KEITH MULLIN, KM CAPITAL MARKETS: WELCOME TO THIS IFR GERMAN CORPORATE FUNDING VIDEO CALL. I WANT TO FOCUS OUR DISCUSSION ON THE CAPITAL MARKETS BACKDROP THAT WE’RE FACING TODAY BUT TO KICK US OFF AND SET SOME CONTEXT, LET’S TAKE A STEP BACK. CAST YOUR MINDS BACK TO BEFORE RUSSIA’S INVASION OF UKRAINE. SOME OF TODAY’S ADVERSE FACTORS WERE ALREADY IN PLAY. MAX, CAN YOU GIVE US YOUR PERSPECTIVE ON THE MARKET BEFORE AND IMMEDIATELY AFTER RUSSIA’S INVASION.
Max Jacob, Commerzbank: When you look back to the beginning of 2022, the mood was moderately positive in terms of the economic outlook. We were largely beyond the pandemic and things looked reasonably optimistic even if not all supply chain issues had been fully resolved for some sectors. Fundamentally, though, the markets were in a good shape. The overall topic of inflation had already come up, although there were few expectations that it would be as severe as it has been.
The big question was how central banks would respond. Looking back at forecasts from that time, the ECB was not expected to hike rates before 2023. At the beginning of last year, the rates outlook was probably still in the below 1% range for most banks. That, in a nutshell, was the overall picture. Markets were constructive and deals could be done; in fact last year started with solid activity in the corporate bond market.
KEITH MULLIN, KM CAPITAL MARKETS: MAX, AS AN INVESTOR, YOU HAD BEEN SQUEEZED BY NEGATIVE YIELDS FOR SUCH A LONG TIME AND AT THE BEGINNING OF 2022 RATES WERE STILL VERY LOW. WHAT WERE YOUR PERSPECTIVES THEN? DID YOU HAVE THE IMPRESSION THAT YOU’D BE STUCK WITH VERY LOW RETURNS ON YOUR BOND PORTFOLIOS?
Max Berger, DWS: To some degree that was the assumption. As Max just said, the idea of inflation slightly turning around was already there. So, that was one factor. The other was that the unwind of the ECB programme was already considered a very big factor. We had so many topics to deal with at the same time in 2022. For almost 12 months, the only discussion we had was “what is the ECB going to do and how is the market going to cope once they unwind the corporate bond purchase programme?”
So, the idea of CSPP unwind was already there. And you know a lot of products in credit and elsewhere benefited from negative rates. Think about corporate hybrids, high-yield or the private debt market where a lot of money was flowing into. Our assumption was that once the unwind or the rate environment changed, it was going to be a slow-moving process. That, obviously, was not the right assumption in hindsight.
KEITH MULLIN, KM CAPITAL MARKETS: FABIAN, AS A BORROWER LOOKING TO RAISE CAPITAL IN THE MARKET, THE BEGINNING OF 2022 AND PREVIOUS YEARS HAD BEEN VERY BENEFICIAL TO BORROWERS. HAD YOU BEEN ACTIVELY PRE-FUNDING TO MAKE SURE YOU HAD CASH ON THE BALANCE SHEET AT A VERY LOW COST? WHAT HAD YOUR APPROACH BEEN BEFORE RUSSIA’S INVASION?
Fabian Lander, Vonovia: Looking back even before the beginning of last year, 2021 had been a fantastic year for the real estate sector. We’d seen a lot of issuance and very tight pricing. We issued a €5bn multi-tranche transaction in August of that year, which was quite remarkable. But by the end of that year, some negative signals emerged from the likes of Evergrande in China and the Adler Group in Germany. We saw issues from certain other companies in the sector and let’s put it this way, they were challenging. 2022 started with a bang. As well as our own issuance, we saw lots of real estate companies hitting the bond market, including Digital Realty, Heimstaden Bostad, LEG Immobilien, CPI, P3, Prologis and Gecina.
Real estate made up almost 40% of all bond issuance in January and February 2022. But for us at Vonovia and for me personally, there were signals in 2021 that the market might change and that is exactly what happened in 2022, so we started to diversify our funding sources, expanding our secured and unsecured loan portfolio.
We hit the bond market in March 2022 with a €2.5bn three-tranche green and social trade, seeking to attract SFDR Article 8 and 9 funds. That was our first social bond and our first 100% EU Taxonomy-aligned green bond.
I would say 2022 got off to a really good start for us.
KEITH MULLIN, KM CAPITAL MARKETS: KAI, WHAT’S YOUR PERSPECTIVE?
Kai Gloystein, Knorr-Bremse: We are not a frequent issuer; we come to the market from time to time. We have really strong cashflows, typical of an A rated company. In 2021, we looked at a large acquisition. In the end, it didn’t happen but we took the opportunity at the time to look at our lending portfolio and decided it would be a good idea to have a back-up facility if a similar situation were to come up again.
We established an ESG-linked syndicated loan facility with a sustainability rating trigger. It came at the right point in time. The signing took place on January 4 so came with a really favourable margin. Like everyone else, we had no crystal ball but our sense was that interest rates would stay low. We had suffered from negative interest rates in previous years and that’s why we changed our strategy from being funded to having a back-up facility.
It’s easy to say in hindsight but it would have been better to have issued a bond in December 2021 but we weren’t sure about the level of certainty around our potential acquisition so we had no reason to seek approval to issue a bond. That’s why we did the syndicated loan.
KEITH MULLIN, KM CAPITAL MARKETS: SIMONE, THE BOND MARKET HAD BEEN VERY ACTIVE INTO THE END OF 2021 AND INTO EARLY 2022. BUT WERE THERE ANY TROUBLING SIGNALS AT THAT TIME AS TO HOW THE MARKET MIGHT EVOLVE?
Simone Wegscheider, HSBC: What we had in 2021 and the years before that was a truly benign market environment, with spreads going constantly tighter. Issuers of course always want better pricing but we did wonder in late 2021 and at the beginning of 2022 if the corporate bond market was fairly priced. From a DCM perspective I love it when my clients pay super-tight spreads but when you think it through from a fundamental credit perspective, were valuations right?
I would think Max Berger would agree with me that what issuers were able to achieve was more technically driven than really justified and there were some signals from a number of market participants that a correction would have to come. Very few of us expected the correction or the revaluation to be that dramatic relative to how events unfolded but I thought spreads couldn’t get much tighter from an issuer’s perspective. As to where we are today, things are more appropriately priced than they were a
year ago.
KEITH MULLIN, KM CAPITAL MARKETS: MAX, DO YOU AGREE WITH SIMONE?
Max Berger, DWS: Yes. There’s no doubt that the tight levels of the previous years were quite extreme. But that said, I think at that time we were to some degree still in pandemic-recovery mode in some sectors. The recovery period had been fairly long. When the pandemic started in 2020, it had been a big shock to balance sheets and there was a very dramatic rating cycle.
When we look at fundamentals today, we still think that one reason we’re actually relatively relaxed about the corporate balance sheet and credit quality, in general, is that companies have spent more than two years now recovering or deleveraging from the initial shock of the pandemic. That was also something driving markets somewhat lower in terms of spreads. There was definitely a tailwind last year.
KEITH MULLIN, KM CAPITAL MARKETS: LET’S MOVE TO AFTER THE RUSSIAN INVASION. THE MARKET IMPACT, IN PARALLEL WITH CENTRAL BANKS’ EFFORTS TO CURB INFLATION, HAVE BEEN WELL REHEARSED. THEY HAVE CONTRIBUTED TO HIGH INFLATION AND CULMINATED IN A GLOOMY GROWTH OUTLOOK. IN THE IMMEDIATE AFTERMATH OF RUSSIA’S INVASION, CAPITAL MARKETS TURNED DISORDERLY AND BRIEFLY SHUT. I WOULD LIKE TO GET A BRIEF SUMMARY FROM EACH OF YOU OF YOUR REACTIONS AT THAT TIME AND IN THE AFTERMATH.
Fabian Lander, Vonovia: The key question we received, mainly from US investors, was: given high inflation and increased capital costs, is property priced at fair value or not? Everyone has their valuation methodologies but to find fair value you need evidence from real estate transactions. And currently there are no real estate transactions so there is no benchmarking possible, no evidence for where property fair value lies. What we see is buyers and sellers with different opinions but no market. And that was one of the issues behind real estate companies trading at big discounts to net asset value.
On the DCM side, there were no real transactions between April and November. We reopened the market just recently [with a €1.5bn dual-tranche bond] to send a message that we have access to capital markets and are able to deleverage and de-risk our upcoming refinancing needs.
We also saw some effects on the business side. For example, early in the year we quickly secured and locked in our gas until the end of 2022. We also adapted and reduced our capex programme for 2022 and 2023, reducing quite significantly our three main investment programmes. We also communicated that we wouldn’t raise additional debt or engage in any M&A activities. The situation in 2022 changed dramatically but we responded early, both business-wise and funding-wise.
Kai Gloystein, Knorr-Bremse: We also tapped the markets in 2022 with a €700m sustainability-linked bond, our debut in the format. Our impression was that despite all the turmoil and the problems out there that there was a market for us, be it the bond market, the Schuldschein market or the loan market. We had no stresses on that front. For us, it was more important to get the right window.
Once we had clarity on the cash-outs, we tried to be quick to prepare the issue. But at the same time, we engaged with investors on more critical discussions than we had experienced in previous years. Not necessarily based on our credit profile; we have an A rating profile, but I had several investor calls where I had to answer questions on all the topics we have been talking about today. But in the end, we firmly got the impression that [tapping the market] was a good opportunity for us, which is why we said: “let’s tap capital markets as an alternative and keep the bank market separate for other events to come”.
KEITH MULLIN, KM CAPITAL MARKETS: MAX, AS HAS BEEN MENTIONED, WE SAW A LOT OF VOLATILITY AND THE MARKET REPRICED. WHAT’S YOUR READ OF THE CHANGES IN CORPORATE DCM?
Max Jacob, Commerzbank: My first observation is that issuers didn’t panic. Obviously, there were lots of concerns but
they weren’t about the market per se but geopolitically, in terms of where things were moving. The greatest concern at the beginning was whether there would be an escalation once it became apparent that the invasion would not last just a matter of days. But once that concern had calmed, the market reopened – not necessarily for everyone; there was a bit of a bumpy road for some but the market was there.
And then over the course of April and May, the overall market focus shifted away from Ukraine to what was happening to the real economy, high energy prices and inflation and the rates environment became the key topics. That was really driving overall market sentiment and valuations and it did result in more challenges.
Few of us had really experienced a rate sell-off of this magnitude and what it would mean for issuers coming to the market. Obviously, we saw more defensive credits and structures but during that phase and into mid-year, it was very difficult. Nobody really knew where to price things. Secondary markets were fairly illiquid and there was quite a discrepancy between secondary market trading versus the benchmark and versus swaps and what that meant for the pricing of new issues.
It was a new experience for everyone and as I said, it resulted in not necessarily everyone being able to come to the market. Or if an issuer was planning to do something, they had to be ready to get into the market when a window became available. That was the key thing in the first half of 2022: tap the window when it’s there.
KEITH MULLIN, KM CAPITAL MARKETS: SIMONE, IN PERIODS LIKE THAT, PRICING BECOMES AN ART RATHER THAN A SCIENCE. HOW DO YOU GET TRANSACTIONS OVER THE LINE?
Simone Wegscheider, HSBC: Echoing Max’s comments. I think one powerful statistic that is quite telling about how things were in 2022 versus previous years, is that we had 119 zero corporate issuer days versus just over 60 in the previous year. I think we will continue to experience a window-driven market and will have rapidly shifting periods of market conditions from benign to unfavourable for issuers.
[Note: the IFR German Corporate Funding call took place on December 13.]
How do we tackle these dynamics from a DCM perspective? Trust becomes more relevant. We have all seen crises before but what’s notable about this crisis is markets did not shut. Cash isn’t the problem, it’s a matter of getting the execution right, getting the timing right. One of the critical factors for successful execution is the choice of structure, finding the sweet spot that matches investors’ preferences.
Communication is absolutely critical. I said earlier that investors buying credit were driven more by technical factors but at the same time we noticed that investors, like Kai mentioned, started asking questions. Fundamental analysis became more relevant and issuers had to be prepared to answer those questions. Then, very importantly, it was about appropriate pricing. The world has changed. We are not going back to 0% bonds for investment-grade corporate issuers. Issuers have to be willing to accept the price that investors demand.
Liquidity is another topic. Private placements were tough, illiquid bonds were challenging so the focus was on benchmarks. And last but not least, ESG is making a difference, not so much for the greenium but for execution certainty. These were some of the elements we felt in 2022 when working with our clients and pricing capital markets transactions.
KEITH MULLIN, KM CAPITAL MARKETS: MAX, WE’VE MOVED FROM A SELLER’S MARKET TO A BUYER’S MARKET. WHAT ARE THE FACTORS UPPERMOST IN YOUR MIND WHEN YOU LOOK TO ENTER THE MARKET TODAY?
Max Berger, DWS: We’ve become quite constructive on 2023. The inflation path will continue to be super important to the outlook: whether you think eurozone inflation will end up at 3% or 5% is a big differentiator on your outlook. Inflation will come down eventually, though we will experience a mild recession. The broad environment for credit is good.
The inflationary environment itself is, from a balance sheet and leverage perspective, one that a lot of companies can cope with reasonably well. The top line is growing but debt is nominal. And as I mentioned earlier, we’re starting with strong balance sheets. If you combine that with the sense that central banks have come a long way – they’ve been behind the curve but have adjusted – we’ll see inflation peak at some point in 2023.
And with inflation coming down, rates volatility will come down. And that was a huge factor for uncertainty in 2022. At that point, levels become attractive. We’re having a lot of discussions with investor groups that haven’t really been involved much in credit or, for that matter, in fixed income in recent years in the low-yield, negative-yield environment.
Whether you look at it from a multi-asset perspective, from a pension fund perspective, from a retail perspective, there’s lots of interest in the asset class. Even from Asia and taking hedging costs into account, European credit looks pretty attractive versus the US dollar as well. We’re seeing good underlying demand and we’re quite constructive.
KEITH MULLIN, KM CAPITAL MARKETS: IN THIS SORT OF ENVIRONMENT, DO YOU DEMAND BIGGER LIQUIDITY PREMIUMS, FOR EXAMPLE, WHEN YOU LOOK TO BUY IN THE PRIMARY MARKET, OR ARE YOU LOOKING MORE AT SECTOR ISSUERS?
Max Berger, DWS: One factor that has gained in importance is sector differentiation. Real estate has obviously been the elephant in the room for euro credit. It has grown a lot and has been the major underperformer. We also think it’s the sector where there’s going to be a lot of fundamental risk in 2023 and some issuers will struggle in this environment. But then again, it’s also the sector where the most interesting opportunities will lie because not every company has to defend its balance sheet and look for alternative sources of funding.
The sector dimension will be very important. You have sectors that are linked more to consumers that can’t pass on price rises easily so there will continue to be risk in some of those sectors. Maybe as a last couple of examples, we’re quite constructive on sectors that are commodity-linked as well as cyclical sectors beginning the cycle with record-low leverage.
To see the digital version of this report, please click here
To purchase printed copies or a PDF of this report, please email leonie.welss@lseg.com
