KEITH MULLIN, KM CAPITAL MARKETS: SEBASTIAN, ON A RELATED SUBJECT, WE HAVE SEEN AN EXPLOSION OF ACTIVITY IN THE LEVERAGED SPACE. THE EUROPEAN CENTRAL BANK HAS REITERATED ITS CONCERNS ABOUT BANKS’ EXPOSURE TO LEVERAGED LOANS. WHAT IS YOUR TAKE ON THE INCREASE OF LEVERAGED CORPORATE TRANSACTIONS? SHOULD WE BE CONCERNED ABOUT HOW MUCH ACTIVITY WE ARE SEEING?
Sebastian Wittkopp, LBBW: We didn’t see any write-offs in our leveraged loan portfolio during the crisis and no company in our LBO portfolio needed fresh money. But financial sponsors have been looking for new companies and we received a lot of requests for LBO financing in the worst months of the pandemic. A lot of money has gone into leveraged land. If you look at the number of transactions in the leveraged loan market, we have higher volumes in Europe now than we had before the global financial crisis in 2007. The market is really hot.
If the ECB does start to taper, you will see the first impacts in the leveraged space and volumes will shrink. Some of the terms we’re seeing on recent transactions have been incredible. On the reporting front, we have had to increase our portfolio work. The ECB does, incidentally, have very wide criteria to define leveraged lending.
The ECB may want to have a further look and be quite careful about what is happening at the LBO market and maybe step in if something goes wrong. By contrast with the US, where all mid-cap LBOs are funded by funds, in Germany and the rest of Europe, half of the mid-cap LBOs are financed by private debt providers, which are not highly regulated; the rest comes from banks. The ECB will keep an eye on leverage but I don’t think they will put too much pressure on mid-cap LBO lending.
Dominik Müller, Commerzbank: Activity in the sub-investment-grade area is a reflection of the low interest rate environment. This market segment is very much benefiting from this environment. Many companies are in a position to raise money at very attractive terms, which they would not previously have been able to achieve.
Likewise, investors are interested in this asset class because as said before, banking groups are shrinking and there is a lot of pressure on pricing for investment-grade companies as a result of which the profitability of those transactions is very low. The focus has also shifted from an investor point of view to the leveraged area in the context of the overall lending landscape. This is not only prevailing in the US as before but now also in Europe and, to a certain extent, in Germany too.
Thomas Wolff, BNP Paribas: There is increasing interest in the crossover space, where sub-investment-grade companies can print in investment-grade format. That is definitely true for Double B plus companies, probably true for companies rated Double B and even for some Double B minus companies. Obviously, to the extent there is high demand in crossover land, the margins tend to fall to levels that make it unattractive for institutional lenders. If there is investment-grade money chasing these types of borrowers, it becomes unattractive for the typical sub-investment-grade institutional investor. They have certain return requirements and it is more difficult for them to compromise. There is probably an element of them being pushed to the more typical non-investment-grade names.
Ulrich Kittmann, DZ Bank: But you also see some companies like Cheplapharm, a privately owned company, placing an institutional loan with CLOs and selling a high-yield bond. The company decided that since it has shown strong growth and needed some acquisitions, it would go down what I would call the LBO route. As did Grünenthal. It can be attractive for some companies to say, “Okay if I go down the LBO route, I have no covenants or I can do a covenant-lite structure”. Banks in the non-investment-grade area always have covenants. But if you are keen on your business model and if you are not shy of doing something new, some companies that are not sponsor-driven will go down the LBO route.
KEITH MULLIN, KM CAPITAL MARKETS: DO YOU ALWAYS INSIST ON HAVING COVENANTS IN TRANSACTIONS?
Ulrich Kittmann, DZ Bank: I am an old-fashioned corporate banker, so yes. And not just covenants but security too. But when I think of some of our clients – and I’m thinking about a particular cruise ship operator – they saw the opportunity to tap the bond market at a Single B rating because the banks were no longer willing to lend at suitable terms. The bond market in the Single B area is still liquid where our senior bankers are a little hesitant to lend more. This is interesting as the bond market is also swamped with liquidity, which is actually good for us in the syndicated loan market as we are not able to finance above a certain leverage level.
KEITH MULLIN, KM CAPITAL MARKETS: I WANT TO MOVE ON AND TOUCH ON ESG. HOW HAS THIS CONVERSATION DEVELOPED IN THE LARGE MID-CAP CORPORATE SPACE? COMPANIES ARE UNDER ENORMOUS PRESSURE TO IMPLEMENT ESG-RELATED BUSINESS-LEVEL IMPROVEMENTS AND MANY ARE CONCERNED ABOUT BEING SEEN TO BE GREENWASHING. HOW ARE YOU DEALING WITH THIS CHALLENGE AS BANKERS, AS LENDERS?
Dominik Müller, Commerzbank: Green and sustainability-linked financing has indeed become the major topic in the last few years. Large companies in particular have focused on it and have structured financings in accordance with sustainability or ESG-linked mechanisms. Now Mittelstand clients are also attracted by that and we see that this topic is also very much of interest for this client segment.
However, as you can imagine, Mittelstand companies often don’t have a large organisation with as many people working on ESG methodology as large-cap companies, therefore this complex topic becomes even more difficult for them to adequately cover. Many smaller companies are tackling this challenge very carefully, also in relation to avoiding greenwashing.
When loans are structured with sustainability-linked or KPI-linked mechanisms, we want to make sure that the product is credible from an ESG angle. From lenders and the companies’ perspectives, all parties are interested in agreeing terms that are ambitious and realistic in order to make sure that this important topic will not be greenwashed or diluted.
KEITH MULLIN, KM CAPITAL MARKETS: ON THAT POINT, THOMAS, IF ONE OF YOUR CLIENTS COMES TO YOU AND SAYS THEY WANT TO DO A SUSTAINABILITY-LINKED LOAN AND SHOWS YOU THEIR KPIs, AT THE END OF THE DAY, YOU’RE BANKERS. IF YOUR CLIENT IS, SAY, AN AUTOMOTIVE TECHNOLOGY COMPANY, IT IS VERY DIFFICULT WITH THE BEST WILL IN THE WORLD FOR YOU AS FOR BANKERS TO KNOW WHAT CONSTITUTES AN AGGRESSIVE KPI FOR AN AUTOMOTIVE TECHNOLOGY COMPANY, IN THE ABSENCE OF GLOBAL STANDARDS. I SEE A LOT OF PEOPLE MOANING THAT KPIs ARE NOT AGGRESSIVE ENOUGH BUT IT’S A HARD BALANCING ACT.
Thomas Wolff, BNP Paribas: Yes, it is, absolutely. The ESG market has very much matured in the last year or two and continues to mature. It is a requirement of all the banks in this market to acquire a level of expertise to deal with exactly these questions, as much as we are experts in forecasting the ability of a company to service its debt. I don’t think I have had a refinancing discussion with a corporate in the last two or three years without discussing ESG. It is mainstream, it is here to stay, and it is very, very important.
There is even an element where you can’t differentiate ESG factors from credit factors. We have all seen the moves by the ratings agencies to acquire ESG advisers. If your business is not sustainable, the chances are you will not have market access and at some point, you will not be able to service your debt.
It has definitely moved from being a nice feature. We still have some way to go but it is vital that your sustainability adviser is doing a good job. In syndication, we get challenged about the job we have done as ESG adviser, as much as on pricing and documentation. If the other banks feel you haven’t reflected ESG factors properly, they will tell you, so you have to be as serious on the ESG element as on all other elements.
KEITH MULLIN, KM CAPITAL MARKETS: SEBASTIAN, ON THAT POINT ABOUT ESG MOVING FROM BEING SEEN AS A NON-FINANCIAL RISK TO A REAL CREDIT RISK, WHEN YOU THINK ABOUT HOW YOU SERVICE CUSTOMERS, DOES THAT THINKING RESONATE?
Sebastian Wittkopp, LBBW: All banks have to focus on ESG at a portfolio level and build up ESG-friendly portfolios. The ECB is starting to take a deep look at the banks’ loan portfolios. What we are doing now is exactly that: establishing the ESG components of our loans because this will become vital with regard to who to lend money to or not. Speaking for LBBW, under our new coal energy guideline, we don’t lend to companies to build new coal-fired power plants, for example, only to green-friendly companies and companies that are on the way to becoming green-friendly.
The ECB will start putting more pressure on this topic. From next year, institutional investors on the bond side will have report on the bonds in their portfolio, what is ESG-compliant and what isn’t. The banks have to be prepared so we have to establish ESG components into loans now. That means pushing all lenders to focus on the quality of ESG covenants, which are becoming as normal as core covenants like leverage covenants.
Ulrich Kittmann, DZ Bank: I think I can speak for all four of us: banks are evaluating where they are in terms of ESG risk in their credit portfolios. What we’re all currently doing is conducting assessments. How does our credit portfolio look with respect to ESG criteria? Second, and I share Sebastian’s view, this topic will become very hot when the ECB starts charging capital with respect to ESG criteria. First, we have to be prepared. Second, when the ECB starts adding capital charges it will really become serious.
For the time being, we agree three, four or five KPIs with our clients and they say “Yes, I want to achieve those targets”, in which case you get 2.5bp less or more. This is a little bit like trial and error, a rehearsal or whatever you want to call it. But it will become really serious when the EU taxonomy starts to charge the banks capital taking non-financial risks into account. Exactly when that is going to happen, I need to look into my crystal ball.
KEITH MULLIN, KM CAPITAL MARKETS: MOVING TO ANOTHER BIG TOPIC, I WANTED TO TOUCH BRIEFLY ON LIBOR TRANSITION. THE LOAN MARKET HAS BEEN CRITICISED IN SOME QUARTERS FOR ITS SLOW APPROACH TO THIS, RELATIVE TO THE BOND AND DERIVATIVES MARKETS. AGAIN, I’M THINKING ABOUT THIS FROM THE PERSPECTIVE OF LARGE MITTELSTAND COMPANIES. GIVEN THAT WE ARE CLOSE TO THE END OF 2021 AND ALL SORTS OF DEADLINES START TO HIT ON THE TRANSITION TIMELINE, ARE YOU COMFORTABLE THAT THE LIBOR TRANSITION STORY IS AS ADVANCED AS IT SHOULD BE?
Dominik Müller, Commerzbank: In general, the process is well advanced but probably more on the large-cap side than on the mid-cap side, where it is somewhat slower. But the attention from the bank side is very high. It’s also worth pointing out that when it comes to mid-cap companies, the need for several different currencies is not as high as it is for larger companies and the transition impact has different characteristics, depending on the currency. Currencies like sterling or US dollars are clearly under more scrutiny than others. But in general, I would say the transition story is well advanced in the banking market and a lot of progress has been made, particularly in the past few months.
Thomas Wolff, BNP Paribas: I agree. The transition narrative has triggered a number of considerations on the client side. Many have asked themselves, “Do I really need sterling? Do I really need US dollars?”. At the end of the day, the answer is probably no because they either have natural hedging or they can use FX derivatives. The number of loan agreements we have had to amend due to risk-free rates is actually very small. Many clients intend to postpone this until the next refinancing. When we do get to refinancing, again clients ask themselves if they really need sterling or dollars. The outcome is often no, or they add the option in the loan agreement for whatever reason so it’s just a few more pages in the loan agreement.
Ulrich Kittmann, DZ Bank: German Mittelstand companies have the big advantage that they don’t have to be at the forefront of this. There was a bit of trial and error, especially in the UK, and different schools of thoughts. In US dollars, we went to compounded overnight rates and then there was the prospect of term rates so some people said, “Okay, we will hang on to what we have”.
German corporates were in a good position to watch from the sidelines and then make up their minds when conventions were more established. That was a positive. Libor transition has been an important topic in the Mittelstand loan market but not a dominant topic. In the loan market in general, it’s been well handled so far.
Sebastian Wittkopp, LBBW: I think Libor transition is a bit like Christmas: you know it’s coming, you write your present list, and here’s the deadline. But seriously, transition is on track for the currencies that require action now. Between now and the end of the year, the transition is a non-issue.
KEITH MULLIN, KM CAPITAL MARKETS: TO CLOSE OUR DISCUSSION, I WANTED TO ASK YOU ALL HOW YOU SEE THE NEXT SIX MONTHS TO ONE YEAR.
Thomas Wolff, BNP Paribas: We are fairly optimistic, partly because that is what we like to be. On the refinancing side, there is no wave coming; companies are well covered. This year, we had maturity extensions to five years so companies that went for three years will come back at some point and extend for five years.
The big element is clearly event-driven transactions. And as I said earlier, levels in the first half were actually quite good. At the moment, it is a bit quieter, apart from the Vonovia/Deutsche Wohnen real estate deal but a lot of corporates are looking very seriously at next steps. And coming back to the beginning of our discussion, and what has Covid done to the corporates, it has not created any new trends but it has clearly accelerated things that were already there.
And thinking about digitisation, supply chain and production networks etc, Covid accelerated a lot of developments, and corporates are taking this aspect very seriously. We have seen already lots of activity: IPOs, delistings, spin-offs, M&A, but I think activity is likely to increase next year given the level of discussions we are seeing. On that basis I’m quite optimistic.
Sebastian Wittkopp, LBBW: As a banker, I am always optimistic. We’re hoping for more acquisition loans and LBOs, which are more interesting for bankers than corporate refinancings. Refinancing is a thing you have to do; it comes every two or three years but as Thomas said, we are all looking for the next event-driven transaction. Consolidation will be driven by supply-chain demand but also by digitisation, which has accelerated. Without Covid, we wouldn’t be as far advanced. Home office working, for example, has become normal. Two years ago, if you told me that half the LBBW employees would work from home today, I would have said you were crazy. But it’s the new normal.
Companies have to build up a technical infrastructure. Technology will drive the growth of companies so we will see more targets for bigger companies.
Ulrich Kittmann, DZ Bank: My expectation is that big credit supply from lenders, in other words liquidity, will meet moderate credit demand from our corporate clients. Like the others, I hope there will be some event-driven opportunities in terms of M&A transactions that will not all be underwritten by the huge American banks. I am optimistic although I think we are still overbanked. There is too much credit supply from lenders.
Dominik Müller, Commerzbank: Over the last couple of years, whenever predictions have been made by bankers, even on a short-term basis, they have hardly materialised. I don’t think it makes sense to forecast refinancing or acquisition financing activity, because of course there will be some, that is pretty certain.
What is really important – and indeed everybody has pointed this out – are the learnings from the Covid crisis. Some companies have struggled a bit but most were successful by driving and managing change and sometimes even took Covid as an opportunity, in particular in the Mittelstand.
As a result of the crisis, companies are starting to reconsider their business models to be successful in the future, and this in turn forms the basis for banks to support these borrowers. These changes are already happening. This trend, in combination with probably one of the most important topics we discussed today – sustainability – should push us into a situation where we can shape a hopefully better world. All in all, we can be quite optimistic for the future.
KEITH MULLIN, KM CAPITAL MARKETS: I WON’T SPOIL THAT OPTIMISTIC NOTE. LET’S CLOSE THERE. THANK YOU VERY MUCH INDEED FOR YOUR COMMENTS TODAY.
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