German Corporate Funding Roundtable 2010: Part one

IFR: Let’s kick off our discussion on perhaps one of the most significant themes of the day: the European economy and the lack of growth. Relative to the Eurozone, the US is looking quite healthy, emerging markets are shooting ahead, while there is little hope in the short-term for the UK economy. Is Germany the engine that’s going to drive Europe out of its current slow growth trajectory? On a more specific level, I’m also curious to get a sense of the situation German corporates find themselves in now, and what their general expectations and aspirations are.

Thomas Kull, WestLB: I think there’s some truth in your comment about Germany. It’s clear that Germany won’t compete with the emerging markets in terms of growth rates long-term, but it will always be more stable and it has two main advantages from a macroeconomic perspective. First, Germany has regained a lot of cost competitiveness and, second, it has a lot of technology advantages that are important for the German export-oriented sector, so I think the Germany economy is on solid footings at the moment.

As for corporates, we obviously have lots of discussions with them. German manufacturing companies are very experienced, and since the beginning of the year, they have witnessed a strong upswing in activity. Everybody had been very cautious and unsure about what 2010 might bring, but in the event many manufacturing companies have seen their expectations exceeded by quite a significant margin.

IFR: So are you saying that the economic recovery will be export led?

Thomas Kull: Yes.

Richard Curtis, WestLB: The strength of the euro is probably the key here, given the export-led country that Germany is. The euro has weakened significantly over 2010; there have been lots of commentators saying it’s going to 1.15 or even parity against the dollar. We’ll see, but in terms of getting competitiveness back, the euro has been overvalued for quite a lot of the latter part of this decade so if you know where the euro’s going, you’ve probably got a pretty good idea whether the economic recovery in Europe is going to be strong or not, and whether it’s going to be export-led or internal.

IFR: So are we going to see a divergence in performance between the export sector and the non-export sector? The data doesn’t suggest that internal demand is particularly strong. So will the internal economy continue to be a little bit weaker? How does that impact on the corporate sector?

Matthias Gaab, Deutsche Bank: Growth over the past few years has been driven by exports, and I think the main impact relating to domestic growth has been how this has translated into unemployment, or ’non-unemployment’ via the short-time working scheme, for example1. Those industries or companies that have been solely focused on the domestic economy, such as department stores, for example, have suffered the most.

Marc Mueller, Deutsche Bank: If you look at European GDP data, it’s clear that Germany as a whole has been outpacing the rest of Europe, so in that sense the answer to your original question is, yes, Germany is definitely leading out of the crisis, and the point that Matthias made about the low unemployment rate is a crucial one because this has given Germany some momentum coming out of the crisis. Through this period, companies have done their homework with regard to cutting capacity, etc and now have much more stable platforms.

Mathias Noack, UniCredit: But the positives still only relate to export-orientated companies. We’ve been waiting for an upswing in domestic consumption for a very long time, and with tax rates going up, people ultimately will have less cash in hand so export orientated companies will benefit. Growth will come from exports, not from internal factors.

Johannes Heinloth, BayernLB: Two related points here are how much additional capital will be required for the banks to be sufficiently capitalised, and how much debt is coming up for refinancing. The results of the stress tests on German banks were pretty good, which was encouraging because this is directly connected to the sovereign debt issue and the exposures of German banks. But if you look at how much additional capital the European banking sector needs, it’s around €300bn.

And if you look at the amount that needs to be refinanced within the next two to three years, it’s a big number. I think there will be competition between corporates and sovereigns because they have the same sources of funding; the bond market in particular. The LBO market is another market where huge refinancing volumes are coming up, particularly in 2014 and 2015.

This sovereign debt crisis has certainly exaggerated the whole situation and makes it a little bit more difficult for us. But bankers are smart guys and I’m pretty certain, because we have some time here, that we will be able to find solutions to cope with the wave of refinancing coming up.

Richard Curtis: The crowding-out issue Johannes mentions is an interesting one at the moment, as is the issue of pricing relationships. Historically, the sovereign was the risk-free rate and we priced things up from there. We got a situation after the Lehman crisis where corporates were shut out of the bond market for most of 2008 and then in November 2008 RWE, E.ON and BMW did deals at very wide spreads and everybody said: “Wow, how can they afford that?”

At the time, corporates were getting squeezed by the banks and they realised that they needed to grab liquidity when it was available elsewhere so we saw tremendous issuance in 2009 in the bond market. Corporates grabbed liquidity, cut spending and rebuilt their balance sheets at the same time as European governments destroyed theirs. So now you’ve got a juxtaposed position. You could argue now that perhaps the big blue chip corporates - the national champions - are the risk-free rate and the sovereigns are the poor relations.

Spain recently did a 10-year at 195bp over mid-swaps. Where should Telefonica print? Historically Telefonica has always priced above Spain. Is Telefonica a better risk than the sovereign? And if it is, should it price inside the sovereign? It’s not quite the same in Germany because Germany has had the fight to quality and Bunds are at historically very low levels. But the point here is that the whole relationship between corporates and sovereigns is probably changin

I believe the average investor today will probably prefer a solid corporate to a less solid government. In terms of who’s buying, one of the interesting things we’ve seen in 2009 (it’s slowed down a bit in 2010) is the German retail investor who has come in and bought bonds in a huge way, either from their Sparkassen, through the exchanges, or through banking intermediaries. This has driven bond performance. You can see the difference between deals that have a €1,000 denomination and deals that have a €50,000 denomination. This whole concept of doing retail targeted deals and getting the secondary performance was a strong story for 2009 and still is (to a lesser extent) in 2010.

As a retail German investor, do you stick it in the stock market and wonder: “Am I going to get a 5%, 10% return a year? Am I going to get a lot of volatility?” Or are they going to buy bonds from the likes of BMW, Deutsche Telekom, Merck, Bayer, BASF or Adidas and clip a 5% coupon for five years knowing they’re going to get 25% over five years and performance is going to be a straight line?

Marc Mueller: I think the sheer mass of demand coming from the retail market was the crucial development in the bond market in 2009. In the past, these investors looked more to the equity side. They now see corporate bonds as a safe bet. They made 10%, 15% on some of these bonds throughout 2009. That will not come back, but I think reinvesting in the same asset class will persist and grow. This to some extent decouples the sovereign risk issue from the German corporate market, because interest in German corporates is not highly correlated to sovereign developments. That is a good sign for German corporates.

Olaf Sarges, UniCredit: I absolutely agree and would even go further. In my opinion, German corporates are profiting from developments in the general market. There has been a move out of peripheral government bonds to the safe havens of France to a certain extent but mainly into Germany. There is a lot of cash liquidity in the market that needs to be invested somewhere. The ABS market is not yet back on track, you still have problems in the financial sector. Many investors want to buy corporates, but are hesitant to go into Spanish or Italian corporates, which means demand from the buy side for German corporates is extremely high, especially with a weaker euro which as we’ve been saying will help German exporters.

Low interest rates not only help the Bund fund at very attractive levels - and in my opinion we will have low rates for the next couple of years - they also offer German corporates very attractive funding. Prior to the crisis, spreads had gone down to really stupid levels. Then you had a short period of time, which Richard mentioned, at end of 2008 after Lehman, where coupons,of 8%-9% were paid in some cases even in the investment-grade area. The market came back quite quickly in 2009. We’re not yet printing again at very low levels. But funding is historically extremely cheap for corporates.

IFR: A lot of the conversation seems to point to an ongoing process of bank disintermediation. There seems to be a very strong case for companies to issue bonds as opposed taking out bank loans. Bettina, with the banking system still deleveraging - albeit with individual banks at different points of the deleveraging cycle - is disintermediation a growing trend in Germany?

Bettina Streiter, DZ Bank: I think there is a trend but I think bonds and loans will continue to coexist. Through 2008 and 2009, corporates discovered that they have several routes to market and can choose. They can look at the bond market, which at times can beat loan pricing, (depending on credit quality and other issues) and for some, it’s the first step to reaching a broader spectrum of investors. Disintermediation will certainly be a trend going forward. We will probably see another cycle of banks tightening lending terms and conditions, so the bond market seems to be more reliable for a lot of corporates, at least at this point of time.

We saw in the first half of the year that you can get longer tenors of seven years and upwards and this has been much more popular than the first half of 2009, where we started with one to three years for top-quality names. So the market has opened in a very broad way in terms of tenors available, in terms of the spectrum of ratings that can come to the market. We’ve seen a huge volume so far this year of unrated and sub investment-grade bonds; I think it is probably close to €20bn so far.

So, yes, I think there is a trend towards further disintermediation, especially when we look at the next couple of months. There are signs that banks will start to look again at loan pricing so maybe the bond market will be more stable, in terms of liquidity and the willingness of investors to look at corporate credits.

Mathias Noack: But isn’t this trend basically what we have been promoting to our clients on the debt origination side for a long time? We went out to our corporate clients and explained to them: “Don’t only rely on loan financing, look at other funding opportunities”. Now being a loan banker one might say that I’m a little bit disappointed about the volumes we’ve seen in the loan market. But in principle from a banking perspective in general I think what we are seeing is exactly what we have been going after for quite some time now.

Matthias Gaab: I think what the current environment suggests is a strong bifurcation in the loan market. Borrowers that have access to the bond market will tap those markets for funding and rely on the loan market only for whatever unfunded volume, i.e. back-up lines they need. Especially if you bear in mind the fact that if you look at the CDS market, the senior financials index trades wider than corporates, so you wonder how long this will support the loan business anyway. Bifurcation in the other direction basically means that those names who do not have access to the capital markets for whatever reason, because they are not big enough or they don’t have the reporting standards etc, will continue to rely on the loan market. That will basically mean that they will need to adjust to whatever the banks are in a position to provide to them with in terms of volume and price.

From the banks’ perspective, this will basically mean that the assets they have on their books, in terms of funded assets, will be probably more geared over time to the mid-cap segment rather than to the large-cap segment. We can always talk about the billions of loans we have to large-cap German corporates, but none of this is drawn. So basically you don’t have it on the balance sheet, it’s a potential commitment that is not going to be drawn.

Johannes Heinloth: I’m a loan banker and I fully agree with what Matthias just said. I’m not saying that the €8bn Telefonica transaction that is now in the market2 marks a turning point in terms of the tide going back towards to loan market, but at least we are talking a three-year tenor for the term loan, with a pretty aggressive margin. I doubt whether the bond market could actually compete with such tight pricing, particularly given that you are talking Spain. Sovereign risk will certainly be one factor in the pricing, but the scarcity of drawn assets and the scarcity of deals in the loan market are certainly bringing a level of competition to the loan market, driving down pricing to a record level.

Matthias Gaab: If I may add one thing, otherwise my statement might have sounded a little bit too negative on loans. Whether our bond colleagues like it or not, loans are much more flexible. And certainly in event-driven situations, that is gold dust for corporates. Secondly, one thing you shouldn’t forget - and I’m sure the bond guys will agree wholeheartedly - is that bond investors are much more volatile than the investor base on the loan side. So I would argue that banks are a more reliable source of funding.

Marc Mueller: I think the one positive that German clients have seen through the crisis is that there were clear benefits in having bank facilities in place. I doubt any of the large and mid caps will disagree and don’t think we disagree here that bank facilities are the centrepiece of the capital structure for corporates, and that’s going to Mathias Noack’s point: all of us have been talking to clients over the last few years and telling them to diversify their funding base, and I think that is what has happened.

Now when you look at large corporates, the percentage of capital markets funding has increased, which speaks to the level of retail interest. All the large and mid caps now have a much broader investor base that they can go to without formal hurdles, such as ratings etc, which were a must-have in the past. But all in all, I think the loan will remain.

I’m a little bit sceptical on the Basel 3 implications for the refinancing volumes coming through in 2010, 2011 and 2012, which are enormous. I don’t think there has been a year - I think 2007 saw a refinancing volume in the order of €700bn - which comes anywhere close to what’s coming due in the European loan markets over the next three years. And that’s in an environment where Basel 3 is contemplated everywhere and discussed. So I think that will drive up bond market volumes in Germany and Europe over the next few years.

Mathias Noack: Let me add to what Marc just said and to what Matthias said before. Yes we have been advocating that companies should look out for other funding opportunities and funding sources. But I think it’s also really important to mention that particularly in difficult times, there’s a relationship aspect and having the opportunity to speak to a handful of banks has proven to be extremely important. In the last 18 months particularly, the syndicated loan has been a crucial instrument to make sure that companies who have been negatively affected by the crisis can sail through it in a safe manner.

Richard Curtis: That is a key point. The recent example of BP illustrates the point. BP’s CDS spreads were around 500bp and there was talk they needed to raise money. The bond market would do it, but with an 8%, 9%, 10%-type coupon. The relationship banks were reportedly prepared to do a deal at a margin of 1% over. So I think the relationship on the loan side is always going to be stronger and when you need it the banks will be there. They will step up and do things that the bond market will just shudder at from a risk pricing perspective.

For the bond market, it’s a moment in time. Where’s the price today? And that’s where the deal gets sold and the market doesn’t care about looking forward. The banking relationship is: “Where have we been? Where are we now? Where are we going and how flexible do we need to be?”

I bet your bottom dollar that a lot of the companies that launched bonds at the end of 2008 and in 2009 at very high coupons wish those fundraisings were loans that they could call away as opposed to having to pay that 9% coupon for five years. That’s expensive. Yes the bond market was there, it gave them the money, they grabbed it because they could and they needed it, but act in haste repent at leisure. So the loan side definitely gives an edge of flexibility.

Click here for Part two.