In this European public and project finance roundtable, eight expert panellists reflect on the specific demands of public and project finance in Germany, France and throughout Europe in 2008, how municipal authorities are taking on a greater share of the funding requirement, and how regional bonds have performed as investors seek safe havens following the crisis in financial markets.Joining EuroWeek in Berlin for the roundtable discussion were: Alex Benoehr, executive director, group head of syndication, Dexia Capital Markets in ParisAchim Bernhardt, head of treasury at the Ministry of Finance, State of Brandenburg in PotsdamRalf Berninger, executive director, public sector origination, Dexia Capital Markets in ParisAnne Bosche-Lenoir, chief financial officer, Région Ile-de-France in ParisSebastien Gothier, senior asset manager, fixed income, Dexia Asset Management in BrusselsEckhard Helms, treasurer, State of North Rhine-Westphalia in DüsseldorfMarkus Ratz, senior vice president, public finance, Dexia Kommunalbank in FrankfurtAlois Strasser, director, sovereign and public finance ratings, Germany, Austria and Switzerland, Standard & Poors in FrankfurtPhilip Moore, contributing editor, EuroWeek
EUROWEEK: Can the borrowers give a brief outline of their funding requirements?
Helms, State of North Rhine-Westphalia: North Rhine-Westphalia is the largest state in Germany in terms of GDP and population. We also have the largest gross borrowing requirement of all the German Länder, which has been quite stable at around Eu18bn to Eu19bn over the last few years, although we have reduced our net borrowing requirement from Eu6bn in 2005 to Eu2bn today.
Bernhardt, State of Brandenburg: Brandenburg has just 2.6m inhabitants which makes us a very small state, and so we dont have as much debt as North Rhine-Westphalia. Our gross annual borrowing requirement is about Eu3bn, although in recent years this has been as high as Eu3.8bn and as low as Eu2.5bn. Brandenburg has enjoyed very good operating figures in the last two years and generated a surplus of Eu400m last year, so we expect to have a net borrowing requirement of just Eu100m next year, which will fall to zero in 2010.
Bosche-Lenoir, Région Ile-de-France: We have a modest funding requirement compared with the German Länder, although in the context of French local governments we are the biggest issuer. In the last few years we have raised between Eu350m and Eu400m per year, but in 2008 that total will rise to between Eu500m and Eu700m. That is because there has been a movement towards financial devolution in France. Our budget has risen by about 40% in the last three years and should continue to increase between now and 2010.
EUROWEEK: Is that bigger funding requirement being driven by rising infrastructure spending?
Bosche-Lenoir, Région Ile-de-France: Yes. Région Ile-de-France holds 51% of the syndicate that is responsible for organising all public transportation in the region, which covers suburban trains and buses as well as the underground system. A number of transportation projects call for total investment of between Eu5bn and Eu10bn by 2013. We have also been given some new responsibilities in the area of vocational training and high schools. To put the size of our planned investment in education in context, it is larger than the entire vocational training investment programme in Belgium over the same period.
EUROWEEK: How have local governments funding strategies evolved in recent years?
Helms, State of North Rhine-Westphalia: There has been a significant change in our funding strategy over the last eight or nine years. In 1999, as much as 97% of our borrowing was in the Schuldschein market. But we recognised that the size of our funding requirement was such that we needed to diversify our funding instruments and our investor base. We did that by adopting an international approach from 2001 onwards, which involved establishing a benchmark borrowing programme. We also set up a medium term note platform in 2002 and we have now issued in 15 currencies.
Bernhardt, State of Brandenburg: We use the same sort of borrowing instruments as North-Rhine Westphalia, but on a smaller scale. The share of Schuldscheine in our overall funding mix has fallen from about 90% to 50% in recent years and we have been making use of our MTN programme to optimise our borrowing costs.
Bosche-Lenoir, Région Ile-de-France: We were the first region in Europe to set up an MTN programme, in 2000. We have been using it continuously since then in more than five currencies. For the last few years we have been preparing for the fact that we will need to become more active in the market. Three years ago we started tapping the Asian market through private placements as a way of helping investors there become more familiar with the Ile-de-France name.
We have been looking to vary our funding mix much more in recent years. We have been an active issuer in recent years in the Swiss franc market, for example, and last year we also considered issuing in the Canadian Maple market, but decided that the levels we could achieve would not have been right at the time.
Another change in our funding mix in recent years has been that since 2003 we have increased the proportion of fixed rate versus floating rate borrowings. Five years ago almost 80% of our funding was in variable rate products. Now 70% is in fixed rate. But we have also had successful hedging strategies in place which have protected us against rising Euribor rates.
EUROWEEK: To what extent did local government bonds act as safe haven investments during the recent crisis in financial markets?
Benoehr, Dexia Capital Markets: If you take a helicopter view of the market it has been a haven of tranquillity relative to other asset classes. We have developed a proprietary index to track the performance of local and regional government debt issues, which is made up of 100 or so issues, the majority of which are German Länder bonds. Over the last 12 months or so the correlation of that index to swaps has been 99.5%, so the stability of the market has been fantastic.
Over the last year, at one end of the triple-A spectrum we saw short dated Bunds move from Euribor minus 20bp to minus 70bp or 80bp, while at the other end covered bonds have widened and ABS has gone into triple digit territory. In comparison to those asset classes, Länder have been very stable.
Gothier, Dexia Asset Management: Sub-sovereigns definitely benefited from a safe haven status during the crisis, and this has been confirmed in recent weeks as they have underperformed relative to government bonds as risk aversion diminishes. Of the German Länder, NRW has underperformed very slightly because of its perceived links to the regional banks. The perception is not that there is any chance of default, but that because there are deficits arising from problems in the regional banking sector, so NRW may have to come to the market more.
Helms, State of North Rhine-Westphalia: When the crisis began, we saw a flight to quality in the form of the Bund. But in the second wave there was also a flight to the German Länder that helped the performance of our spreads.
This year the pattern has been different. In the first quarter we issued nearly Eu5bn, but since the Bear Stearns crisis we have seen a sharp decline in demand for Länder paper. Issuers with the same rating as ours are offering investors pick-up that they havent seen for years, which has reduced the relative attractiveness of our sub-Libor bonds.
Benoehr, Dexia Capital Markets: Since the end of March the flight to quality has been easing, with sentiment improving in the covered bond market where borrowers are prepared to pay a premium to get issues done. In the corporate bond market, meanwhile, we are seeing new issues attracting huge order books because they are paying plus 150bp or plus 200bp. One of the results has been that demand for the highest grade and most stable Länder has been softer.
Helms, State of North Rhine-Westphalia: Im not worried about this development which is a temporary phenomenon. When spreads start to come down again in the corporate market, investors will reassess their portfolios and recognise that there is room for top quality Länder issues with very low spread volatility.
Ratz, Dexia Kommunalbank: As demand patterns in the new issue market have changed in recent months, have you seen any shift in the distribution of demand between local and international investors?
Helms, State of North Rhine-Westphalia: As we didnt issue a benchmark in the first quarter I cant say if there has been a significant shift. But if you look at the distribution of the recent benchmark from Saxony-Anhalt there does not seem to have been much of a change in demand patterns.
Bosche-Lenoir, Région Ile-de-France: As a triple-A borrower our spreads havent been affected very badly by the crisis. On average the widening has been no more than 2bp-3bp. Why? Because we have maintained a regular dialogue with our investor base and the rating agencies have reiterated in their coverage of us that we are a solid triple-A borrower and one of the best risks in France.
EUROWEEK: How have Ile-de-Frances spreads been affected by your risk weighting?
Bosche-Lenoir, Région Ile-de-France: Were 20% risk weighted, but of course that only applies to banks. Because we have always tried to broaden our investor base to include asset managers, pension funds and insurance companies our spreads have not been affected by our Cook ratio.
Benoehr, Dexia Capital Markets: In recent months the investors who stayed most liquid were the real money accounts. Will the Länder focus more on the real money investor base in coming roadshows?
Bernhardt, State of Brandenburg: The last time we roadshowed, in 2006, we had a mix of MTN and real money investors but next time we will probably give more weight to real money accounts.
Benoehr, Dexia Capital Markets: Infrastructure-driven funding is by definition longer term and as the flight to quality has receded, access to three year finance is generally good. Five year bonds are also OK, but for anything of 10 years or more it is still very difficult. How are municipalities and regional authorities handling the fact that long term money is becoming so expensive? Do you bite the bullet or try and roll over your funding on a short term basis for as long as possible?
Helms, State of North Rhine-Westphalia: That is not really an issue for us because we dont do project-related funding. We finance ourselves using a portfolio approach, so if demand dries up at the long end we can easily go to the short end of the curve instead. In any case, the duration of our new issues this year has been no shorter than it was last year. We were still able to sell long-dated Schuldscheine in the first quarter.
Bosche-Lenoir, Région Ile-de-France: Our maturity profile hasnt changed recently. The banks are telling us there is more demand for short term maturities, but because of our limited borrowing requirement we think we will always find demand for 10 year issuance. That is important for us because we dont have much need for short term maturities, so most of our issuance will be in the eight to 10 year maturity range.
Berninger, Dexia Capital Markets: Borrowers with smaller funding programmes can probably still raise 10 year funding. But in larger transactions the maturity profile is very much driven by the investor base, and 10 year transactions are unlikely to generate any Asian or European demand, so borrowers wanting to maximise the diversity of their investor base wont have as much choice in terms of maturities.
Helms, State of North Rhine-Westphalia: Our benchmark deals are very much investor-driven, but the two Eu1bn benchmarks we did last year accounted for a little more than 10% of our total funding for the year. That gives us plenty of room to steer our overall duration targets with other instruments.
EUROWEEK: Did demand for structured products diminish with the flight to quality?
Bernhardt, State of Brandenburg: There has been a decline in demand for the funky stuff. But we have been able to respond to rising investor demand for structured Schuldscheine. Even for a small state like Brandenburg it is important to retain the flexibility to issue products other than plain vanilla Schuldscheine that can save 10bp or 15bp for the issuer.
EUROWEEK: How important are considerations like ratings, liquidity and investor relations to spread performance in this market?
Strasser, Standard & Poors: Ratings are obviously an important factor in determining bond pricing in the case of the German Länder, which have tended to perform very well in comparison to other local and regional governments, but there are a number of other factors. Regular issuance in the market is a very important consideration.
Berninger, Dexia Capital Markets: Compared to the local government sector elsewhere in Europe, the German Länder have benefited immensely from their relatively high liquidity levels. We were able to place large amounts of Länder paper throughout the crisis, whereas for other European regional governments, even those with a triple-A rating, placement was much more difficult. The reason is clearly that institutional investors and central banks require a minimum size.
Gothier, Dexia Asset Management: Of course, all triple-A ratings are not created equally. We monitor the macroeconomic situation of every country as well as considerations such as the supply of new paper in the sub-sovereign sector. We need to see clear evidence of a link between sovereigns and sub-sovereigns in terms of the support that local and regional governments enjoy from the sovereign. But on top of that, issue size is a big concern for us and always has been. For example, the Spanish regions have no deficits so they dont come to the market very often, they dont issue large bonds and therefore liquidity is very low.
EUROWEEK: Are the spreads in the local and regional governments a fair reflection of their credit quality?
Berninger, Dexia Capital Markets: An interesting trend during the crisis was that in the German Länder segment prices moved in line with each other. There didnt seem to be very clear differentiation between the spread performance of issuers rated triple-A by S&P and Moodys and those in the double-A segment. In other markets the trend was quite different. In the market for Canadian provinces, which is quite liquid, there was much more noticeable divergence between the performance of the triple-A and double-A segment.
Helms, State of North Rhine-Westphalia: Of course we would like to see our spreads go tighter, and the budgetary situation of the German Länder is certainly improving. Two years ago nobody would have imagined that Germanys overall budget would be in surplus which of course has a very positive effect on regional governments and municipalities. In the recent crisis we have benefited from our international approach to the market but also from Germanys healthy economy and budgetary situation.
Gothier, Dexia Asset Management: Sub-sovereigns are priced against both the government curve and also against swap spreads, and the liquidity crisis in the bank sector has of course led to a sharp rise in swap spreads. To a large extent, sub-sovereigns have followed this widening in swap spreads. But at the macroeconomic level we dont see any prospect of a deterioration in credit fundamentals among sub-sovereigns, so in our view the impact of the liquidity crisis has created a good opportunity. The 10 year swap spread in euros is now about 50bp and our predicted fair value on a six month horizon is in the area of 35bp-38bp, so we see very good value in swap-related products at the moment. Furthermore, a current liquidity premium of up to 5bp in the sub-sovereign sector should fade as risk aversion vanishes.
EUROWEEK: What is the outlook for global issuance in the regional bond market?
Strasser, S&P: We expect about Eu160bn of gross borrowings in bonds and loans combined from regional governments in 2008, which is flat compared with 2007 and down from Eu185bn in 2006. In our projection for 2008, the largest share will come from the German Länder.
Central and eastern European borrowing will grow quite considerably compared with last year, and we are expecting Russian issuance to increase by about 50%. But the question is: is there enough volume from borrowers in single issues? Very often Eu100m is the preferred minimum for investors. Although we have seen occasional big issuance in the past from cities like Bucharest, outside the German Länder market we seldom see single new issues for more than Eu100m.
One of the reasons why supply is restricted is that many municipal borrowers in Germany, for example, generally prefer to have amortising rather than bullet issues.
Ratz, Dexia Kommunalbank: The other reason is that in Germany the bank and private placement markets are very liquid for the municipals. The Schuldschein market can easily handle deals of up to Eu100m or Eu150m even for borrowers such as cities without ratings. But we also see quite a lot of bullet debt from municipal borrowers in the short term Kassenkredit market. The municipals long term debt has been falling over the last 10 years but their short term Kassenkredit has risen to about Eu30bn and we now have some cities with short term deficits of more than Eu1bn.
Strasser, S&P: One reason is that German municipalities arent allowed to finance their operating deficits with long term maturities. The same is true in Austria.
EUROWEEK: If there is some doubt about whether the local government market can be seen as a homogenous asset class, which borrowers do the issuers here see as their main peer group?
Bosche-Lenoir, Région Ile-de-France: Because we have a very different funding requirement, we dont really compare ourselves to the German Länder. Our closest peers are French public sector borrowers like Ville de Paris, SNCF and RATP, which have comparable ratings and liquidity to us.
Helms, State of North Rhine-Westphalia: Our goal is to be as close to the Bund as possible. We explain on our roadshows that under the German constitution we are on the same level as the Bund, so from the very beginning of the jumbo Länder market our aim has been to be priced not against the swap curve but against the Bund curve. That hasnt succeeded because were still priced against swaps, but theres no harm in dreaming. Of course were not as liquid as the Bund but we are a good alternative in terms of credit quality.
EUROWEEK: Will there be more local government issuers in the near future?
Benoehr, Dexia Capital Markets: Decentralisation has put more responsibility for financing into the hands of regional authorities. Last year the market got ready to broaden its spectrum because it was an opportunity for newcomers to come into the market at historically low levels. In particular, the awareness of issuers in central and eastern Europe about the potential of this market was heightened.
Obviously the spread widening and repricing that weve seen over the last 12 months has put the brakes on any expansion of the market, because single-A borrowers which could have come to the market at between Euribor plus 20bp and plus 50bp last year will be looking at as much as Euribor plus 150bp today.
On the other hand, the refinancing possibilities for banks have also changed. This time last year banks in central and eastern Europe were highly liquid in their local currencies, but as liquidity in the banking system is also under pressure borrowers in this region may be pushed towards the capital market.