When the senior unsecured funding market finally re-opened in late September after a drought of nearly three months, it was no surprise that the first borrower to issue was Deutsche Bank.
The scarcity with which Deutsche issues in the senior market makes its paper a valuable commodity not only is the bank a solid international player, it is also headquartered in the eurozones strongest economy. Playing on a flight to quality bid, borne out of three months of frustration with the eurozones sovereign debt troubles, the bank printed 1.5bn of three year floating rate paper at 98bp over Euribor a solid trade in a challenging market environment.
Deutsche may be a global institution, but it still carries a German moniker and trades like a German name. And the 1.5bn transaction was no different 50% of the paper went to German investors.
While the spreads on offer might not be particularly eye-catching even in the wake of the market widening seen over the summer they are good enough for the Germans.
German buyers know their banks well and the countrys relative economic strength and high savings rate means its financial institutions can count on investors from their hinterland.
"The German bid for German banks has always been very reliable," says Christian Mundt, FIG syndicate at DZ Bank. "If you have the right price, the right timing and do not target long maturities, the domestic market can easily be good for a 500m trade."
The strength and reliability of this support is one of the forces behind the relatively low spreads German banks pay in the capital markets, says Roger Doig, credit analyst at Schroders.
"There is a very strong domestic bid for German bank paper both in Pfandbriefe and senior unsecured, and as a result the spreads at which they fund are generally lower than where equivalent credits in other jurisdictions would fund," he says.
But the thriving domestic market has its drawbacks notably that international investors can be put off by the tight spreads on offer.
Consider the difference in spreads between Germanys Aareal Bank a small, wholesale funded bank focused almost entirely on the mortgage business and a French bank in the same sector and there is a vast difference in spread, says Mundt. Investors outside the German community, without the loyalty inherent in the domestic bid, may well be minded to chase yield.
"German banks are trading on very tight levels, compared to their non-German peers," says Mundt. "Especially in these times where banks from other jurisdictions have huge increases in funding costs, for many investors it just doesnt make sense to buy German unsecured debt. Thats why the domestic market is so important for them."
Some market participants see German banks lack of outside interest as a circular phenomenon, caused in the first instance by lack of supply. This narrows the distribution of their paper when they do come to market: "If they werent so rare, they probably wouldnt price so tightly and would have broader distribution," says one syndicate banker.
Another factor keeping spreads and supply down in senior unsecured is German banks use of the private placement market. The countrys regional Landesbanks and co-operative financial institutions such as DZ Bank are all players in the MTN market, as are private banks such as Commerzbank and Deutsche Bank.
"Co-operative and savings banks have a strong standing in domestic private placements," says Christian Klocke, covered bond syndicate at Commerzbank. "They dont need the public market so they are not forced to issue benchmarks."
Rock solid retail
Deposits at German banks surged over the summer, even as the eurozones debt crisis threatened to spiral out of control, and banks continue to deleverage their balance sheets after the crisis, making wholesale funding in international markets less of a priority than for many other European jurisdictions.
In the third quarter, German banks were lagging behind other core European jurisdictions in refinancing this years redemptions, having covered 38% of this years maturing debt compared to 97% in other countries.
In August alone, deposits in German financial institutions rose by 30bn, offsetting that deficit in capital markets funding. Market participants are keen to emphasise that the jump did not constitute the start of a war for deposits, but say it indicates that German consumers are happy to support their countrys banks wholeheartedly.
"If youre a German institution issuing in euros, the motivation to pay an international rate for long dated senior unsecured must be quite low when you can issue the same paper at a much tighter spread in euros in your own market," says Doig at Schroders.
German banks have become more active in the retail arena. Deutsche Bank, in particular, has stepped up its push for term deposits, recognising the value in looking after ones domestic consumers in a market that is fiercely competitive. Many believe DBs purchase of Postbank was motivated by the large deposit base it would bring with it.
Pfandbriefe cool off
Strong domestic support is also evident in Germanys beloved Pfandbriefe market. A true German institution, the product is a staple in secured debt portfolios but issuance is on the decline.
Data show a steady slide in Pfandbriefe volumes over recent years. Although issuance increased marginally in the run up to the credit crunch, after the crisis, ownership restructuring and balance sheet deleveraging meant it almost halved between 2009 and 2010.
It 2011 it has been similarly quiet, with just 28bn from 171 deals this year to date less than half 2009s figure of 74bn and just over a quarter of the 124bn issued in 2005. This figure includes privately placed Pfandbriefe, a staple source of funding for Germanys Landesbanks.
To an extent, the market has benefitted from this slowdown in issuance, as the scarcity of new supply has given Pfandbriefe pricing a certain level of immunity from the spread widening in the rest of the eurozone.
"Some of those redemptions have been put back to work in new Pfandbriefe, so it has created a structural demand for the product which has allowed it to be much more resilient to the widening market we have seen over the last couple of years in contrast to every other jurisdiction," says Rupert Carter, a member of the FIG syndicate team at Société Générale.
However, in contrast to senior unsecured, domestic support for new Pfandbriefe paper is dwindling, say bankers.
"While the domestic buyer base is carrying senior deals through, that is exactly what is currently less pronounced in Pfandbriefe," says Christoph Alenfeld, covered bond syndicate at DZ Bank. "The German fan base is not too active, so all of a sudden it has become challenging to bring 500m let alone 1bn. The German punch in this market was more pronounced in the past."
Indeed, recent Pfandbriefe deals have been less than convincing. The last transaction to hit the market, a 500m five year from Deutsche Pfandbriefebank which was priced in late October, was only just covered in terms of bids.
But domestic buyers took 78%, showing that the German investor base, while perhaps less active than it used to be, is still alive and kicking. By contrast, international interest was thin on the ground. Debates over the quality of cover pools in public sector-backed Pfandbriefe have been popular this year, but given that this type of paper has made up only 15% of new issuance this year to date and that many of its most active proponents have all but disappeared from the market, that discussion is largely theoretical.
The problem, agree most market participants, is that at 68bp over mid-swaps, Deutsche Pfandbriefebanks deal like others before it was just not juicy enough for international buyers. The transaction is symptomatic of a wider issue: in terms of spreads, at least, Pfandbriefe have outdone themselves. The decline in supply is keeping yields down, and consequently the product does not carry enough relative value for international investors.
"The problem seems to be that German covered bonds are trading very rich to everything else out there," says Alenfeld. "There is just not enough yield, and that has made support dwindle."
With fewer deals around and ever-tighter levels, traditional Pfandbriefe buyers both domestic and international are looking to other regions to put their cash to work. Scandinavian issuers in particular are profiting from this relocation of investment as well as being some of Europes top financial institutions, they also benefit from being based outside the eurozone.
"Those investors will diversify into Germany or go abroad," says Commerzbanks Klocke. "Mainly into Scandinavia and the Netherlands, some into Australia, some into Austria. That was the story this year and will be next year as well. But the domestic market is still very strong, and Pfandbriefe will continue to be supported, especially in a crisis."
Indeed, for all the talk of a retreating domestic bid, Pfandbriefe remains a bigger market than senior unsecured in Germany. Euro denominated senior unsecured benchmark issuance out of Germany this year to date totals 5.6bn, while German issuers have sold 19.4bn of benchmark-sized Pfandbriefe paper.
"Pfandbriefe is what is leading the way in terms of public issuance," says Carter at SG. "I dont really see that changing in the near term. There is a functioning covered bond investor base OK, its not as international as in other countries, but it is working at the moment and if supply remains as low as it has that will continue to be the case."
The challenge for issuers, as far as Alenfeld is concerned, is finding the right balance between tapping their domestic networks and getting investors with a more pan-European outlook on board.
"Deal size is shrinking and prices are significantly tighter than good quality stuff from elsewhere in Europe," he explains. "All of a sudden you are competing with 10 year French paper at 120bp, or five year paper from Norway at 58bp, and its getting challenging. But the fact its getting smaller than it was four years ago need not necessarily be to the detriment of the product and the market."
Putting most of your eggs in the domestic basket does indeed have its disadvantages. Doig at Schroders, for example, warns that it prevents credit markets from exercising their own discipline.
"The cost of funding for German institutions is artificially depressed or lowered by this surplus of savings which is directed towards them," he says. "That means there is less credit market differentiation between issuers, and we think that is part of the reason for the structurally low profitability of German banking."
However, as long as Germany retains its position at the top of the eurozone pile, it would seems that its banks can have their locally produced cake and eat it.
"[Relying on domestic support] would be a problem if the German savings rate went down to, say, US levels. But clearly it isnt, you have a very high domestic savings level."