The funding strategies of German investment grade companies are in a period of transition, as borrowers turn away from a dependence on syndicated loans and look instead to the capital markets for the bulk of their financing.
E.On is one of the German borrowers at the forefront of this charge. Like many corporates, since the credit crunch emphasised the dangers of a reliance on bank lenders for its funding it has made a very deliberate move to the bond market.
"Many banks have become more and more reluctant to lend at good terms, and that was not fully unexpected," says Verena Volpert, senior vice president, finance, at E.On in Düsseldorf. "In 2007, we took the decision to focus our financing programme on bonds. The bank market is not really relevant for us when it comes to funding E.On as a group, although we do use it for project financing."
E.On retains a revolving credit facility which last year it reduced from 10bn to 6bn but this is never likely to be drawn and is used as a back-up line for the companys commercial paper programme and to reassure the ratings agencies of the firms access to liquidity.
Another German borrower, BMW, has also reduced its reliance on bank financing as much as possible, instead turning to the international capital markets where they are viable. The auto firm now estimates that its bank loans make up less than 5% of its total debt.
Kai Otto, head of capital markets and asset management at Volkswagen in Wolfsburg, says that the bond market is the first point of call for its funding needs.
"For accessing financing of a certain size we often turn to the money and capital markets," he says. "The loan markets are better used in the emerging markets and for back-up facilities."
This move away from a reliance on loan financing and an increased focus on the capital markets is symptomatic of a wider change in financing strategy across the European corporate sector.
"High grade borrowers will not use the syndicated loans market for funded credit for a prolonged length of time," says Reinhard Haas, head of loan capital markets Europe at Commerzbank in Frankfurt. "They will come to the market for funded deals to bridge to takeouts, but you will rarely see a term loan from a borrower with a rating over triple-B if its not for a specific need, such as an acquisition or an investment."
Other market participants have also noticed the shift, and think that it it is part of a more fundamental change in corporates approach to funding.
"I believe that were on the road to having a similar set-up to the US market, where for example the banks will be left to provide undrawn back-up lines," says Matthias Gaab, managing director in the global lending group at Deutsche Bank in Frankfurt. "The funding needs of corporates will instead be covered by the issuance of appropriate debt capital market instruments, which offer variety and opportunities."
By early November 2011, there had been more bonds issued by German investment grade corporates than in the whole of 2010. German borrowers had also been more active in the bond markets than in loans, and treasurers point to a number of reasons why the capital markets have proved more attractive. In contrast to the loan market, where maturities have been restricted to five years or below, German companies have found that the capital markets offer far longer tenors.
The bond market can also provide innovative financing solutions for corporate treasurers capital needs. Energie Baden-Württemberg, for example, issued its first hybrid bond in October in an effort to shore up its ratings, and completed a 750m transaction after the book grew to 1.5bn.
While German borrowers still use the bank market for funding in countries where the capital markets are not yet fully developed, or where regulation does not allow for efficient use of the local bond markets, they often find that loans are less cost-effective than raising money in the public markets, especially for drawn funding.
"Bank funding was never regarded by us as a cheap source of financing," says E.Ons Volpert. "Rates in the bond market were always comparable, and now it is much cheaper to go there than to try to get something from the banks. This is clear as banks own costs of public funds are so much higher than ours."
Over 2011 though, German corporates did see prices for undrawn facilities in the loan market tumble almost to pre-crisis levels. Pharmaceutical group Bayer (A3/A-/A-) set a new pricing benchmark in February with a five year revolver at 42.5bp, while in July Volkswagen (also A3/A-/A-) priced a five year revolver at 35bp over Euribor, the tightest margin then achieved by any borrower of that rating since the financial crisis began in late 2007.
However, as European bank lenders have seen their own cost of capital increase over the second half of the year, the cost of the revolving credit facilities for corporate borrowers has risen. Bank lenders are also keenly aware of the possible implications of the Basel III regulations, which are now looming over the market. Under the liquidity coverage ratio, banks will have to hold assets against their committed credit facilities, and while the exact requirements have not yet been confirmed, lenders are starting to prepare for the increased costs. As the implementation dates draw nearer, the regulatory requirements will weigh heavily on the way banks make credit decisions and on the costs they charge for a piece of their balance sheet.
"There will not be a paradigm shift, but there will be an alignment in pricing and structure to the Basel III regime in the short to medium term," says Roland Boehm, head of debt capital markets loans at Commerzbank in Frankfurt. "I would expect pricing to move into line with banks cost of capital, and for the sweet spot to remain in the three to five year maturity space."
There could also be a shift in the number and nature of bank lenders active in the German investment grade market. While many of the Landesbanken, contending with their own problems, have stepped back from lending over 2011, foreign banks have replaced them in many German borrowers syndicates. But regulatory requirements and pressures on banks own balance sheets will mean that lenders have to focus their lending activities on core clients that give them enough ancillary business to make their loan books profitable, and many non-domestic banks may retreat from the German market.
"There have been some deals this year for blue-chip corporate German names where, in the end, there have only been two German lenders in the syndicate," says Gaab. "If the foreign banks significantly change their strategy, rethinking who their target clients in Europe are, that will have an impact on the lending sector."More options than most
But even if international bank lenders do retreat from the loans market, German borrowers have more financing options open to them than corporates from other parts of Europe. The Schuldschein market remains a Germany focused product, although foreign names such as Frances Michelin have tapped it in the past. The product is a mainstay of the Mittelstand borrower, but provides an interesting financing alternative for big, corporate credits too.
"A company cannot finance exclusively in Schuldscheine," says Haas. "The market is not that deep, and it only provides drawn money. But its quite an interesting product for term facilities as it offers bullet repayment structures and investors are more interested in longer tenors than in the syndicated loan market."
While the Schuldschein market offers a very domestic funding solution, German borrowers are also able to look further afield. The corporate borrower base in the country is dominated by export-driven, industrial names, which are able to use their global footprint to access international financing markets.
By tapping investors in niche currencies, such as Norwegian kroner and Swiss francs, and by looking further afield across the Atlantic, many German credits have been able to maintain continued access to bond funding over the summer.
"In Germany, while there has been a slowdown in euro denominated transactions there has been a flurry of alternatives available," says Marc Müller, co-head of debt capital markets and corporate coverage in Germany and Austria at Deutsche Bank. "Daimler, for example, tapped into US dollars in the 144A market, and for many German corporates there is good liquidity available overseas."
Alongside 144A transactions, the US private placement market has also become an increasingly attractive product for German corporate borrowers, enabling them to access long-dated, drawn funding whether they are publically rated or not. Even if a borrower does not have a requirement for US dollars, the market can still pose an interesting prospect at times.
"There is a rising interest in US private placements," says Haas. "Its not always the case, but it can be economically sensible to raise US dollars and then swap the funding into euros. There are windows of opportunity when the basis swap is low that makes it an interesting market."
As German borrowers expand the horizons of their financing, they are not just looking to the US. Many German investment grade corporates have operations and investments in Asia, so it is unsurprising that they have found funding opportunities in that market too. E.On has issued private placements in Japan, while other borrowers have tapped into the burgeoning offshore renminbi bond market.
This market only opened to international corporations in August last year, but since then it has grown exponentially. Although it is still a niche market compared to more established regions, some bankers expect the dim sum bond market to peak over Rmb100bn in 2011.
The potential in this market for internationally focused German borrowers is especially great.
"The German Mittelstand has hundreds of corporates that have operations and investments in China," says Müller. "So theres very high interest in the market developing further. Its only been open for a year, but deposits are growing fast and the issuance volumes are increasing."
In May, Volkswagen (A3/A) became the first German corporate to tap the dim sum market with a Rmb1.25bn ($192.1m) transaction arranged by Bank of China, HSBC and Standard Chartered. The five transaction, the largest ever offshore renminbi bond from a Western borrower at the time, was followed in September by German house appliance manufacturer Bosch und Siemens Hausgeraete, pricing its debut debt transaction.
"Volkswagen has a worldwide presence, and we think its useful to have access to funding products in the markets in which we operate," says Kai Otto. "Using the local markets is often the most efficient way to raise money and avoids using derivatives."
For internationally minded borrowers with funding requirements in many different currencies, the development of local capital markets is an exciting proposition. Many more German names are likely to tap the dim sum market as the sector grows, with the product now firmly established as just one of the many funding options open to German high grade companies.