Many bankers believe that as the growth of the European government bond market slows, there will be an opportunity for sub-sovereign issuers, including those in Germany, to attract investors. However, those hoping that the Länder might prove willing substitutes have so far been disappointed.
In common with those elsewhere in Europe, investors in Germany are facing an unprecedented decline in the size of the government bond market. According to a report by Merrill Lynch analysts in August, the German government issued a net Eu12bn via the Bund market in the first three quarters of 2000. "We expect this also to be the total for all of 2000," they wrote, "down from Eu45bn last year. In gross terms, bond issuance is likely to fall from Eu110bn to Eu93bn."
But looking to next year, the Merrill Lynch analysts say there may be some respite for those investors keen on German government bond exposure. "In 2001," noted the analysts, "bond issuance is likely to increase again in gross and net terms. The underlying federal budget deficit is likely to increase on account of the tax cuts planned (but not yet approved) for 2001. However, privatisation revenue is likely to remain strong. Our baseline is for net bond issuance of Eu20bn next year."
Be that as it may, the trend is towards lower issuance over the longer term, meaning investors in the German debt capital markets will increasingly have to look elsewhere for top rated paper.
It has long been hoped that German sub-sovereign borrowers, and in particular the Länder, might emerge as strong candidates to partially plug the gap left by the fall in government issuance. In a report published by Dresdner Kleinwort Benson in July, analysts predicted that "demand for bonds of the German Länder should be boosted by the announcement of the German federal government that it is using revenues from the auction of UMTS licences to buy back Eu33bn of the AfW Floater Bond".
"Investors could substitute the central government debt with bonds of European regional and local governments," suggested Dresdner's analysts. "Demand for German Länder should increase, as they have the largest market share in the regional and local government sector, represent a good credit and are well known. Whether the regional governments will increase supply remains to be seen. The spreads therefore have some potential for tightening."
To date, however, the funding strategies of the Länder have consistently disappointed investment bankers hoping for a steady supply of bond issuance from this source. In general, German sub-sovereigns continue to fund themselves wherever they can find the cheapest funding - which has meant either going to the bank market or raising funds via the liquid domestic Schuldschein market.
There have been exceptions to this rule, most notably Land Sachsen-Anhalt, which has worked hard at building a following among international fixed income investors. This year the state continued its international issuance with a Eu1bn 10 year global launched via bookrunners Deutsche Bank and BNP Paribas in March and increased it by Eu600m in April, with Morgan Stanley Dean Witter joining as joint bookrunner.
But investment bankers are not holding their breath in expectation of more widespread benchmark issuance from the Länder.
"My impression," says one London-based banker, "is that, if anything, the Länder have been even more opportunistic in their funding this year than last, and much less interested in strategic deals than most of us had been hoping or expecting." *