KEITH MULLIN, KM CAPITAL MARKETS: KAI, CAN YOU TALK ABOUT FUNDING DIVERSIFICATION? WHEN MARKET CONDITIONS STARTED TO CHANGE, DID YOU LOOK AT ALTERNATIVE FUNDING SOURCES TO SEE WHERE THEY WERE PRICING CREDIT?
Kai Gloystein, Knorr-Bremse: We did turn over some stones but that’s part of our general business. We had already decided in 2021 that we would like to extend our debt issuance programme just to be sure that we had continuous infrastructure that would enable us to tap capital markets. It took some time to update the programme and to incorporate the ESG features. Then we look at a range of funding instruments. It was also interesting to see in 2022 that at a certain point the Schuldschein market was more favourable than the bond market. It’s normally the opposite but it shows how investors were thinking.
We try to keep our funding strategy constant. That’s why we opted to keep our debt issuance programme. It costs us money and we weren’t sure if we would use it but to have a €3bn programme in place gives us the opportunity to tap the market if necessary. It also needs to fit our funding needs.
I don’t have a funding need in China, for example. We have strong cashflows there; stronger in normal times than maybe today but I don’t need to jump on a Panda bond. That narrows the number of instruments we look at. On top of that, we always focus on internal financing. We have a huge supplier financing programme and we digitised our factoring business. We were the first, I think, to tap CRX, the multi-bank factoring platform. That helps to optimise our internal funding sources before we have to go to the debt markets.
Fabian Lander, Vonovia: Of course we analysed alternative funding sources. As a real estate company, we always have a look at secured loans and secured products generally. I like secured bond structures for a very simple reason: they can give you size. If you look at our balance sheet, we have €45bn of debt, two-thirds of which is capital markets-related. You can use credit market products like secured loans or promotional loans but you never get the size you need, at least in our case, compared to our balance sheet. Secured bonds are not as attractive as secured loans, which are definitely cheaper than corporate euro bonds.
After completing our analysis, we opted for the unsecured Schuldschein product and tapped that market. Pricing wise, there was an arbitrage compared to senior unsecured as Schuldschein was mainly at the same level as secured bonds. If you look at the work you have to do for a secured bond, you need a rating, you need a structure in place, you need an SPV, ring-fenced portfolios and everything has to be set up. We don’t have those things as of now. Considering secured bond transactions like CMBS or RMBS, it takes time and they can’t be one-offs. We need to have programmes where we can issue every two years, for example, and we are not that far.
KEITH MULLIN, KM CAPITAL MARKETS: SIMONE, CAN YOU GIVE US A SUMMARY OF WHAT HAPPENED IN THE SCHULDSCHEIN MARKET?
Simone Wegscheider, HSBC: The Schuldschein market is heading towards a record year [in 2022]. Notably, there’s also a large portion of ESG instruments being printed; roughly one-third of issuance, which is in fact similar to ESG instruments printed in public bond markets. The Schuldschein market is getting more international on the issuer and the investor side. The beauty, if you like, of the Schuldschein market is that it reacts more slowly than the traded public bond market.
We did see a phase where things were more stable from a pricing perspective and an investor demand perspective than the bond market. Smart issuers that would normally have done a bond went into the Schuldschein market because the liquidity was immense. However, over December we have seen an adjustment and Schuldschein conditions have now converged with conditions in the bond market.
In my personal view, for a well-rated investment-grade name, the bond market is probably the smarter option but it’s always worth looking look at both markets for funding diversification.
Max Berger, DWS: Debt markets have been in crisis mode for most of 2022. We’ve talked about how opportunistic issuers need to be to get things done. But in the end, you could argue that the bond market has functioned really well from the perspective of new issue premiums in tough times, when issuers needed to do something or had something strategic to do but didn’t have the option of waiting six months. They had to pay up 40bp or 50bp but the market has proven that liquidity is available.
There are other ways the primary pipeline can de-risk itself by moving much shorter. We’ve obviously seen a lot of maturity extension in the last three or four years but it’s been quite amazing how big the share of short-dated, one, two three, four, five-year bonds has become. And it’s also fascinating if you compare sectors and look beyond investment-grade.
The high-yield market has been challenged but then again there’s pretty much been zero issuance. A lot of issuers were -pre-funded so it’s not like nine months of no high-yield issuance has led to a wave of defaults. And now the market is finally opening up and issuers are seeing the windows and taking them.
For high-yield, and that probably holds for investment-grade too, we have been a bit surprised that we didn’t see more issuance into December. But I think it goes to show that balance sheets, especially for investment-grade companies, are generally strong and that issuers are not in a rush to force things.
Finally, I’d be interested in hearing some perspectives regarding this mental shift of issuers having been able to print at coupons of below 1% for a couple of years but moving to a market where the coupon is 4% or 5%. It must be a mental challenge to get to accept that. Or maybe when you’re not in a rush, you just take your time making that decision.
KEITH MULLIN, KM CAPITAL MARKETS: MAX, HAVE BORROWERS BITTEN THE BULLET AND ACCEPTED THAT THE PAST COUPLE OF YEARS WERE OUTLIERS AND WE’RE NOW BACK TO REAL LEVELS?
Max Jacob, Commerzbank: Overall, yes. Six months ago, not necessarily. Issuers that hadn’t been monitoring the market regularly or which come to the market maybe once a year or less were surprised about the significant market movements, particularly in the second quarter. To be honest, what happened was also a surprise to many other market participants, particularly on the rates side.
But most issuers accepted market conditions. They didn’t necessarily like them and tried to argue about a few basis points. But it was also an internal issue for issuers, having to sell it to senior management because quite often treasurers have targets that they’ve promised to achieve. But we’re in a new normal. Overall, most issuers accept market conditions as they are. There are still some concerns now and again about execution, when bookrunners discuss initial price talk levels and the right level to go out at. For issuers that hadn’t come to the market for some time, those levels looked elevated but as I say, levels overall have been accepted.
KEITH MULLIN, KM CAPITAL MARKETS: HAVE YOU ACCEPTED THE NEW NORMAL FABIAN?
Fabian Lander, Vonovia: I’m still struggling, to be honest. Just to give you a few numbers, in August 2021 we issued €5bn in five tranches and the [blended] coupon was below 0.5%. In March 2022, we issued €2.5bn in three tranches and the coupon was below 2%. In November, we issued €1.5bn and the coupon was just below 5%. That’s a massive increase in coupons. Let me put it this way: if issuers are in no rush, they don’t issue.
We issued our November transaction for a very simple reason. It wasn’t because there was a liquidity need, it was quite simply that we were asked by ratings agencies and equity investors: “do you have access to the capital market?” And we said: “sure, we have access” and they countered: “we haven’t seen any real estate issuance for months”. And because at the time we had an €8bn refinancing need to the end of 2024, we thought it would be wise to demonstrate first that we have very good access to the market and second to demonstrate that we are able to delever and de-risk our refinancing needs.
[The bond of €1.5bn came in combination with a tender for bonds maturing in 2023/2024.]
KEITH MULLIN, KM CAPITAL MARKETS: WHAT ABOUT YOU, KAI?
Kai Gloystein, Knorr-Bremse: I would have liked to have been a treasurer with zero-coupon bonds in the portfolio but unfortunately I missed that because of the crystal ball problem I mentioned earlier! But in 2022, our discussions around margins and base interest rates just got worse and worse. I recall my CFO calling me in May, telling me there was 99% certainty that we would be doing two acquisitions and that we should look for funding. We were lucky at that point and put on an interest-rate hedge and played the full suite of instruments available for treasury so that helped the situation.
But in September, we paid a 3.25% coupon on our €700m sustainability-linked bond; a level that was just non-existent in previous years. We were able to bring it down to 2.50% -- that’s an acceptable level but nothing like I would have considered in the past. But that’s the new reality.
What makes me happy and shows that we are still a good credit is the secondary market where we were trading in the past few weeks at a spread level of around 45bp over. Let’s see how the world develops and whether the market gives us some good arguments if we have to tap the market again.
KEITH MULLIN, KM CAPITAL MARKETS: IS YOUR SENSE THAT THE MARKET HAS OVER-REACTED IN TERMS OF THE REPRICING TRAJECTORY AND THAT THINGS WILL SETTLE DOWN AND WE WON’T SEE QUITE AS ELEVATED SPREADS AS 2023 PROGRESSES?
Max Berger, DWS: I don’t know if I would call the reaction an over-reaction. One very interesting observation is that if you compare the moves we’ve seen with previous recessions, cash usually underperforms CDS much more, so you’re pricing much more of a liquidity premium versus CDS. That didn’t happen. And although the ECB pretty much exited its CSPP in July 2020, it was like a non-event. Considering the risks we face, including at least a mild recession, I think credit pricing is adequate.
Another interesting perspective that we’ve seen is the euro market has visibly underperformed the US dollar credit market and that’s also probably fair since we’ve had an energy crisis and we’re much closer to the Ukraine war. I think that was justified too.
One area we did see an overreaction was definitely in real estate. Yes, there are idiosyncratic stories, there are companies that are facing downgrades, even into non-investment-grade. But what happened is that everything was pushed wider. We’ve got so [many issues], investors, everybody was overweight. People had too much real estate, which caused a terrible sentiment.
And, of course, there is fundamental pressure, but I would say that was definitely an area where we did see some over-reaction, especially in October. Some of that has been priced out to some degree. And then, as I said earlier, we remain constructive that spreads have room to tighten into next year, on the arguments I laid out earlier.
KEITH MULLIN, KM CAPITAL MARKETS: I WANT TO MOVE ON TO ESG. THE NARRATIVE CHANGED A LITTLE IN 2022 AND AS A TOPIC IT SEEMS TO HAVE GONE DOWN SOME AGENDAS BECAUSE OTHER FACTORS CAME TO THE FORE. SIMONE, FROM A CORPORATE DCM PERSPECTIVE, WHAT’S YOUR READ?
Simone Wegscheider, HSBC: Despite everything, ESG is absolutely critical and that importance is not declining. What we witness or hear, however, is that there is an increased focus on the type of ESG label, whether it’s a green bond, whether it’s sustainability-linked or another format from the investor side. Just the label is not enough. Very often, investors would, for instance, also look at some external ESG ratings. And let’s not forget ESG includes an S and a G as well.
We expect the portion of ESG instruments, at just over 35%, to increase as a portion of overall issuance backed by European corporates. Obviously, there is various guidance coming from institutional bodies like ICMA and others regulating the field even more.
KEITH MULLIN, KM CAPITAL MARKETS: WHAT’S YOUR PERSPECTIVE, MAX. WE HAVE SEEN CERTAIN ISSUERS ISSUE ESG-LABELLED BONDS WHERE THE ENVIRONMENTAL IMPACTS AREN’T PARTICULARLY AMBITIOUS. DO YOU THINK THERE WILL BE MORE SCRUTINY ON THE CLAIMS MADE BY ISSUERS WHEN THEY COME TO THE MARKET?
Max Jacob, Commerzbank: I agree with Simone. One point to add is that the focus has been primarily on use-of-proceeds and other formats such as sustainability-linked offerings. But it’s not just the format that is important; increasingly it’s the issuer’s ESG profile that is the focus and this will be an important theme for issuers to have access to the broadest pool of cash.
In terms of structures, there is more scrutiny. Targets or KPIs should be ambitious and in terms of the step-up, that should be meaningful so issuers have a real incentive to meet KPIs so investors can take comfort that objectives are being met. This is a new development that we observed increasingly over the course of 2022. Yes, temporarily, there were other issues that had greater focus but the topic remains key for everyone.
KEITH MULLIN, KM CAPITAL MARKETS: MAX, AS AN INVESTOR YOU SEE A LOT OF SUPPLY COMING INTO THE MARKET FROM DIFFERENT SECTORS WITH A VARIETY OF KPIs. ISN’T IT DIFFICULT TO DIFFERENTIATE ONE ISSUER FROM ANOTHER ON ESG ASPECTS? AT THE END OF THE DAY, YOU’RE BUYING CREDIT. HOW DO YOU APPROACH LABELLED ISSUANCE?
Max Berger, DWS: We’ve had some situations when the market was very friendly and you see bonds coming to the market and you think “it’s not really a sector I want, it’s not really an issuer that I want but it’s green and the CSPP is probably going to buy it”. Over the course of 2022, we saw green bonds from issuers that experienced a fundamental deterioration, maybe underperformed more because they were held more by sustainability funds.
One key takeaway for us is that the integration of credit research and ESG research is very important. You have to look at both at the same time. We sensed there was a lack of that in the market, especially in the last couple of years. Better integration [on the research side] has been quite helpful. Regarding the complexity with sustainability-linked bonds, that’s something that we’re definitely conscious of. We’ve put in a lot of work internally to formalise a framework on how to compare them.
Data standardisation is a challenge and that’s something we’re working on as well as taking an efficient and systematic approach to [deciding] “is this a good structure or a bad structure”. But overall we do like the product. However, since a third of bond issuance is now ESG-labelled, we’ve had a bit too much of this discussion of “is there a greenium or not”. That is not so important any more.
The next step, having a broad set of SLBs to choose from, is being able to say which has such a great structure that we’re even willing to even sacrifice spread because we really appreciate the effort the company is taking.
KEITH MULLIN, KM CAPITAL MARKETS: TO WHAT EXTENT DO YOU RELY ON SECOND-PARTY OPINIONS OR THE FACT THAT ISSUERS MAY HAVE GONE THROUGH ESG STANDARDS BODIES?
Max Berger, DWS: We still rely on opinions. These things are complicated; they come with documents of 40 pages. To replicate [external processes] 100% with internal resources is a big challenge. But we do put a lot of resources and a lot of technology into the process. For us, it’s a combination of things but for the time being, we rely on second-party opinion providers. We’re also quite aware that this segment and the market for ESG data provision are consolidating very quickly.
KEITH MULLIN, KM CAPITAL MARKETS: KAI, CAN YOU BRIEFLY TALK ABOUT THE ESG FACTOR, EITHER IN YOUR BUSINESS OR WHEN IT COMES TO FUNDING?
Kai Gloystein, Knorr-Bremse: I can assure you that we also spend a lot of time really talking to second-party opinion providers on structure because we take it very seriously. In the past, I sometimes felt “yeah, okay, it’s the new product of the month that the banks are marketing”. But now we have taken on board that ESG and sustainability are here to stay and these topics have become part of our strategy. We want to have green financing instruments. I wish, personally, that there was more harmonisation because one product relies on a credit rating, another on a KPI. But at the end of the day, it’s always Knorr-Bremse and the business behind it.
We are quite proud that ESG is part of our DNA. In the €700m sustainability-linked bond we issued in September, because we are already Scope 1 and Scope 2 ready, CO2-neutral, we had to be more creative and promised the market that we would establish a Scope 3 target. That was an innovative structure but, in the end, we said, “hey, we want that structure” and that’s why we did it.
[Knorr-Bremse has committed to a Scope 3 emissions reduction target focusing on its value chain, approved by the Science Based Targets initiative.]
KEITH MULLIN, KM CAPITAL MARKETS: FABIAN, GREEN REAL ESTATE HAS BEEN ALL THE RAGE FOR A LONG TIME. WHAT DOES YOUR ESG STRATEGY LOOK LIKE?
Fabian Lander, Vonovia: For us, ESG bonds, like green and social, are the best way to fund green and social investments and we have a lot of them. From a treasury perspective, if you look at the euro bond market, two-thirds of investors are asset managers and they are subject to the Sustainable Finance Disclosure Regulation so have to classify their products into Article 6, 8 and 9. To get the best access to funds, you have to offer some kind of ESG.
We updated our green bond framework in 2022, including two social categories – affordable housing and senior-friendly housing. On the green side, we focused on the EU Taxonomy. Our green bonds are 100% Taxonomy-aligned, as confirmed by ISS, our second-party opinion provider. And we are quite proud of it.
In the past, green bonds have been king and I still think they are unchallenged and remain the number one product from an ESG investor perspective. But what we have seen is that at a time of rising rents; multiplying ancillary costs, especially for heating; and the inflow of refugees, social issues have become important to investors.
We saw big demand for our green and social bonds. For the November issuance, though, there wasn’t a big difference in how much demand we received for the green and social tranches. That means the gap is narrowing and social is coming increasingly into the minds of investors.
[Vonovia issued its first two social bonds and its first EU Taxonomy-compliant green bond in March 2022 for a total of €2.5bn and tapped the market again for €1.5bn in November with green and social bonds.]
KEITH MULLIN, KM CAPITAL MARKETS: TO FINISH OUR DISCUSSION, I’D LIKE TO ASK EACH OF YOU TO MAKE A BRIEF CLOSING STATEMENT SUMMARISING WHAT’S ON YOUR MINDS.
Max Jacob, Commerzbank: I’m moderately optimistic for 2023. markets are constructive and that gives a number of issuers opportunities to tap the market. For issuers with excess cash, there might be also some opportunities on the liability management side, given that valuations look a little more attractive compared to a year ago.
The thing to watch is inflation. Fingers crossed that there will be no surprises to the upside that results in market volatility. We also need to watch the geopolitical stage and developments there. As long as the winter weather is reasonably warm, energy prices should be okay as well,
and therefore markets should be stable.
Max Berger, DWS: We’re definitely looking constructive into 2023. We’re seeing a lot of interest in bonds from clients whom we haven’t really spoken to about the asset class in a couple of years. We’re conscious about the liquidity framework we’re in, though, and we’re very conscious that risk-on/risk-off can return quickly.
Fabian Lander, Vonovia: For the real estate sector, there are three issues: climate change, demographic change and urbanisation. The answer is to invest in energy-efficient modernisation, senior-friendly modernisation and in space creation. These investments need to be funded either by social or green products. From a treasury perspective, we need to be prepared to broaden our investor base and tap into different investors so if one of our funding sources dries up, we can be flexible and deal with it.
Kai Gloystein, Knorr-Bremse: I would love to see the mild recession that analysts have been writing about. And to avoid another big crisis on top of what we have today so that our relationship with clients and suppliers is a bit more relaxed. When I look at the supply chain, we do not see any negative surprises. I’m not saying I would like to go back to the old normal, but maybe to a new normal. If I have another wish, it’s for less volatility to avoid having to engage in day-to-day planning and focus on a longer-term horizon.
Simone Wegscheider, HSBC: Sorry, Kai, but I think volatility will remain our companion. For the year ahead, I would expect increased scrutiny on company fundamentals and ESG strategy, leading to higher differentiation between sectors and between credits.
KEITH MULLIN, KM CAPITAL MARKETS: THANK YOU EVERYONE FOR YOUR EXCELLENT COMMENTS.
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