German corporate bonds remain extremely popular with investors, although issuance levels have been disappointingly low this year as a result of continued deleveraging. However, there have been some spectacular highlights such as deals for RWE, Volkswagen and BMW, and stunning innovations including the corporate sub debt transaction for Linde. But further down the scale, the Mittelstand remains stubbornly in love with the loan market and high yield deals are genuine rarities.
Germany celebrated Unification Day at the start of October, but the country's corporate bond market remains as bifurcated as ever.
The good news is that issuance activity this year has continued to demonstrate that there is excellent demand for exposure to German credit among local and international investors. The magnitude of that demand was illustrated in May, when Volkswagen launched the largest European corporate bond since France Télécom's jumbo in January. This was a three tranche Eu4.5bn issue led by BNP Paribas, Citigroup, Dresdner Kleinwort Wasserstein, ING and JP Morgan that stoked up demand of close to Eu8bn.
That allowed the borrower to price at the tight end of guidance with virtually no new issuance premium and, according to some bankers, to ruffle one or two feathers by virtually doubling the size of the originally planned transaction. That is an allegation that the deal's leads rebuff. "It was always earmarked as a deal with a minimum of Eu3bn," says Roland Hinterkoerner, head of German and Swiss corporate issuance at BNP Paribas. "But we had a fantastic order book that grew much faster than we expected."
One of the most striking elements of the VW transaction, which is a characteristic of corporate bond markets throughout the euro zone, was the success of the longer dated tranche. "The opening up of the long end of the yield curve has been one of the main stories of the year throughout Europe," says Hussain Hussain, who covers German corporate origination at ABN Amro.
The strength of demand for the 15 year tranche of the VW deal took even champions of longer dated corporate issuance by surprise. "At BNP Paribas we argued for a larger 15 year tranche than the Eu500m that was actually priced," explains Hinterkoerner. "And if you look at the secondary market spread of the 15 year tranche over the four to six weeks after launch it came in so rapidly that at times it was trading well below the 10 year tranche and even matching the six year spread. Demand was huge and the market could easily have absorbed a Eu1bn 15 year tranche."
Before the VW deal, RWE had made a striking contribution to the lengthening of the euro denominated corporate curve in January, when it launched the first ever 30 year euro deal for a utility. Led by ABN Amro, HVB and Morgan Stanley, this Eu750m offering rapidly drummed up orders of about Eu3bn, allowing for pricing to be set at 115bp over swaps compared with price talk of between 120bp and 125bp over.
"The RWE bond was 3-1/2 times oversubscribed and bookbuilt in about five hours," says Hussain. "For a 30 year transaction in a sector where it hadn't been tried before, that was a phenomenal achievement."
Stephen Coles, head of high grade origination and syndicate at HVB in Munich, agrees. "We had an extraordinary and very wide ranging order book for the RWE bond, with demand coming from a much broader base than the obvious insurance company candidates for longer dated paper," he says.
The RWE transaction was followed by a series of other long dated deals from German companies. In March, Deutsche Bahn extended its yield curve, with a Eu500m 2018 transaction led by Credit Suisse First Boston, Merrill Lynch and UBS.
BMW stands out
But Coles picks out BMW's first foray beyond 10 years, led by Deutsche, DrKW, HSBC and HVB at the end of July, as another example of a transaction that generated immense demand at the longer end of the curve.
The result: orders of about Eu2.5bn, and Coles says that one reason why BMW was able to price this Eu750m deal flat to its existing curve was that at the time investors were looking more for the security of a household name in advance of the summer lull than for the yield pick-up on offer at the 15 year point in the curve.
A common feature of many of this year's longer dated corporate transactions, says Coles, has been the diversity of the placement they have achieved, with investors new to the 10 year-plus sector of the market, such as German Sparkassen, becoming much more active players in the market.
Indeed, there appears to be so much demand for longer dated credit exposure that corporate treasurers are being left with more 15 year money than they know what to do with.
Some bankers express amazement that more companies have not beaten down the doors of investment banks in search of bargain-basement longer dated issuance.
"It's almost criminal for companies not to take more advantage of current opportunities to tap longer dated funds, because I don't think those opportunities will still be there in two or three years time at similarly attractive levels," says Andreas Schlotter, managing director and head of European corporate debt origination at UBS in London.
While the increased supply of (and demand for) long dated transactions has been an encouraging sign of the continued development of the German corporate market, then so - albeit to a limited degree - has been the arrival of new names in the market, such as Deutsche Börse and the pan-European but Munich-based EADS.
A notable example of issuer diversification came in May, when Henkel launched a debut Eu1bn 10 year deal led by Citigroup, Deutsche, DrKW and HSBC. Originally planned as a Eu750m deal with price talk at 48bp-53bp over mid-swaps, an order book that reached Eu5bn - in spite of the company being downgraded by Standard & Poor's (S&P) in the middle of its roadshow - allowed for the bond to be increased and for pricing to be set at 45bp over.
Hugh Carter, managing director of debt syndicate at Dresdner Kleinwort Wasserstein in London describes the Henkel transaction as a classic example of a German issuer that is now able to access very widespread pan-European distribution. "Henkel was the antithesis of a typical German corporate bond of a few years ago which would have been distributed principally among the domestic banks, funds and insurance companies," he says.
The Henkel deal was certainly a welcome move away from the cabal of sectors that has hitherto dominated corporate issuance in Germany. "Henkel was definitely a diversification play and helped Germany to move away from what I call the three-sector market, which has basically been telecoms, autos and utilities," says Hinterkoerner at BNP.
Perhaps. But corporate issuance in Germany remains very concentrated. "The top 30 or 40 German corporates are firmly established in the capital market and well covered by intermediaries on the research and trading side," says Walter Henniges, head of debt capital markets at Deutsche Bank in Frankfurt.
"The challenge Germany is facing now is in developing a similar market for second and third tier companies."
In part, say bankers, the structure of the euro denominated market has militated against increased participation by Mittelstand borrowers which - particularly in a depressed economic environment - simply do not have the financing needs that could justify the launch of a bond big enough to attract the attention of investors and index providers.
The relatively high threshold perhaps provides one explanation why total new issuance volume in the corporate bond market in 2003 has failed to match the expectations of those who were expecting huge growth in the market as bank lenders retrench. "Volume has been disappointing, with total new issuance down significantly," says Schlotter at UBS.
He says that total investment grade issuance weighed in at about $37bn (equivalent) in the first nine months of this year, compared with $48bn in the same period in 2002.
That decline, he says, is predominantly a reflection of the fall-off in jumbo M&A related issues that were the main drivers of benchmark issuance last year.
A deleveraging tale
That slack has not been taken up by the sort of cross-section of borrowers that bankers were hoping would become established as issuers in the bond market.
"If you take a snapshot of who the issuers have been in the last few years, very little has changed," says Christian Kolb, head of origination at HSBC Trinkaus in Düsseldorf. "Although we've seen some new names this year, you can still count the benchmark corporate issuers on two hands.
"And if you look at the borrowers that would be able to fire out an issue any moment, no more than a dozen or 14 have established MTN programmes, and only about 50% of those are currently active. The big topic at the moment is clearly deleveraging, rather than raising new debt through the bond market."
|Top 10 Bookrunners of all international bonds for German corporates - 2003 (October 27, 2003)|
|Bank||Amount (Eu m)||No. of issues|
|Dresdner Kleinwort Wasserstein||2,444.77||16|
|Credit Suisse First Boston||1,439.38||6|
|Total eligible issuance||38,998.18||121|
Pressures on the banking system, which were supposed to have driven Mittelstand companies into the welcoming arms of the bond market, have not yet had the desired effect.
Schlotter says that the Mittelstand is alive to the implications of Basle II and the constraints on lending capacity throughout the German banking sector. "In meeting after meeting with Mittelstand companies it is clear that companies are aware that their credit relations are becoming more centralised," he says.
"They recognise that German banks are becoming much more professional and looking in greater depth at credit risk management on a portfolio basis rather than allowing the local branch manager to distribute loans as and when he deems appropriate."
Mind the gap
The problem for the bond market, says Schlotter, is that even faced with a more demanding bank lending environment, the costs of financing via the bond market still fail to stack up attractively. "As soon as you start talking to Mittelstand companies about financing costs, the gap between what they are used to paying in the bank market and what they would pay in the international capital market is still significant," he says.
"So they say that they would look at the international capital market but only if they have a real and pressing financing need. And given an overall economic backdrop of falling capital expenditure, at the moment they do not have that need."
Even those that may have the need remain hesitant about the rigmarole associated with public bond issuance in general, and about the role played by ratings agencies in particular.
Continued downgrades in 2003 have prompted renewed mistrust of the agencies in Germany - so much so that at least one company was so disgusted by a recent downgrade that it has engaged in the rather pointless exercise of commissioning a university professor to come up with an academic analysis aimed at proving the offending rating agency wrong.
Paradoxically, however, it was a spate of downgrades of German companies that led to one of the most innovative corporate transactions of the year. Those downgrades came when S&P intensified its analysis of the extent of pension fund liabilities within corporate Germany, culminating in a number of companies - including Linde, ThyssenKrupp and Deutsche Post - being put on what Kolb at HSBC describes as a "list of death".
Linde's response was to launch an innovative corporate subordinated bond via Citigroup and Deutsche Bank in June that generated total demand of Eu1.4bn and was increased from a foreshadowed Eu300m to Eu400m.
"Issuing sub-debt does not put you in a position to get a higher rating," says Kolb, "but it qualifies the borrower for some equity credit and sends a positive signal to the ratings agencies that management is aware of the problem and is prepared to tackle it."
Not that the Linde transaction impressed everybody. "I was delighted to see the Linde transaction get done," says one banker, "because it demonstrated that there is a credible funding alternative for corporates. But the deal was disappointing in that it only generated equity credit of about 20% or 25%, which is not very meaningful. Given the thin capital structures of so many companies, this structure could be a constructive product, but only if it can generate higher equity credit."
The Linde deal failed to open the floodgates for issuance of corporate subordinated debt, even though it prompted investment bankers to scour Germany in search of potential issuers. Kolb says that he spoke to at least six companies about the possibility of a Linde-style transaction. The response was generally luke-warm, with companies concerned about the cost and indicating that in order to have a meaningful impact on their corporate structures they would need to raise Eu2bn-plus, rather than Eu400m or Eu500m.
If Mittelstand corporates are not stampeding towards the euro denominated bond market, where are they looking instead?
One increasingly attractive source of funding is the US private placements market, which does not insist on huge issue volumes and subsequent liquidity, does not demand that borrowers are rated, does not insist on laborious SEC registration and does not ask corporate issuers to reconcile their accounts in line with US GAAP. That makes the credentials of the market appealing to German borrowers, although it has taken time for the penny to drop.
ZF Batavia set the ball rolling in 2001, when it was the sole German issuer in the US private placement market, with Schott and Claas following in 2002, while by the end of September 2003 others such as Hella, Bertelsmann, Adidas and the football club FC Gelsenkirchen-Schalke 04 had all followed suit. That represents an encouraging increase in issuance, although as Jim Volkwein, head of US private placements at Barclays Capital in New York, says, it still leaves Germany severely under-represented in the US private placement market relative to the size of its economy.
He estimates that of the $32bn or so raised in the US private placements market this year (60% of which has come from non-US borrowers), Germany has accounted for no more than 2% or 3%. "For years people have been wrongly predicting a wave of issuance coming out of Germany," says Volkwein. "At last we may be seeing the start of a trend, and I would expect that 2% or 3% to reach at least 5% in the near future."
High yield splutter
If activity among new issuers has been slow on the ground in the investment grade corporate bond market, it has been pitifully intermittent in Germany's high yield bond market, with just three issuers having tapped the sector by the end of September. Granted, one of those - the Eu700m seven year deal led in July by Citigroup, Deutsche Bank and RBS Financial Markets for HeidelbergCement - was at the time the largest single tranche euro denominated transaction ever launched.
Nevertheless, with the HeidelbergCement bond complemented only by much smaller transactions for Fresenius and Flender Holdings, primary activity in the German high yield market has hardly been buoyant.
Bankers express cautious optimism that there may be better times ahead. At CSFB, which co-led the successful Eu250m seven year dividend recapitalisation deal for Flender, head of European leveraged finance group Jim Amine is one of these.
"I don't see the floodgates opening, but I think we will see a re-emergence of high yield issuance," he says, adding that he expects to see more issuance arising from corporate borrowers than from LBO situations.
Increased issuance, he argues, will be driven by continued pressure on bank lending combined with the gradual diminution of the stigma associated with non-investment grade bonds.
That view is echoed by Brian Bassett, managing director of high yield capital markets at Deutsche Bank in London. He believes that medium sized companies in Germany and elsewhere in Europe will have taken notice of the fact that credits such as HeidelbergCement, Rhodia, Vivendi and others have successfully raised funding in the high yield market.
"Deals like that have made it much easier for treasurers and CFOs to go to their board and explain that as double-B rated credits they can access the high yield market at rates that are infinitely cheaper than raising equity," he says.
At the same time, Bassett says that he is encouraged by a rise in demand for higher yielding bonds among European institutions. Deals from cross-over credits such as HeidelbergCement - which in any case is expected to make a rapid return to investment grade territory - have been exceptionally well supported by investment grade funds as well as dedicated high yield buyers.
But as Bassett says, the demand for the more recent Flender transaction, which was not suitable for consumption by buyers of investment grade paper, demonstrated that traditional high yield investors have been amassing a considerable stock of liquidity over the last nine to 12 months.