Crisis Talk — with Carsten Tegtmeier, Nord LB’s head of primary products
Unlike many banks, NordLB had been actively reducing its balance sheet well before the coronavirus crisis hit, so its need for funding is more modest than most. Though it seems likely Pfandbrief issuance will eventually return, German borrowers are hesitant to come to market, especially when there is cheap, plentiful central bank funding available. And, while Pfandbrief investors are well protected, it seems likely that a slow recovery in the commercial real estate market and a more questionable outlook for SME lending, will take its toll on lenders’ business models.
GlobalCapital: How has your funding plan changed since mid-March?
Tegtmeier, Nord LB: There’s a big difference between us and the rest of the world. After recapitalisation we have continued to reduce our balance sheet. That means there’s been no massive funding need for Nord LB. If we have to refinance bonds and replace funding we’re using the different options given by the ECB but we also see good demand for privately placed senior preferred issuance. The senior preferred market has seen a very strong spread uplift.
Why have we not seen any Pfandbrief supply lately?
At the time of talking, Pfandbrief spreads have tightened somewhat from their widest levels, but given generous new issue premiums, no German issuer has so far been willing to test investor appetite.
A lot of trading positions are also still massively underwater compared to pre-corona levels. While there was Pfandbrief demand at the wider spreads, no one was willing to sell, as this would have crystallised losses on their trading accounts.
But now in some segments, like the German Laender, we see primary and secondary market levels closing together, so hopefully it is only a matter of time before Pfandbriefe will follow.
How do you view Laender versus Pfandbrief from a supply perspective?
Before the corona crisis the Pfandbrief market had already suffered. In January it was too expensive, but now I believe German covered bond issuers might soon be ready to return. But issuers will also rely on the ECB facilities, so we'll have to see how the market develops.
The major question is what kind of business activity people are expecting in bank lending in the next six to 12 months. For the time being everything that has a public sector background is funding billions to support the economy, and this is not typical bank business.
If you look at the State of Bavaria, for example, they’ve not been seen for about five years with public issuance and now they’ve turned up to issue at very attractive levels, from an investor’s point of view.
The public sector and SSA issuers are the ones throwing money to support economy and help the workforce to survive. I don’t think under these circumstances that over the next 12-24 months, a company is likely to apply for a bank loan to support an expansion of its business .
From that viewpoint direct bank lending in this stage of crisis is not going to be much. The public sector is going to dominate primary volumes and covered bond issuance is likely to be scarce for a while.
How helpful is the ECB's Targeted Longer-Term Refinancing Operations (TLTRO) and other measures?
All the different central bank programmes and their conditions are very helpful. It takes a few moments to understand what sources of liquidity are available and what needs to be done to meet the criteria for the cheapest funding.
There is a strong will to ensure banks stay in the market to support corporate customers and do not reduce lending. If banks can prove that they are lending then they can get access to very cheap funding.
And when you take account what’s happens on the regulatory side such as [relaxations of] MREL timelines, capital buffers, IFRS 9 and so on, it is clear both central banks and regulators are doing everything possible, which is very helpful.
How has your balance sheet changed in the first quarter
In return for our recapitalisation we promised the European Commission we would completely leave the shipping business, so the €5bn portfolio that we began the year with is being actively reduced.
We also have a programme looking into our corporate exposure, trying to figure out our existing and future business, with a view to prioritising activities which we want to hold or expand.
As a result, the balance sheet has gone down, which means risk-weighted assets (RWAs) have also been reduced. Of course, this has got nothing to do with the corona crisis, but is simply driven by our plan and the commitments we’ve made to the European Commission and our shareholders to cut our balance sheet.
Do you have any visibility on how deferred loan payments and non-performing loans (NPLs) are likely to evolve?
For the time being everything that’s linked to government support is helping, so that means there is no massive deferral in loans so far. Of course definitions have now changed and a loan that is past due is different from one that’s been renegotiated under a national mortgage moratorium regime. Ultimately a full understanding of how how loans will perform will take time.
Nobody should be surprised when banks have to build up more provisions against their exposure to affected industries — such as for the automotive sector for example. The big car producers are probably not likely to face an immediate problem. But there is a question over their suppliers from the SME sector. Do these companies have sufficient reserves to survive for weeks or months with poor or even no demand?
There is also a question over consumer sentiment. In Germany we have around 10m workers on Kurzarbeit, which means short-time working. They get 60% of their net-salary, do not work full time and mostly stay at home. With so much uncertainty about the employment situation, demand for cars is likely to be poor for a while.
My personal view, is that a recovery is not going to happen quickly. People will really think much more carefully about their spending priorities compared to before crisis.
After the 'official end to the crisis', whenever that will be, you have to ask whether consumers will run off to the shops and spend as they would have done before the crisis.
There is a question as to how this change in behaviour will hit the economy. I’m a little bit surprised people are so optimistic that everything will return to normal by 2021. I’d be happy to see that, but I’m skeptical, as I think it will take longer to recover — which means banks may see renegotiated loans transition to loan deferrals and some loans may eventually end up as non-performing.
But as far as the Pfandbrief market is concerned, investor protection is high as loan-to-value (LTV) ratios are relatively low, especially in the residential sector. Homeowners’ first priority will be to pay down their loans — even in difficult times. Interest rates are low, and will remain low, so I see no reason to worry there.
It’s a slightly different situation on the commercial real estate side of the business, especially when you look at hotels, restaurants and shopping centres. There, the recovery will take a longer time, but again the LTVs are also low, so in reality there is no major concern.
Bank profitability is also poor due to low or even negative rates, but that’s a problem that existed before the Corona crisis. On the other hand, there is also good news for banks when you take accounts of the relaxation in regulations and cheap central bank funding that is easily accessible.
Most importantly, since the financial crises banks have built up their capital and liquidity buffers, so are now well equipped to withstand the crisis.
How has it been working from home?
Like other banks we are generally working in a split mode with two teams rotating in two week terms, in the office and out. Our markets division is also operating in split mode but without rotation. The idea behind this is that we are fully able to continue the operation if, in a worst case, the head office is hit by an infection. In addition to the HQ, we have another location on the outskirts of Hannover as a backstop.
This present modus operandi works quite fine — but it is not a long term solution. Colleagues in the home office say they don’t feel close enough to the market. On the trading floor there is a continuous flow of information from all the conversations being had by colleagues. Whereas at home its necessary to set up more calls and chats to be fully conversant with all the market dynamics, which is time-consuming.
But much also depends on the job you're doing. People responsible for legal documentation for example, can probably work more easily from home than traders. Let’s hope that it doesn’t take too much time until we get back to normal, whatever normal means.