KEITH MULLIN, KM CAPITAL MARKETS: WELCOME TO THIS IFR WEBINAR ON GERMAN CORPORATE FUNDING. LET’S KICK OFF WITH AN INTRODUCTION ABOUT THE ECONOMY. ALEX, CAN YOU TO MAKE SOME OPENING COMMENTS?
Alexander Hirt, Allianz IM: If we look at the economic picture, we’ve seen a very strong global recovery led by China and the US, followed by Europe. For Germany, Allianz Research is projecting economic growth of around 3.4% in 2021, which is below the numbers for the eurozone or the US. The reason for that is two-fold: first, the recession last year in Germany was milder than in other parts of the eurozone; and second, if we look ahead, growth for next year is expected to be 3.8% so a tick above this year’s number.
Growth was driven by manufacturing but now the service sector has also come into play that needs to take over. That’s true for Germany as it is for Europe. If we look across sectors, the recovery is very uneven and there are differences.
We have also seen some supply chain issues. We have seen issues around semiconductors, which came to the forefront with the blockage of the Suez Canal. But it’s not just that; we’ve also seen it in German construction, for instance, and in the supply of raw materials.
One consequence on the economic side is obviously inflation, which as an investor we are very focused on. For now, it’s mainly a topic in the US, where inflation is really rising quite fast. If we look at Germany and the eurozone it will be less pronounced, not least because of labour market differences. We’re not yet seeing wages contribute to inflation. Overall, inflation is not so much of an issue here, but it is a global economy and a global market.
That brings me to the things that as investors we keep a close eye on. One is monetary policy: if the Fed starts to normalise its policies, it will have global implications. In a nutshell, the economy is looking good. It’s on a good trajectory, but as we progress the air is getting thinner and we need to be very careful, especially around normalising monetary policy.
Mirko Gerhold, Commerzbank: The recovery is coming a little later than anticipated, due to
extended lockdowns, but the recovery is coming and it’s coming strongly, notwithstanding some of the mitigants that Alex mentioned on the supply side. The real-time indicators, especially in the services sector, are ticking up and reflecting that. I think what contributed to that is, among other things, the massive build-up in savings that developed during the crisis.
But, also as mentioned by Alex, we will not see the same growth in every region. In the US, we have already returned to the output levels we had before the Covid crisis. We expect the eurozone to reach that point at the end of the year. We also expect the US to return to its original growth path next year while for the eurozone we expect a remaining gap versus pre-crisis conditions.
That’s also one of the reasons why inflation pressures should be more pronounced in the US even in the medium term than they will be in the eurozone. At the moment, borrowing rates in the eurozone are still low and we expect them to pick up only slightly towards autumn. The big question is how long will higher inflation last. Will it be a temporary effect, or will it fade once we have overcome the base effect from the increase in inflation in the eurozone in autumn?
Ingo Nolden, HSBC: As Alex mentioned, the recovery will be quite uneven. I imagine each of the corporates on the panel will have totally different views about the recovery with regard to their businesses. We’ve had some hiccups but this is not the first crisis we’ve been through, nor will it be the last. Everybody should know what they need to do. The speed with which the situation evolved 12 months ago was astonishing, but if you look back, everyone – the market and economic decision-makers – adapted to the circumstances very quickly. There’s a huge resilience in the overall system, not necessarily in each and every segment, but I’d like to send a positive message here.
KEITH MULLIN, KM CAPITAL MARKETS: MAX, CAN YOU COMMENT ON THE MONETARY POLICY ASPECTS OF THIS IN EUROPE? ONE OF THE BIG TOPICS IS THE EXTENT TO WHICH THE ECB HAS ROOM FOR MANOEUVRE, WHAT ITS OPTIONS ARE AS THE ECONOMY RECOVERS, AND WHAT ACTIONS IT MIGHT TAKE.
Max Berger, DWS: In terms of how much room to manoeuvre the ECB has, we’ve been quite surprised over the last three or four years about its ability to come up with new solutions. In the pandemic, there have been lots of cases where they’ve successfully innovated their programmes. From the fixed income perspective, there are two elements we’re focusing on now: one is what the exit strategy is; the other is what the ECB is going to do in terms of ‘greening’ its programmes.
In terms of tapering, we almost like this scenario because central banks, including the ECB, have become so good at preparing the market and executing tapering programmes that with spreads so tight and in great shape, it’s almost as if we’re hoping that any volatility coming from this would be a buying opportunity because it’s such wealth-led risk, and definitely not anything we’re overly concerned about.
KEITH MULLIN, KM CAPITAL MARKETS: ON THIS ECONOMIC QUESTION, JÖRG, THE AUTOMOBILE INDUSTRY IS A BELLWETHER FOR CONFIDENCE IN THE GLOBAL ECONOMY. HOW DO YOU SEE THE RECOVERY AND HOW IS THAT REFLECTED AT VW?
Jörg Boche, Volkswagen: I liked Ingo’s point about the resilience of the system, which, indeed, was surprisingly strong. In the second quarter of 2020, we were all staring into the abyss and it was scary. But by the third quarter of 2020, mainly driven by China, order books had already started to come back. Over the course of the second half of last year and into the beginning of this year, demand has looked really strong; order books have been pretty impressive.
Interestingly, the situation was better the more you went into the premium brands: the more expensive the car, the more people wanted to buy it. The other effect is that as everyone was so shell-shocked when the crisis started, there was a lot of activity on the shop floor, so to speak, to preserve cash to make sure that you were running your business as cash-efficiently as possible.
A lot of capital expenditure was pushed forward so that meant cash-generating capabilities became really strong. Once demand started to hit production facilities, they almost had a super-double-whammy effect because, on the one hand, you had trimmed your expenses so much, and on the other, demand was strong so cash generation also became very strong very quickly after the crisis.
I think that all fleshes out Ingo’s observation about the resilience of the system. As far as this year is concerned, so we are quite optimistic in terms of market growth and profitability, and we think that this will last at least into next year. It’s looking pretty good.
KEITH MULLIN, KM CAPITAL MARKETS: CHRISTIAN, WHEN PEOPLE ARE FORCED TO STAY AT HOME AS THEY WERE DURING LOCKDOWN, THAT HAS A DIRECT IMPACT ON TRANSPORT BUSINESSES LIKE YOURS THAT RELY ON PASSENGER TRAFFIC. CAN YOU FOLLOW UP WITH SOME THOUGHTS ABOUT HOW THINGS HAVE EVOLVED?
Christian Große Erdmann, Deutsche Bahn: We are in one of the harder-hit industries but we’re not exclusively exposed to transportation. In terms of revenues, around 40% comes from logistics and while logistics may sound similar to transportation, the economics are completely different. DB Schenker, our logistics business, had a record year in 2020 and the way 2021 has started, it looks even better.
If you look at our headline numbers, the situation is significantly better than you might think. And things are getting better. Our response to the crisis was a little different than on the Volkswagen side because our management and supervisory boards, alongside our sole shareholder [the Federal Republic of Germany] decided that we would not cut down on capex but continue to execute on our ‘strong rail’ strategy, which among other things aims to help the economy meet its climate targets.
We’re still working on doubling passenger numbers and significantly increasing freight volumes. The response from the industry to these initiatives is strong. We experienced a temporary dip, obviously – well we hope it’s temporary – but we’re seeing the recovery. Those of us who are travelling can see that railways stations are livelier, while you can once again have coffee and food again on the trains, something we had to stop for a couple of months.
Things are getting better, but of course the impact of executing a big capex programme through the crisis, where operating cashflow falls away, leaves you with higher debt levels after the crisis. That’s our situation.
Sven Vorstius, Bayer: We operate in three sectors, crop science, pharmaceuticals, and consumer health – so our situation is a little different. By comparison to previous speakers, we have a more diversified business. When I look back at the impact we felt in 2020, the different results were a little mixed, but the impact was limited. You need to look into the different divisions.
If you take the pharmaceutical business, for instance, we suffered because we have products for medical procedures that could not be carried out because hospitals were kept empty for Covid-19 patients. On the other hand, comparing it to our consumer-focused business, people stocked-up their vitamin inventories.
Our biggest division, crop science, was not really hit by the pandemic. We had to make sure that the supply chain around the world was operating smoothly, but the impact was really limited. In Q1 2021, all divisions have been very strong so all in all, that mirrors what was said on the overall situation before.
KEITH MULLIN, KM CAPITAL MARKETS: I WANT TO STAY WITH THE CORPORATES AND ASK YOU TO DO A REVIEW OF WHAT YOU DID LAST YEAR IN TERMS OF MANAGING THE BALANCE SHEET, FUNDING AND RELATED DEVELOPMENTS, COMING IN THE EYE OF THE STORM AND COMING OUT OF IT. JÖRG, COULD YOU TO KICK OFF THIS SEGMENT?
Jörg Boche, Volkswagen: The first reaction to the onset of the crisis was to seek cash and we had to expand our balance sheet. Luckily, central banks were very quick in their response, and the banking industry was in good shape. We chose to go for bank debt, drawing on our lines and putting cash on the balance sheet.
We decided we would wait for a while to find out where the crisis was going, whether it was going to get worse or improve. It was as much an insurance policy approach as anything to hoard cash. As we went into the third and fourth quarters of the year, we started to term out the debt, going back into the capital markets and seeking longer tenors and paying back the short-term bank debt.
By the end of the year, we were almost back to where we were in terms of industrial debt at the end of 2019, almost a complete reversal of the expansion of the balance sheet that we had seen in the first quarter or in the first half of 2020.
Christian Große Erdmann, Deutsche Bahn: We did a lot of things but in a different order, and maybe with a slightly different logic. When the crisis started, we received a lot of phone calls from banks offering us big tickets to help, which was well received because it gave us comfort. We didn’t take them up, though, and remained committed to our approach of funding through capital markets. We found that, except for maybe a couple of weeks, markets were open and accessible. We issued a record number of bonds in 2020, €5.4bn. Our typical programme used to be €2bn–€3bn.
The German government, our sole shareholder, said they didn’t want us to cut down on our capex but to continue to invest. And they expressed an intention to provide financial assistance in terms of equity or equity-like instruments. That gave comfort to the investor community that the German government would stand behind us and provide support.
If the government provides financial assistance, that needs to be cleared through the European Union. That process is still not completely finalised, so we did see a need for bridge financing, a bridge to equity. In the second half of 2020, we took down around €3bn in funded bank debt, something we had never really done, apart from smaller amounts around the world.
That’s been a major shift. This €3bn was funded bilaterally by four banks, part of which was at negative interest rates. It was also a good experience because a lot of bankers told us that it was the first time they had done that. I’m never sure whether I should believe that, but we talked about significantly negative numbers – and I don’t just mean single basis points.
Finally, because we always try to be conservative, as bankers and investors will know, we try to avoid peak maturities and extended our maturity profile and issued in longer tenors. We had only issued out to 15 years in public benchmark format before but we added 20 and 30-year paper, which was extremely well received by the market. This was also a signal to ratings agencies that we were not increasing risk or refinancing needs in the near term and were maintaining a well-balanced maturity profile.
Sven Vorstius, Bayer: Our funding story is actually away from Covid. It’s worth keeping in mind that Bayer is not a frequent issuer. Having put debt on our balance sheet for acquisitions, we are in deleveraging mode. Nevertheless, in 2020, we had additional funding requirements but these were driven by litigation developments that were obviously completely unrelated to Covid.
Driven by those needs, we sourced €6bn from the euro senior market in June and paid a new issue premium of about 20bp. Given the volume and the context of the transaction, that seemed very reasonable. A lot of corporates sold bonds last year to avoid using bank funding and because they had liquidity needs. For us it was completely different.
We chose that market window because we saw the bond market was very good, and we did not know how the Covid situation would evolve, either for ourselves or for the overall economy going into winter. Those risks did not materialise. On the contrary, we issued €4bn in January at much more favourable conditions due to the continued support of the central banks. And with the first transaction, we had substantially de-risked.
With regard to Covid impacts, we saw no liquidity drain from the underlying business, but we were affected by the commercial paper market, which was barely available for a couple of weeks. We have strong seasonality in our working capital and in April/May we were at our peak, and that’s where we wanted to employ commercial paper, which we were not sure we could do. We put in place bank loans but did not use them; they were there as a buffer until we were able to access the commercial paper market and make use of what we required for seasonal borrowing.
KEITH MULLIN, KM CAPITAL MARKETS: FROM A MARKETS PERSPECTIVE, CREDIT SPREADS WERE VERY TIGHT PRE-COVID AND YIELDS IN EUROPE AND ELSEWHERE WERE VERY LOW TO NEGATIVE. WE HAD THAT BLIP AT THE BEGINNING OF THE COVID CRISIS AND A FEW DAYS OF NEAR PANIC AND HUGE VOLATILITY FOLLOWED BY AN INCREDIBLE RECOVERY, PUSHED BY MONETARY AND FISCAL ACTIONS. ALEX, CAN YOU TALK TO THIS FROM A BUY-SIDE ADVISORY PERSPECTIVE?
Alexander Hirt, Allianz IM: You’ve mentioned the key aspects of the last 18 months. We are a long-term investor and, as such, we calibrate our strategy to our risk-bearing capacity to avoid actions that are triggered by market stress. Our strategy is firmly in investment-grade corporates. For that reason we were already cautious before the pandemic, when as you said, spreads were very low.
When I say ‘cautious’, we kept investing in investment-grade credit but we looked carefully for opportunities because valuations were so tight. When the crisis hit, we didn’t really change our stance but because we didn’t know how things were going to pan out; we’ve been mainly observing and analysing the portfolio for credit risk.
Even though there wasn’t much to look at in the investment-grade segment, we pay close attention to the potential for downgrades to calibrate our internal risk budgeting and be aware of how much additional risk budget we have.
At the height of the crisis, there were some real dislocations in financial markets. One thing I found interesting was if you looked at credit default swaps, which is the more liquid credit instrument, and then you looked at the bonds, there were wide differences, which you rarely see. That was a clear signal that there were severe dislocations. We even saw that in Triple A US ABS and CMBS, which is backed by collateral.
But as things stabilised and central banks came in, we gained more comfort, and the areas mentioned are where we’ve been looking for opportunities to add exposure. On the investment-grade credit side, because we’re a long-term investor and because we have long-dated liabilities, one of the things
we looked at specifically was the long end of the curve: long-term bonds which, especially in Europe, are not so frequent. This segment of the market is not as broad, well diversified or liquid as in the US but it was definitely an area where when we gained comfort through the summer months when we were looking to add.
Fast-forward to today and we’re back to square one, where spreads are very tight and it’s about being selective, looking for remaining pockets of value.
KEITH MULLIN, KM CAPITAL MARKETS: ONE OF THE THINGS THAT ALEX BROUGHT UP WAS EVEN THOUGH WE HAD A QUICK RECOVERY AND SPREADS REGAINED THEIR PRE-COVID LEVELS, THERE IS RESIDUAL ANXIETY ABOUT CORPORATE CREDIT QUALITY AND DOWNGRADE RISK AS WELL AS BANK ASSET-QUALITY DETERIORATION. THIS HASN’T HAPPENED YET PARTLY DUE TO PAYMENT MORATORIUMS AND GOVERNMENT SUPPORT SCHEMES. MAX, HOW DOES THIS PLAY INTO YOUR THINKING?
Max Berger, DWS: Maybe two observations. I think the first is that monetary and fiscal programmes in Q2 changed our thinking about credit risk. If you think about all the liquidity measures, coming from the angle of investment-grade and high-yield, not so much for SMEs, what the liquidity programmes did was significantly reduce default risk.
What the programmes did not necessarily do was protect from deterioration in credit profile, protect from downgrades. Downgrade risk was huge and there was lots of talk about fallen-angel risk. In the end, that played out as lots of people suspected at that time. I think this has very important implications. If you think about credit cycles, in general, even if the central bank reduces default risk, a lot of downgrades can still happen.
Another observation is that this time was no different in terms of how to play the recovery, because something we’ve seen over the last 15 years in the big crises is you’ve got to be in the market once the recovery starts, and that’s typically when the primary market opens and you get once-in-a-decade opportunities to capture initial premiums of 50bp–60bp. But you’ve got to be in the market.
Luckily, we had a lot of opportunities to buy into Covid-impacted names that were coming from, let’s say, a Single A balance sheet where we thought there were uncertainties, and visibility was very low, but that even in adverse scenarios they would be able to withstand and protect the balance sheet. Airports, for example, a somewhat regulated infrastructure sector, were good examples where you had very good opportunities to start playing the recovery.
This pattern of the 50bp–60bp initial premium is something we’ve seen in every crisis. It might last one week or two, or maybe a bit longer, but that’s an important lesson to learn. The difficulty, of course, is you need to prepare the funds to do that. That usually means you’ve got to generate cash into the sell-off to prepare to buy into the recovery. Alex mentioned CDS. Liquidity diversification in the funds is also an important pre-requisite.
KEITH MULLIN, KM CAPITAL MARKETS: MIRKO, THE BANKS WEREN’T JUST SUFFERING THE SAME EFFECTS AS OTHERS; THE CRISIS FORCED OFFICES TO CLOSE AND YOU DID DEALS FROM HOME, KEEPING EVERYTHING TOGETHER IN THE BUSIEST PERIOD OF DEBT CAPITAL MARKETS EVER. CAN YOU GIVE US A FLAVOUR OF THAT?
Mirko Gerhold, Commerzbank: Yes, we were able to continue. At the beginning of the working-from-home period, everyone needed to sort out how the different technical platforms worked, to ensure we were operational and maintained regulatory requirements. We split the teams into people working in the office, from home, or from our disaster recovery site. But, in the end, we learned very quickly that working from home worked better than expected when talking to clients or when executing transactions. There were some things we needed to get familiar with, for example, virtual issuer marketing and virtual roadshows, but we adjusted quickly and continued to effectively assist our clients.
In terms of the points raised so far in the discussion, we’ve gone through different stages in the crisis. At the beginning, the focus was very much on strategic positioning, on building up cash. Many of our clients focused on securing liquidity and market access. Sven mentioned the commercial paper market. We updated quite a lot of commercial paper programmes to make them ECP-eligible. That was the first stage; a lot of discussion about how to strategically position in the crisis and to secure liquidity.
But as the market quickly reopened and conditions were very strong, the focus shifted to advising clients how to term out bank reserve facilities and term debt into capital market borrowing. As more and more credit demand came in, as Alex and Max mentioned, we saw that there were several opportunities, especially at the longer end, as Christian mentioned. That was the second phase of the crisis after the initial reopening of the market.
Ingo Nolden, HSBC: This was first and foremost a health crisis. This time, it was a question of: ‘Okay, we need to get our job done and get liquidity in for companies’. All of us – banks, asset managers, corporates – had to deal with operational issues. But, again, the resilience was remarkable. The market functioned extremely well.
We now need to consider how we get out of this scenario. It’s not healthy for people to attend virtual meetings for more than 10–12 hours a day. We need to move to some kind of a hybrid working world if it can work.
But in short, we moved through this very quickly. We collectively managed it very well. Most companies, especially in Germany, are well prepared and have learned their lessons about strategic funding management. As Jörg said, it’s an insurance premium you need to pay. We occasionally got questions like: ‘Why do we need all this documentation and these programmes?’. But you need to have your infrastructure in place, including paying for your documentation. You need to be able to react to a crisis.
Whenever the next one is and whatever its cause, it means that everybody can draw the right conclusions and reassure their board members that liquidity is there so they can focus on the real topics. Whatever crisis comes, and hopefully it’s not a financial crisis, we will be there to support overall operations.
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