so there wasn’t much of an uplift. By now, we’re more or less back to where we were.
As for today, we’re swamped. The fourth quarter is going to be enormously active. In the last two months, we’ve had more than 150 deal introductions across our European platform, which is a record in Pemberton’s history. There’s clearly pent-up demand; deals that didn’t get done early in the year are now coming to market. We have a lot more information now about how certain business models did through Covid and we can make more informed decisions about credit.
KEITH MULLIN, KM CAPITAL MARKETS: THOMAS, IT WOULD APPEAR, LOOKING AT MARKET SHARE DATA FOR THE FIRST NINE MONTHS OF THE YEAR, THAT BNP PARIBAS HAS TAKEN A DECISION TO RAMP-UP LENDING ACTIVITY.
Thomas Wolff, BNP Paribas: Unlike the financial crisis of 2008, the financial sector has been part of the solution, not part of the problem. The past few months have just shown how good a shape the banking sector is in general. Lessons have clearly been learned from the financial crisis. Most banks are in much better shape and were able to react quickly and very decisively from mid-March onwards.
BNP Paribas made a decision early on that our clients needed us so we were willing to put our balance sheet to work and do a number of very large underwritten transactions. It was essential at the time for some situations to get to market quickly. We were in a situation from mid-March where margins were increasing almost day-by-day so there was an imperative to go to market very quickly with firm pricing. There was no time to put club deals together and to reach a consensus. Speed was of the essence. It worked well and we were able to deliver.
Clearly a lot of the banks had to make choices. There was a bias in many cases towards lending in home markets, but all the transactions we have been involved in have been well supported by the market. Not necessarily supported by all the banks, because, as I said, some banks had to make choices. But support from the bank market was enormous.
Transactions were priced to sell and the market reacted very positively and was very busy dealing with these requests. The loan market never closed, nor did the Schuldschein market. However, as loan professionals, both in the loan market and the Schuldschein market, we were so busy between mid-March and mid-May that we didn’t have the time to look at anything other than liquidity facilities. There was no time for more opportunistic deals. But the bank market was very supportive of the situation at the time and helped clients get through a very difficult or potentially difficult period.
KEITH MULLIN, KM CAPITAL MARKETS: HAVE RISK TOLERANCES RISEN?
Thomas Wolff, BNP Paribas: Risk tolerances didn’t really go up but more importantly they didn’t go down. When we talk about liquidity facilities, they were clearly geared to companies that were in good health up until mid-March, where the bank market had the conviction that they would be in good shape again once the pandemic was over or under control. Situations where companies were already in trouble were not the focus of liquidity lines. There was no need to increase risk awareness but we didn’t decrease it and were able to support clients despite the impacts of lockdown.
KEITH MULLIN, KM CAPITAL MARKETS: JUERGEN, GIVEN THAT THE CUSTOMER BASE YOU FOCUS ON IS AT THE HIGH-YIELD END OF THE SPECTRUM, HOW DID YOU EVALUATE AND THINK ABOUT RISK IN THIS VERY DIFFICULT PERIOD?
Juergen Breuer, Pemberton: We’re active in the mid-market, focusing on companies in the €150m-€750m turnover range with ticket sizes of between €50m and €300m. And it tends to be slightly higher leveraged companies as part of acquisition financing and leveraged buyouts. The way we approached the risk situation was based primarily on forming a view of the nature of the impact on each and every company ie, are there things we could identify as entirely or primarily Covid-induced so therefore a temporary issue or a disturbance to the business that we would expect to go away if the root cause, the Covid pandemic, went away?
Or, a more concerning outcome, were we seeing any changes, question marks around the business model of these companies? It’s fair to say that in our portfolio of about 80 names, we didn’t arrive at the latter conclusion for the overwhelming majority. That is partially the result of the fact that, because we’re lending at relatively demanding levels, we have a focus on business models like food, IT services, and healthcare. A large part of our portfolio is in reasonably defensive sectors.
In most of these cases, we judged that disruption was a temporary affair. As we sit here today in the middle of October, we have gone down and back up in most of our businesses. What’s now going to be relevant is what happens in the second wave and how we manage during second lockdowns. But again, as I said earlier, we’re better prepared to assess any effects on the basis of having had the experience of the last seven or eight months.
KEITH MULLIN, KM CAPITAL MARKETS: REINHARD, MOVING TO THE SITUATION TODAY. SOME LARGE CORPORATES EXPRESSED EXTREME SURPRISE THAT SO MANY COMPANIES MOVED SO QUICKLY TO DRAW DOWN LIQUIDITY EARLY IN THE CRISIS. IN RECENT MONTHS, WE’VE SEEN A LOT OF COMPANIES PAYING BACK THOSE LIQUIDITY LINES, AMONG OTHER THINGS BY TAPPING THE BOND MARKET.
MOVING FORWARD TO WHERE YOU STAND TODAY, WE ARE IN A SECOND WAVE BUT WE DO HAVE, AS JUERGEN SAID, THE VISIBILITY OF HAVING SEEN HOW CERTAIN SECTORS BEHAVED IN THE FIRST WAVE, HENCE MORE VISIBILITY ON POTENTIAL OUTCOMES. HOW IS YOUR BUSINESS POSITIONED NOW? WHAT ARE YOU FOCUSING ON IN TERMS OF DEAL PROVENANCE AND DEAL TYPES? IS IT ALL ABOUT REFINANCING? ARE THERE STILL SOME ASPECTS OF SHORING UP LIQUIDITY?
Reinhard Haas, Commerzbank: You’re absolutely right that the quick drawdowns in the early phase were driven by fear among borrowers that lenders might succumb to market disruption or something of that sort, so they wanted to make sure that they had access to liquidity. That proved to be unfounded as banks stood by their clients. By the way, a lot of the money drawn down was deposited right back with the same banks but clients had the comfort of knowing they had access. Once they understood that the banks would stand by them and even provide emergency facilities, as Thomas alluded to, that calmed down.
When you look at what Ulrich was talking about, the KfW facilities, some of these weren’t even drawn. They were put in place similarly because of prudence, just to make sure that there would be enough liquidity available. The phase of emergency facilities and KfW programme usage has now died down. The evidence of August, September and October is that the mindset is focused on getting back to normal; that is, regular refinancings. Where that’s not possible, a lot of companies have asked for extensions. There’s pressure to go to longer tenors or, where that would be too pricey, companies reverting to extension options attached to refinancings to address that. I think we’re set to go back to normality.
A lot of that will depend on the further developments around resolving the pandemic. Assuming we get a vaccine, can we get quick approvals? Can it be distributed quickly around the world? We learn from the press almost on a daily basis that that point is nearing although it may be not as close as we might wish. But it’s likely going to happen at some time in the first half of next year. That is driving confidence among companies that they can plan for the longer term and that things will eventually go back to normal.
Some sectors like leisure and travel have been heavily affected and it won’t change in the immediate term for the most affected industries. But most industries by-and-large have a better feel for what is likely to happen. You’re already seeing a return to M&A-driven finance in the US. Once the clarity I was talking about comes into play, there’s going to be enhanced activity in Europe too.
KEITH MULLIN, KM CAPITAL MARKETS: ULRICH, LOOKING AT MID-MARKET COMPANIES, PARTICULARLY AROUND THE BOTTOM END OF OUR TURNOVER RANGE, THERE’S BEEN A LOT OF TALK THAT MANY WERE NOT IN GOOD SHAPE EVEN BEFORE THE PANDEMIC STRUCK AND HAVE MANAGED TO SURVIVE LARGELY BECAUSE OF ULTRA-LOW INTEREST RATES. WHEN ALL OF THE GOVERNMENT COVID SUPPORT PROGRAMMES EMERGED, MANY COMPANIES THAT WOULDN’T NECESSARILY HAVE SURVIVED WERE IT NOT FOR STATE SUPPORT GOT ACCESS TO SUPPORT LINES.
I AM CURIOUS ABOUT YOUR THOUGHTS ABOUT WHAT HAPPENS TO WEAK COMPANIES THAT HAVE AVAILED THEMSELVES OF SUPPORT PROGRAMMES WHEN THE SUPPORT PROGRAMMES COME TO AN END. PARTICULARLY AS EUROPE AND GERMANY SUFFER A SEVERE RECESSION, THIS STRESSED SITUATION IS NOT GOING AWAY QUICKLY. HOW DO YOU SEE THE LANDSCAPE AND HOW DOES IT IMPACT HOW YOU THINK ABOUT LENDING?
Ulrich Kittmann, DZ Bank: Well, let’s see what happens with the KfW programmes. The government is thinking about extending support depending on the second wave. It’s also not just the low interest rate discussion and the ECB’s QE policies. There are other factors like the Kurzarbeit social insurance scheme in Germany where companies are relieved of some of their personnel costs and these are covered by the state to avoid workers being made redundant. There’s another effect: under certain conditions: Germany has suspended the duty for companies to file for insolvency.
Taken together, this does have the impact of a ticking time bomb where we’re shifting the problems of today into the future. Alongside increasing numbers of coronavirus incidence, that might be a dangerous development, which leads to the question of what’s going to happen next year. I’m a little concerned. We already have an impact on higher risk-weighted assets due to lower ratings in certain industries. I think I can speak for Reinhard and Thomas (less so for Juergen and Pemberton) that we are not in a position to select certain industries. We mirror what’s going on in the economy; we can’t escape the fact that ratings in certain industries will go down. This has an impact on the RWAs of the banks and on lending policy; not really on risk policy but on funding policy and funding costs.
Reinhard Haas, Commerzbank: I agree that there is a certain danger that things that should have been worked out by market tectonics are being postponed. Providing additional liquidity probably also helped avoid some of the tougher effects the crisis might have had. When you think about the government’s short-term working scheme to prevent workers being laid off, that also allows for a quicker recovery once the economy picks up. You can see how that has played out in Germany when you compare German employment figures to those of the US, where within just months you had tens of millions of unemployed. In Germany, that just didn’t happen.
The unemployment rate did go up but only to around 6%; not into the double-digit region. The psychological effect on people in Germany in general is not the same as in the US. I just wanted to remind everyone of this positive effect.
Juergen Breuer, Pemberton: You have to give lawmakers a bit of a break here. The short-term working scheme was extremely successful in Germany in the aftermath of the financial crisis, so it was absolutely logical to use those instruments again. The potential change in perspective now could be that this crisis may end up being more drawn-out than the financial crisis. The recession following the financial crisis was V-shaped. The short-term working scheme helped to keep people in work and helped companies maintain their strength but it was all over relatively quickly. Where this is going, we don’t know. The concern is that we’ve already extended the furlough scheme to the end of 2021. Why? Because next year is election year. It could become rather costly for taxpayers and may bail out a few weaker businesses but the experience with these measures in Germany is clearly a positive one.
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