Strategy comes into focus as funding challenges loom

Think what you will about long-standing weaknesses in the German banking system, for bank borrowers in today’s fragile environment a German post code is still among the most valuable commodities in the capital markets, especially in the covered bond space.

  • 28 Sep 2011
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Nevertheless, formidable challenges remain, even for banks in Europe’s largest economy. The market is still regarded as over-banked and too politicised. Profitability across much of the industry remains weak and question marks remain over the capitalisation of some banks.

In the EuroWeek German FIG roundtable, representatives from a broad cross-section of the country’s banks gathered to discuss the prospects for the sector in the context of a very uncertain outlook for Europe’s economy and its banking industry.

This roundtable took place in Frankfurt at the start of September.

Participants in the roundtable were:

Horst Bertram, head of investor relations, BayernLB, Munich

Jonathan Blake, managing director and global head of debt issuance, treasury, Deutsche Bank, Frankfurt

Dr Tammo Diemer, managing director and head of treasury, Aareal Bank, Wiesbaden

Gabriele Frediani, head of markets, MTS, London

Jörg Huber, managing director and head of funding and investor relations, LBBW, Stuttgart

Franz-Josef Kaufmann, head of capital markets funding, Commerzbank, Frankfurt

Mike Koerkemeier, head of financial institutions Europe — DCM, ING, Amsterdam

Hansjörg Patzschke, senior country manager, Natixis, Frankfurt

Oliver Radeke, managing director, head of financial institutions group, Germany and Austria, Deutsche Bank, Frankfurt

Franz Rudolf, managing director, head of financials credit research, UniCredit, Munich

Christian Scharf, head of FI origination, Germany, Austria and Switzerland, HSBC debt capital markets, London

Andreas Schenk, managing director and head of treasury, pbb Deutsche Pfandbriefbank, Frankfurt

Carsten Tegtmeier, senior director, investment banking and head of primary products, Norddeutsche Landesbank (NordLB), Hannover

Frank Teuber, head of funding execution and syndicate, HSH Nordbank, Kiel

Philip Moore, contributing editor, EuroWeek

EUROWEEK: Let’s start by talking about Germany. We’ve heard today that manufacturing growth ground to a halt in August and we’ve even had some people speculating that Germany’s triple-A rating may be at risk, which would have been unthinkable even a year ago. Is the world going mad? From what you’ve seen and heard, are FIG investors starting to worry about Europe’s largest economy?

Patzschke, Natixis: I certainly haven’t heard any news or rumours about Germany being downgraded. What we have seen throughout the recent crisis period when there was virtually no issuance is that in the context of a very volatile and uncertain environment, German public sector borrowers like KfW, Rentenbank and L-Bank still had access to the market. In this environment it turned out that German issuers and German credit is still regarded as the safe haven signature throughout Europe.

Tegtmeier, NordLB: Up to now it is as though we’ve been living on a very happy island. But at the moment, due to the very low interest rate environment, at the long end of the curve German borrowers are experiencing slight difficulties in finding sufficient investors. This is because if you look at 10 year Pfandbriefe they’re only paying a 3% coupon. At the moment, long term investors such as insurance companies and pension funds are looking for coupons of 3.25% or 3.5%. In search of those coupons they are looking at issues from some other areas believed to be safe, such as Scandinavia or France.

So Germany is in good shape but from a longer term perspective the very low interest rates we’re seeing at the moment could make it a little more difficult to fund ourselves because German rates are no longer attractive to investors. Or, it will take some time to get used to these levels.

Schenk, pbb: What you say is absolutely true for everything which is highly rated. But there are other banks, such as ours, which have a single A minus /triple-B rating, and for those banks on the unsecured side the only funding source that is open is the private placement market. In Germany we have historically had the advantage of this deep private placement market and a very strong bid for Schuldscheindarlehen. This is still the case, although compared to previous years even this market has slowed down a little. This is still very much a domestic market, however. We’re not seeing much demand outside Germany for these private placements at the moment.

Koerkemeier, ING: This is still an important advantage for German banks compared with issuers in other countries that don’t have such large domestic investor bases. In that respect I would agree with Carsten that Germany is a happy island.

Rudolf, UniCredit: Carsten mentioned low spread levels and the challenge this creates in selling to investors wanting more of a pick-up. But we have seen throughout the crisis that for covered bonds and all other asset classes the driver of demand has been the sovereign. Particularly in the periphery, the quality of the sovereign has been a more important consideration for investors than the issuer’s business model or collateral pool. In Germany we have the benefit that our sovereign credit is not regarded as a problem and we can use that as an argument for justifying lower spread levels.

This is also supported by other competitive advantages such as the Pfandbrief legislation and the huge size of the German investor base. When German bank borrowers come to the market, about 70% of each issue is generally placed with domestic investors. That is clearly a benefit compared with other markets, where that share is usually between 20% and 30%, or maybe 40% sometimes.

Bertram, BayernLB: What has substantially changed over the last couple of years is that, despite the fact that we still have a very efficient domestic market for senior unsecured, most if not all of us would be unable to fund in our domestic market the volumes which we were able to fund three or four years ago.

I believe the massive restructuring we’ve seen in the German banking industry, in some cases on a voluntary basis but in most cases on a forced basis, has meant that we are all funding less. It also means that we are all looking to diversify our funding sources, through using our retail networks for example. Our bank has a retail subsidiary with €32bn of retail deposits and we are now working to attract more deposits from corporates.

But on the capital markets side, the situation has dramatically changed, particularly in senior unsecured. In 2008, we issued €12bn or €13bn of senior unsecured. There’s no way that these volumes could be repeated in this market environment — certainly not at reasonable terms.

One of the reasons for this is that the German investor community has become more international in terms of the names it has been prepared to take on. Second, German investors recognise there is still an issue of over-concentration on domestic banks, which is a challenge that even some of the Pfandbrief issuing banks need to address.

I agree that the overall situation in Germany remains favourable. But in some ways it is also a tricky situation for banks, which still need to reduce the size of their balance sheets and funding programmes and work on increasing their earnings. The half yearly results we’ve had from German banks so far have not been very encouraging in this respect.

Scharf, HSBC: Many German issuers still benefit from the domestic bid, which in the past secured them significant volumes of funding at very compelling levels — particularly in senior format — and well inside what would have been achievable in the international markets.

I think Horst raised a very important point about a growing international focus of the German investor base. German investors are the most important primary investors in European covered bonds. Increased covered bond supply, in particular from France and Scandinavia, offers more and more investment opportunities for the German investor base. This in turn introduces a competing supply for the German jumbo and jumbolino issuers.

Huber, LBBW: We also need to define the German domestic market more precisely, because I think we’re now seeing a big split in the market. On the one hand there are the big institutions, which until a couple of years ago were mainly invested in Germany. They are now being forced to go overseas to diversify their portfolios where they can get much higher spread levels than by investing in German banks.

On the other hand, the smaller investors which have not yet started to diversify are still prepared to buy domestic paper at quite tight spread levels. But in the future I imagine these investors will also be forced to diversify more and more. This will create more of a level playing field in Europe and we will no longer have the benefit of these tight spreads.

EUROWEEK: Would you see this happening across the board — in Pfandbriefe as well as senior unsecured?

Huber, LBBW: It will probably be more applicable to senior debt than to covered bonds, because in the senior market investors can generate much more of a pick-up than in covered bonds, where spreads are so low.

Kaufmann, Commerzbank: What we have seen throughout the crisis, which seems to be gaining more importance today, is that country risk is back. If you are located in a country like Germany, with its solid high rating, you can bank on the support of international investors as well as on a strong home market.

We should also bear in mind that other considerations, such as a strategic business model, quality of collateral pools and the Pfandbrief law, all need to be put into the equation. But as I’ve said, in the peripheral markets country risk is now on the top line, and if spreads on those sovereigns move out they influence the other spreads as well. And this can even lead to a situation where you have covered bonds trading inside sovereign debt.

Teuber, HSH Nordbank: I agree that the market overall, and especially the senior unsecured market in Germany, is not as deep as it was before the crisis. This is strongly underlined by the shift in focus towards retail investors, which is still a very deep market for the Landesbanks.

Patzschke, Natixis: We all agree that it’s more difficult to fund in the senior unsecured market than it was three or four years ago. That’s no big wonder. But I think that in Germany the banks are very well positioned to fund in the senior unsecured market, although maybe not at the same terms and in the same volumes that they did in the past. Relative to some other countries, however, the situation here remains very favourable. Elsewhere in Europe, there are some very solid banks which are unable to fund in the senior unsecured market simply because of the country they are in.

Tegtmeier, NordLB: We’ve been looking at our funding books on the senior unsecured side, and at the moment we see relatively stable demand in this market. This means we don’t feel under any pressure to go into the market with a liquid benchmark issue. There are no big liquid new issues in the German senior debt market at the moment. This suggests that there is still a natural demand not just from retail but also from institutional investors, which may be because the spread on senior unsecured is now more attractive than it has ever been.

Without going actively to the market, every day we get demand of between €30m and €40m of senior unsecured across the whole curve at very attractive levels, which means we have no need to go to the market with benchmark issues. If I had to go to the market with a benchmark five year issue attracting international investors, for example, I would probably pay somewhere in the area of 120bp over swaps. In the day-to-day market I can access the same maturity at around 90bp. And €30m to €40m a day equates to between €6bn and €8bn a year, which is absolutely sufficient for our funding needs.

Of course, over the longer term the question is how the structure of the asset side develops in terms of the split between those assets that are eligible for the cover pool and the volume of business that needs to be funded through senior unsecured debt or some new hybrid instrument.

Patzschke, Natixis: This is a key point. Raising funding is not the problem. The bigger problem faced by many German banks is their lack of a real business strategy.

Schenk, pbb: Another important point is that you can’t assume your existing funding sources will remain available for ever. That means you must think about what your alternatives are on the unsecured side and ensure that you are always in a position to diversify into other funding sources. This is something we’re looking at and I’m sure many other issuers are doing the same. Even if we have a strong German market it is important to have this diversification in place.

EUROWEEK: Which alternatives are the most viable?

Schenk, pbb: That always depends on the business model of the banks. Those that have retail customers have the alternative funding source of deposits. But you can also look at secured funding if you have the right assets. That doesn’t necessarily mean structured covered bonds. There are many other solutions which allow you to create a structure with which to replace your normal unsecured funding, although not by 100%.

Koerkemeier, ING: The question remains whether the market for those alternatives is liquid enough and provides you with the volumes you need, especially if you don’t have a retail presence as a source of deposits.

Scharf, HSBC: I agree. Liquidity and volume in the wholesale funding market can only come via plain vanilla type products. Key is ongoing diversification across currencies, maturities and asset classes. Having such a diversified funding strategy will reduce an issuer’s reliance on one investor base, create scarcity and hence drive spreads lower. Furthermore, by hitting multiple markets an issuer doesn’t appear to be prolific versus were they to just issue a euro benchmark every two months or so.

Blake, Deutsche: A good portion of our funding activity this year has been accounted for by retail deposit gathering within the Deutsche Bank network, as distinct from Postbank, in which we recently acquired a majority stake. We are also a relatively recent entrant to the Pfandbrief market, and have issued €1bn in that market this year.

The difference in investor bases is something that the current crisis has really brought to the fore. Deutsche Bank is in the fortunate position of having access to investors in the US and Asia as well as Europe. Depending on the pricing and execution dynamics in each market, we have a number of alternatives available when it comes to funding the bank. That access is something we have built up over a long period before any crisis occurring.

EUROWEEK: The Deutsche deposit gathering programme is already well ahead of its target, isn’t it? What is the reason for this, given that the savings banks make Germany such a difficult market in which to compete for deposits?

Blake, Deutsche: I think the success of any deposit gathering activity depends largely on two key characteristics. The first is the rate you’re offering and the second is the brand standing behind it. Because of the strength of the Deutsche Bank brand, we don’t have to offer the highest coupon.

You’re right to say we’ve already met our target for the year for deposit gathering. We’ve now raised €7bn. As our funding requirement for the year is €26bn, you can see how important a source of funding this is for us.

Diemer, Aareal: Aareal is able to collect a significant amount of deposits without having an expensive branch network because we play the role of house bank to the German housing industry. Up to 15% of our refinancing sources actually come from deposits, which is a great competitive advantage for us.

I’d also like to point out that fixed income investors expect borrowers to have a diversified refinancing source these days. They’re not just looking for high equity ratios, better equity quality, a solid business model and a track record of good risk management — which are all important aspects. They are also demanding that borrowers are able to tap into a diverse range of funding sources.

EUROWEEK: Does that mean a broader investor base from a geographic standpoint or a more diversified range of funding instruments, or both?

Diemer, Aareal: It’s the domestic support that is the most reliable in challenging environments. So with our senior funding we definitely benefit from our footprint in the domestic market. Additionally, we enlarge our investor base with our premium product, which is the Aareal Pfandbrief, by encouraging demand from European investors.

Bertram, BayernLB: Over the last couple of years, for most of us it has been easy to get access to international investors via Pfandbriefe, even in foreign currencies such as US dollars, Swiss francs and sterling. But on the senior unsecured side, even offering to pay up quite a substantial amount we have seen times when US investors have been unwilling to buy senior unsecured bonds of some European banks at any price. You can access foreign currencies through cross-currency swaps, but as those of us who still live in the world of IFRS accounting know, a cross-currency swap can have a life of its own, sometimes up and sometimes down.

So while we can all access senior unsecured in euros at acceptable terms, the big challenge for most of us — excluding a bank like Deutsche which is clearly a global player — is accessing senior unsecured debt in dollars or sterling.

Radeke, Deutsche: I’d agree with what’s been said so far, which is that on the one hand we have a very deep domestic market, which every bank is using to its advantage. On the other hand there is a strategy at most banks of deleveraging and de-risking the balance sheet and adjusting the business model.

That also means that banks are having to realign their funding strategies. As has been said before, the more diversified your access to funding is, the more flexibility you have in responding to certain stresses.

One of the biggest challenges German banks are facing is to think about how and at what price it is sensible to diversify their investor base, and how they should address the issue of funding in foreign currencies. A large share of the Landesbanks’ balance sheets, for example, is US dollar-denominated and they have no natural US dollar funding, which is one of their biggest challenges. Before the crisis of the last few weeks, this was an area that many of the banks have tackled in the sense that they have formulated a strategy. These banks are now emphasising much more than they were before the crisis of 2008 the need to secure access to dollar funding.

EUROWEEK: Jörg, LBBW re-opened the dollar covered bond market last year, didn’t it?

Huber, LBBW: Yes, and this is one area that is quite important for us. We agree that the domestic investor base is the strongest and one that we rely on very much. But there is a bit of a question mark about whether that will be there for ever. So we have tried to start diversifying with our Pfandbrief issues, which at the very least helps to get investors worldwide comfortable with our name. This is why we try to issue frequent transactions in dollars.

We issued dollars in the US once this year, with a one year transaction, and we have also done a couple of Reg S transactions this year and last. This has allowed us to reach investors that we would not normally have in a euro transaction.

EUROWEEK: Presumably US investors are looking for assets to make up for the diminishing supply of GSE paper and bank debt?

Huber, LBBW: They are, and what is especially interesting for us is that they tend to focus on the diversification opportunities offered to them by German assets. They also look in great detail at the cover pools of German issuers.

Rudolf, UniCredit: An interesting point is that the process of diversifying their investor base internationally improves the quality of banks’ disclosure policies. US and Asian investors tend to look much more deeply into the contents of the cover pool and the state of the housing market than domestic or European investors do. Because they are less familiar with the product as well as the region, investors from outside Europe drill down to the nitty-gritty stuff much more.

Scharf, HSBC: US investors are cash rich and looking to diversify. But these new investors to the covered bond sector are very thorough in their approach to the product. In order to come to the right relative value assessment, investors not only examine the issuer and the cover pool but also consider sovereign risk and secondary trading levels of relevant agencies.

EUROWEEK: International and local investors may also have different expectations and requirements in terms of liquidity. Gabriele, would you like to comment on how you see the secondary market in German FIG bonds developing?

Frediani, MTS: Yes. As I run MTS, which is an electronic trading platform, I can be quite neutral in my assessment of the market. Someone mentioned that this is a happy island and I think it is a very refreshing market. Clearly, the work that German borrowers have done among the investor communities both inside and outside Europe has given them a head start over borrowers elsewhere, which are desperate to do the same.

My angle is liquidity in the secondary market. In the old model, investors saw secondary market liquidity from the banks which won the mandates from the issuers. Since 2008 that model hasn’t been working in the covered bond market, nor in the corporate bond market. Even more worrying, it hasn’t been working in the government bond market, which is a space we know pretty well.

We’ve heard that there is a shortage of investors because of low coupons. But the need for paper on the Pfandbrief side is tremendous, not least because covered bonds enjoy preferential treatment under Basel III. Every time new regulation comes out on liquidity, covered bonds are very much in the spotlight. But the concern we have is that we don’t see much liquidity in the secondary market; or rather that the liquidity we see is not tangible. That is arguably a problem for investors in the secondary market.

EUROWEEK: Is that as true for the jumbo Pfandbrief market as for other European covered bonds?

Frediani, MTS: Yes. I’m not saying trading doesn’t happen on a B2C basis or by phone. But there is no more electronic visibility, and that is why in France the Cassiopee project was launched under pressure from ex-finance minister Christine Lagarde to make markets more transparent in order to help lower the cost of funding. That’s obviously not an issue in Germany today but it could become a problem very quickly.

We responded to specifications put forward by the Cassiopeia Committee and have worked closely with buy-side investors to develop an all-to-all electronic market, MTS Credit, for euro-denominated non-government debt, including covered and corporate bonds. When this is launched later in the year, we believe it will meet the specific need for an electronic trading venue offering efficient access to liquidity and price transparency in this market.

Koerkemeier, ING: The reason we don’t see so much secondary market liquidity is two-fold. One is that the natural buyer of covered bonds is a buy and hold investor who doesn’t necessarily need liquidity.

The other point is Basel III and the fact that banks are buying covered bonds as liquidity buffers. Most of the banks are happy to keep these assets on their books and don’t see the need to trade them. So I understand why you say you see so little liquidity in the covered bond market. The question is: do investors really need that liquidity?

Huber, LBBW: There’s also another element arising from what we see in the primary market. Until 2007, in order books for jumbo Pfandbriefe it was not uncommon to see ticket sizes of €50m, €100m and even €200m. Today, order books are much more granular. We have many more individual tickets, and those investors who used to put in €200m tickets are still in the books, but usually with maximum bids of €50m. There is some liquidity in these smaller ticket sizes, but obviously much less than there used to be.

Schenk, pbb: Everybody likes to talk about the jumbo Pfandbrief market, but my guess would be that every issuer around the table is doing more private placements than jumbo Pfandbriefe. Therefore there are many investors out there who don’t really need liquidity. This supports the deep private placement market which is a big competitive advantage for the German market.

Bertram, BayernLB: In response to what you were saying about low liquidity on the trading platforms, one of the things that definitely changed over the past three years is that issuers themselves have been forced to play a more active role in market making for their own instruments. If you have a long-standing loyal investor who for whatever reason wants to get rid of his 2013 or 2014 bond and move into a 2019, you as an issuer have to be there with a bid.

Both the German and the international investor base are much more demanding these days in this respect. They want issuers to play a more active role in their own issues, not just on the private placement side but also sometimes on the jumbo side. This is business that has probably migrated away from electronic platforms in recent years.

Patzschke, Natixis: But liquidity between banks and customers is still fine, because customers get good prices on both the bid and offer side with clear electronic bids from several banks. There we need to differentiate between issues that banks can still trade in, such as German Pfandbriefe, and others such as certain peripheral issues where liquidity is of course declining.

Tegtmeier, NordLB: What we have learned is that there is a stronger focus on solid placement in the primary markets. In other words, it’s an investor’s market. Nobody, not even the biggest houses, is willing to take residual lots of €50m or €100m on their books. This means that issuers are having to pay 2bp or 3bp more and none of the big houses has any trading positions left on their books.

I agree with our friends at MTS that what is missing is secondary market transparency. Every issuer is therefore well advised to make solid secondary market quotes to investors.

But unfortunately we don’t see many of those quotes in the day-to-day market.

If you go back a couple of years ago, a number of the big trading houses would often be left with €10bn or €20bn of covered bonds on their books at the end of the day. That is no longer the case. The question is: is this a positive or a negative sign? I’m quite happy with a situation in which the bigger proportion of any issue you bring to market ends up directly in the hands of the investors. But I agree that that is a very different story to what we had two or three years ago when you could trade lots of €50m or €100m in covered bonds with any banker on the Street.

Frediani, MTS: I agree with all the points that have been made around the table. The old MTS with a market making obligation and a thriving interbank market isn’t going to come back. I’m not trying to suggest that it should. We even question if that sort of model will survive in the government bond space.

But the fact is that there is no visible liquidity, and even on the B2C platforms — one of which we own — liquidity levels are a concern. When we talk to investors, liquidity is one of the decision-making factors they mention to us.

There are fewer banks active in the market than there used to be. Playing in the secondary market can be a dangerous game to play and I’m not pointing a finger at anybody. Five years ago there were probably too many houses offering too much to the issuers in terms of liquidity.

Radeke, Deutsche: A common theme for the last three or four years now has been deleveraging, not just on banking books but also on trading books. The positions that banks are taking on are getting smaller in every product. I therefore think it’s difficult to judge whether there is now less liquidity in Pfandbriefe versus other comparable products. I also think that investors are now becoming comfortable with benchmark issue sizes of €500m instead of just jumbos because balance sheets are shrinking and issuers are looking to diversify their maturity profile, too.

Huber, LBBW: In the past everybody assumed that liquidity meant they could get out of their positions if they needed to. But when markets shut down that became impossible and prices even for triple-A paper fell to levels which had not previously been foreseeable.

Nowadays we’re all discovering we can live pretty well without this liquidity. The difficulty now is that investors have money that they need to invest, and borrowers need to borrow. We need to find an equilibrium between the two in terms of pricing.

The new issue premium in the market today is huge, although this is not a good reflection because the secondary market is so slim it’s impossible to use it as an accurate pricing benchmark.

But pricing has also been made more difficult because the market whisper mechanism has gone. This worked very well for investors because they need the confidence that there are other investors going along with them at the same kind of level. Because this has gone for the past two months, new issues are sometimes priced at a wrong indicative price and therefore have to be re-priced.

This is not very positive for the primary markets because next time investors will hesitate to come in again.

Scharf, HSBC: Lack of liquidity is highlighted on a regular basis by issuers and investors alike, but we are in a very different world now. Many issues are only €1bn these days, investors’ tickets tend to be much smaller, and many investors are now more buy and hold accounts; hence, it is not so surprising that liquidity has reduced. Once we have a more robust market backdrop I suspect that liquidity will pick up as we see more supply. Furthermore, we are increasingly seeing liability management used as a tool to generate momentum for new issues, with issuers being prepared to bid back bonds in order to enable investors to extend duration in a name.

Rudolf, UniCredit: There are two other points to consider with respect to liquidity, which are the maturity and size of the bond. A 10 year covered bond that is liquid at the beginning won’t stay liquid for the whole 10 years of its life. Liquidity dries up over time.

It also makes a difference if it’s a €300m or €3bn covered bond. With rating agencies pushing for more asset-liability management it makes sense to issue in smaller size, which also has an impact on secondary market liquidity.

Schenk, pbb: I don’t just look at size from an asset-management perspective. I also look at it from an operational point of view. A few years ago there were several Pfandbriefe of €3bn or even €5bn outstanding. These days, I prefer smaller issues because I have no way of telling what the market will look like when the bond matures or if I’ll be able to refinance it. With a reduced balance sheet it makes sense to have a more diverse maturity profile and smaller transactions outstanding.

Frediani, MTS: One last point on liquidity is that the fact that there is no tangible liquidity has a very negative impact on the repo market. If you close your door on the repo market you also risk closing the door on the funding market, which is another of our concerns.

EUROWEEK: Let’s put Pfandbrief liquidity to one side and talk about some of the longer term structural issues facing the German banking industry. We’ve touched on deposits and on business models. Is the central issue that we remain in a transition period as German banks search for more durable and profitable business models?

Bertram, BayernLB: The business model not only of the German banks is changing. Some are under pressure from the European Commission to become much more nationally oriented players. Ultimately that won’t help to address one of the issues we have in the German market, which is that it remains a very friendly market from the perspective of the users of banking services, be it retail customers, SMEs or large corporates.

Competition in the market means that margins have not improved for the banks. I think the only time recently that the banks enjoyed a profitable period of lending to corporates was in the first half of 2009 but it lasted no more than five or six months. Margins are currently OK on a risk-adjusted basis because the German economy is doing well and loan loss provisions are relatively low. But the long term trend is that intense competition, which shows no sign of changing, is still putting pressure on lending margins.

German banks’ balance sheets are becoming smaller and at the same time we are seeing heightened competition from local and also foreign banks, more of which are coming into the market for large corporates.

I believe a lot of banks have readjusted their ambitious targets in terms of return on equity. If you exclude the global investment banks like Deutsche, which no longer counts as a German bank, a 10% return on equity before tax is seen as quite a reasonable result these days.

Scharf, HSBC: Yes, the size of many German banks’ balance sheets is decreasing, but I think that there are business lines of German banks with interesting RoE opportunities. Worth mentioning is the commercial real estate business and I think that the retail business – even in the strong German competitive environment – can generate sustainable and interesting RoEs with the right products and distribution strategies. And we are seeing new players entering and growing in the retail market.

A major reason for the balance sheet reductions is the decreasing size of public sector business and the reduction of investment.

Diemer, Aareal: I disagree in part with your observation. I think competition in the German banking industry has always been quite intense. This is one of the reasons why Aareal decided at a fairly early stage to diversify out of Germany and has been acting as an international property lender for the last 20 years.

That has been one key success factor in our story. The share of new business we generate in Germany is around 10% a year. Our business model proved to be successful throughout the financial crisis. As a result we haven’t adjusted it and the size of our balance sheet has been pretty constant.

Tegtmeier, NordLB: I agree that there is a need to adjust business models and to a certain extent that is very visible throughout the German banking industry. Many of us are downsizing our balance sheets. Others are pulling out of businesses that are no longer profitable.

But we just heard mention of the so-called SME business. The first problem there is it brings you into competition with the savings banks, the co-operative banks and most if not all of the Landesbanks. It’s also an area where you compete with Commerzbank and Deutsche Bank. So the question there is how strong is the competition and from a longer term perspective can you really expect to earn worthwhile risk-adjusted margins in that business?

On the other side, what some banks — including us — are doing is looking at the different groups which are sourcing assets. We are trying to set up a sort of incentive scheme to make sure that we get more assets on the balance sheet which over the longer term we can refinance through Pfandbriefe or Pfandbrief-style issuance.

Most banks are focusing these days on the quality of their assets. Even if at the moment it’s difficult to earn higher margins on them, because so many banks are reducing the size of their balance sheets, it is becoming possible to do more cherry-picking. That’s not an expression I like using, but as some of our competitors have either disappeared or are reducing their activities, there will be a trend towards slightly higher margins and better quality on the asset side. This is a trend that we have started to see and which will accelerate in the foreseeable future.

Also, I’d like to come back to this very nice idea of deposits. Deposits are fantastic for short term liquidity. But what is more important is to have solid long term funding, because whether you’re talking about the savings banks or the Landesbanks or Postbank or even Deutsche Bank, most of the deposits they attract are short term. They’re not three or four or five year deposits. So the question for the future is how we can succeed in match-funding our asset activities with the same maturities on the liability side?

Paying 3.5% plus a bonus for one year deposits is all very well. But it’s not a business model, because next time if another bank pays higher rates or offers other incentives, the customer moves on to the next bank.

EUROWEEK: But you haven’t yet seen in Germany the sort of cut-throat deposit wars we’ve seen in markets like Spain, have you?

Tegtmeier, NordLB: No. Since the beginning of the crisis after the Lehman default we have seen stable deposit volumes. Of course some investors have been buying gold, but the German government’s reassurance that savings would be safe has helped to stabilise the market.

Diemer, Aareal: You need to build a relationship with your depositors, ideally a business relationship. In our case, the relationship is so deep that these deposits turned out to be very stable over the last few years.

Bertram, BayernLB: Carsten raised a very interesting point. All of us have tried to make our balance sheets more liquid and ensuring that everything can be refinanced through the Pfandbrief market is a huge advantage. Some banks are discussing the possibility of structured covered bonds for SME or corporate loans. I’m not sure about how that discussion is progressing, but by slightly amending the documentation of loans to large corporates it may be possible to make them repo-eligible with the Bundesbank or the ECB. It would take quite a while but it’s doable and would help to make balance sheets much more liquid.

On the funding side I think we are seeing a bit of a deposit war, even in Germany. Some banks have shown that they are willing to offer corporate clients levels that most of us would not like to pay.

Blake, Deutsche: Clearly, Basel III has put the subject of deposits more into focus. But more specifically, I would make a distinction between corporate and retail deposits, which have very different stickiness characteristics, depending on the client relationship.

It will be easier for banks with a retail franchise, such as Deutsche Bank, particularly, following the acquisition of Postbank, to raise any additional long term funding required. As we know, Basel III requires a higher amount of long term funding and in the absence of a deposit base most investors will charge you increasingly expensive rates for your senior unsecured funding.

So in summary we think the Basel III changes point to the validity of the universal banking model.

Huber, LBBW: But is this retail money really that sticky? Deutsche has raised €7bn of retail deposits. That money can’t have been very sticky for the banks where it was previously deposited. I would agree with Tammo that the really sticky deposits are from corporates. Retail customers are younger and more used to shopping around for the best rates on the internet.

Blake, Deutsche: Corporate investors are by definition professionals, so they will very quickly move to the highest bid. As far as the retail investor is concerned, a lot depends on how you acquire him. If you do so through your branch network or through other kinds of retail products it tends to be more sticky than if you acquire him through an internet platform. Our model is the former. This is not to say the latter can’t work but there is a difference in terms of stickiness.

Koerkemeier, ING: Speaking on behalf of ING DiBa, which is ING’s direct banking platform, I can only echo what Jonathan has said about deposits. We have also seen a stickiness of retail deposits and little sign of retail depositors actively looking for other homes for their money.

EUROWEEK: To what extent have other foreign banks looked to move into this market? I notice that ICICI has set up shop in Frankfurt, and Crédit Mutuel bought Citibank’s retail operations here a few years ago. So foreign banks obviously see some potential in Germany, which is a notoriously difficult market to break into.

Huber, LBBW: Santander has also targeted this market and is now quite a big player. So yes, in the retail market foreign banks are coming in and in some case building up quite successful business models.

EUROWEEK: On the funding side, we haven’t spoken about securitisation. I believe Deutsche Bank recently launched the first German CMBS since the crisis. Is this a market that is likely to be revived in Germany?

Patzschke, Natixis: RMBS and CMBS will continue to be seen as exotic instruments in Germany, I think. The Pfandbrief sector is the big market for collateralised funding and will continue to be so.

On the other hand, if we’re talking about consumer or auto loans, that’s a completely different story. There’s a lot going on in this market. In comparison with other European countries the German market is quite significant in this area. Given the size of the domestic market it definitely makes sense to develop the market for securitisation of consumer and auto loans.

Rudolf, UniCredit: Given the dominance of the Pfandbrief in Germany and the funding advantage it creates compared with securitisation, I think the revival of the market will take some time. The benefit of securitisation is the flexibility it gives you regarding the underlying collateral. Although we’re unlikely to see much in the way of RMBS, in certain other asset classes such as SME loans, securitisation techniques can be used.

Radeke, Deutsche: Outside of the areas already discussed, it is worth noting that the securitisation market in Germany has never been used primarily with regard to funding operations. It has been used more in synthetic trades to manage risk positions. Most of the leading banks have continued to use securitisation in this way and I think the technology remains valid for risk management purposes. It could also even become a valuable additional source of funding, because for certain banks, issues backed by loans might make sense pricing-wise or as a way of further diversifying their term funding.

For Pfandbrief issuers there is already a discussion about how they can use their over-collateralisation to hold against Pfandbriefe either from a legal or ratings perspective. So I think we will see asset-based funding playing a role in Germany, but not in the same volumes as we see in markets like the UK or the Netherlands.

Schenk, pbb: We may see securitisation take a different form compared with what we have seen previously in Germany. In the past, everything was transferred to an SPV, which issued the paper. This meant you only had recourse to the assets. Now we may be moving to a model where you have recourse both to the assets and the issuing bank, which is more like a secured funding than a traditional securitisation. We may not see this in benchmark size but it could be a useful addition to our funding sources.

Diemer, Aareal: We expect there to be concerns among investors about structured funding tools of the kind you describe. We also suspect that they may not be cost efficient for the issuer. This is why Aareal relies on traditional refinancing tools ranging from Pfandbriefe to senior unsecured debt and deposits, all of which are established, straightforward products.

Patzschke, Natixis: We shouldn’t forget the investors here. If you securitise everything you have on your asset side, it may create risks for senior unsecured investors.

Diemer, Aareal: Exactly. Pfandbrief issuance in our case equates to about one third of our balance sheet. Actually, we view up to 40% as a healthy ratio.

Scharf, HSBC: This is an important point. I agree that the German market will stay with the Pfandbrief funding concept and that securitisation will only play a minor role in the medium term in the German market. Any other collateralised funding concept beside the Pfandbrief will be observed very sceptically by the market. Investors’ perception has changed and nowadays they look at whether certain collateralised funding transactions undermine the unsecured standing of the banks. This is by the way an important discussion among US investors with regard to their own covered bond law.

Tegtmeier, NordLB: I think the prospects for securitisation depend on the gap in funding costs between senior unsecured and Pfandbriefe. At the moment this is still relatively narrow but my personal view is that securitisation will make sense for assets like SME loans but without any kind of tranching. Investors will see one tranche, rather than senior, junior and equity pieces. The question then will be what kind of rating will investors expect for this new asset class and what level of over-collateralisation is then necessary for the rating agencies?

If it’s too close to senior unsecured funding the structure won’t work from an issuer’s perspective. Or the other way round: if you find a structure which in the view of the investor is as secure as the Pfandbrief, then you start to cannibalise that market. If a German institutional investor is offered a five year Pfandbrief at 20bp and a similar single-tranche ABS structure offering a return of 50bp, why should be buy the Pfandbrief?

Huber, LBBW: If you take SME loans or whatever, and structure them in a similar way to a Pfandbrief with a soft bullet structure to reach a triple-A rating, the investor base might be different. That might allow you to establish a product which sits in between senior and Pfandbriefe.

Diemer, Aareal: I would like to emphasise that in the case of German Pfandbrief legislation, the Pfandbrief investor and the senior investor rank pari passu. The picture that has been painted of the Pfandbrief investor being senior is wrong. He or she has preferential access to a high quality pool of assets, yes. But any surplus out of the Pfandbrief business is in the hands of the senior investor.

EUROWEEK: Moving to the question of capital, we can’t really ignore the issue of the stress tests and, more specifically, the decision by Helaba not to participate. Was Helaba’s argument about silent participations supported by other Landesbanks?

Radeke, Deutsche: That’s a difficult subject to discuss while the issuer itself is not here. The devil lies in the detail because it is a legally complex subject that which was discussed intensively behind closed doors, I guess.

In general the stress tests revealed some unsurprising results. On the other hand some of the German banks addressed issues such as the silent participations before the stress tests.

But I believe that it is Basel III, and the changes in capital and liquidity rules, that will ultimately change the business models of banks in Europe. That is particularly relevant in Germany where we only have three listed banks — Deutsche Bank, Commerzbank and Aareal — all of which are sitting round the table. None of the others yet have access to all capitalisation tools.

An important issue going forward for all German banks will be shaping up their business model so that they continue to be able to access liquidity. Before the crisis, when German banks went around the world collecting assets, the liquidity they needed was always available. Now the structure of balance sheets will increasingly be driven by the liability side, and banks will only be able to acquire assets they know they can refinance.

The business model will also be driven by how much equity banks need and where they will get it from, which is the biggest challenge many German banks will face.

EUROWEEK: Would any of the unlisted banks like to come in and explain where they will get their equity from?

Bertram, BayernLB: The easiest answer to that is that banks should be able to increase and strengthen their capital base through retained earnings. That is where the German market has suffered for so many years. German banks historically went repeatedly to the capital market and there must be a question mark over how equity investor-friendly all those capital raisings were. The biggest challenge is to increase and maintain profitability.

Huber, LBBW: What we’re seeing for the time being from banks which don’t have access to the equity market is that they are freeing up capital by shrinking their balance sheets. When it comes to the question of retained earnings it then depends on whether a bank’s business model is valid under Basel III, because the constraints of the new regulation are quite big. We used to operate with tier one equity of 6% or 7%. Now we need more than 10%.

At the same time margins aren’t very different from what they used to be before the crisis. So when the size of balance sheets has been reduced to the point where we have sufficient capital ratios, the extent to which banks are able to pay their owners and at the same time to keep their retained earnings will remain to be seen. It certainly won’t leave much room for growth.

Tegtmeier, NordLB: The discussion with the EBA about capitalisation in general has had one positive effect. This is that all the banks involved are doing more on the equity side. We are all faced with the struggle about what qualifies as capital, and we are all familiar with the discussion about whether or not loss-absorbing silent participations are capital. The German regulator has its view on that topic and so does the Basel committee.

The next step that I see happening is that after a while, when all the banks have more capital, the rating agencies will announce that we need a higher return on equity, because if we have more equity we should be doing more business. Then the cycle begins again and we’ll all be sitting around a table asking what business we can do with no risk and higher return.

So I repeat: the positive thing that came out of the EBA stress tests is the recognition among banks that they need to do something about their equity levels. All the banks I know are working very hard to develop solutions on the capital side.

Scharf, HSBC: I think that for the German unlisted banks the concept of non-voting capital will still be important due to the corporate governance of these banks. I agree with what was said: unlisted German banks need to rely more on retained earnings in future. In addition, the hybrid capital – or additional T1 capital – market will be very important for these institutions. In this respect the development of efficient additional tier one concepts for the overall German banking market and in particular for the unlisted banks is very important.

EUROWEEK: Frank, how has HSH Nordbank dealt with the issue of silent participations?

Teuber, HSH Nordbank: At HSH we exchanged all our silent participations held by our owners into ordinary shares long before the EBA stress tests. From today’s perspective, there is no need for us to raise capital.

EUROWEEK: Coming back to the Helaba story, how much agreement was there with Jochen Sanio when he was quoted as saying that "without any legal authority, not to mention legitimacy, the EBA has knitted together a new definition of equity capital"?

Huber, LBBW: Silent participations are not comparable from bank to bank. Each bank has a different set-up.

But I think the bigger problem is that this issue was not addressed beforehand by the government, which talks directly to the EU, but has not done much over the last couple of years to support the cause of the co-operative banks or Landesbanks.

Bertram, BayernLB: A reasonably large number of German banks have clearly said that they are not entirely happy with the constraints issued by the EBA. One question raised by some banks is: why does the EBA use a capital regime which is not yet legally in place, given that Basel III has yet to take effect? Why do they assume that banks’ balance sheets will remain static for the next couple of years? And why do they assume that portfolios of poorly-rated ABS will remain on the banks’ books despite known maturity dates?

Tegtmeier, NordLB: One of the other problems was that the EBA kept changing the rules on the stress tests. They even changed them in the week leading up to the deadline, which sometimes made it impossible to have a clear overview of what the current guidelines were.

Did this harm the market? No, because at least the German investor base buying this sort of debt was perfectly aware of the funding discussions that were going on with the EBA, and was happy to look at banks’ capitalisation on the basis of the German regulator’s existing legislation. So nothing really happened on the funding side. I’m not aware of any German bank facing funding problems since the results of the stress tests were published.

Blake, Deutsche: I have some sympathy with Helaba’s position and with Jochen Sanio’s comment because ultimately a bank can only manage itself in accordance with the rules set out by its regulator.

Having said that, if the EBA hadn’t done what it did, the stress testing exercise would have been less successful than it was. The EBA has been subjected to a lot of criticism for being too lax in terms of write-downs and so on, and when it came to a definition of capital I don’t think they had any alternative but to take the most restrictive one. That clearly hurt those banks that had been using other forms of capital.

EUROWEEK: Looking at the question of capital from another angle, as one of the leading SIFIs, what impact would the additional capital requirement under the proposed SIFI guidelines have on Deutsche Bank?

Blake, Deutsche: It seems highly likely that Deutsche Bank will be a SIFI. Now, we have already made a commitment to reaching a core tier one capital ratio in excess of 8% by 2013, and we will comfortably meet additional SIFI requirements under the terms of the phase-in.

This effectively means that the SIFI rules formalise a buffer that we would probably have held anyway. So the quantum of capital that we will hold is unlikely to change.

EUROWEEK: How will it affect the Deutsche business model? A Morgan Stanley report on this subject says that "many of the top 25 banks could approach likely G-SIFI standards in the next 3-4 years, but at the cost of dividends, returns or, critically, through more aggressive deleveraging. The latter is the key risk we see to economic recovery and RoE". That’s quite a strong comment. Is this a risk for Deutsche and Commerzbank?

Blake, Deutsche: If you look at Deutsche Bank’s balance sheet it has undergone significant deleveraging since 2007. The Global Markets balance sheet is in excess of 40% smaller than it was at its peak during the crisis, although the returns it is generating are actually quite comparable to what they were previously.

Furthermore, from a capital perspective we’ve always been quite cautious in terms of avoiding excessively over-capitalising the bank. As some people around the table have already commented, at some point the pendulum will swing and the focus will no longer be on banks having the highest core tier one ratio but on those with an acceptable RoE. That is only achievable if you manage your capital base prudently.

EUROWEEK: Commerzbank will also be a SIFI, won’t it? Franz-Josef, how will that affect you?

Kaufmann, Commerzbank: This decision is subject to the supervisory authorities. One of the questions that arises in the SIFI context is to what extent a higher capital hurdle may affect business models. Then we have to ask what the market will expect? Will markets differentiate between SIFIs that need to maintain a core tier one capital ratio of 10%-plus and the second camp of banks that could probably run with 2% or 3% less than this group of banks?

I personally have doubts that the market will differentiate very much in this sense. So regardless of whether or not you’re a SIFI, we may see that the markets will still ask for a certain amount of capital.

I agree with Jonathan that some banks need to adapt their business model to the new requirements, also resulting in a need to deleverage. Commerzbank for example has scaled down its balance sheet, and we have already done a pretty good job in downsizing and de-risking.

But clearly looking forward you need to run a business model that allows you to generate a return with the higher capital you need to hold in order to run your business profitably across the entire bank.

Bertram, BayernLB: I think the jury is still out on whether or not it’s desirable to be a SIFI. From an equity perspective it may not be attractive to be a SIFI. But as banks are so dependent on their debt investors they may consider it worthwhile to pay an insurance premium for SIFI status.

Kaufmann, Commerzbank: I agree that the question of whether the SIFI status is favourable has to be seen from different angles. The perspective of your debt and equity investors has to be taken into account, then possible funding advantages come into play, and of course the standpoint of your clients is crucial. You can also look at it from a management and employee perspective, regarding the attractiveness of a SIFI as a company to work for.

The first natural answer is probably that a SIFI needs to hold more capital, which means it has a lower return on equity, which in turn will hurt the dividend payout. But the questions raised are much wider. It is very important to understand at an early stage what being a SIFI really means and which aspects need to be taken into consideration when forming ultimate views.

Bertram, BayernLB: Did you conclude that your funding will be cheaper as a SIFI and your rating will be higher?

Kaufmann, Commerzbank: Those are two of the many questions one has to ask, and the answer from my point of view is: not necessarily.

Bertram, BayernLB: But as a SIFI you have more reason to believe you would be bailed out in the event of difficulties, which is important for your stakeholders.

EUROWEEK: Which suggests that moral hazard and too big to fail are back?

Diemer, Aareal: Another consequence is that it is equally important for banks that aren’t SIFIs to have a very solid capital base. Oliver mentioned that Aareal, Deutsche and Commerzbank have all already completed successful capital increases. The result in our case is that Aareal already has a common equity capital ratio above 10%.

EUROWEEK: Oliver, you made a very interesting point when you said that business model development will be driven by Basel III. I know this is a question we’ve been asking for the last 20 years, but will the regulatory changes coming in lead to accelerated consolidation in the German banking industry? Presumably SIFI militates against consolidation by making capital requirements higher for larger banks?

Radeke, Deutsche: You mentioned too big to fail, and when the heads of state met at the G20 in Pittsburgh they said they wanted to prevent the creation of these entities. What we’re seeing now in many countries is that banks aren’t necessarily getting smaller as a result of Basel III. In many cases they are getting bigger.

Consolidation has happened in some cases in Germany — look at Commerz and Dresdner or at Deutsche and Postbank. Some Landesbanks have also merged, with LBBW buying Landesbank Rheinland-Pfalz and Sachsen LB. It’s very difficult to bet on how much more consolidation we’re likely to see. Indeed, we may even see some deconsolidation with some banks being privatised or re-sold in order to comply with the rules on state aid.

Overall the question will be: how competitive is each bank in its market? And that again comes back to the question of how banks capitalise their balance sheets. That might lead to mergers. But I don’t think mergers will necessarily solve any problems, because without naming names, two Landesbanks merging won’t necessarily make it easier for them to raise capital.

EUROWEEK: And it might even make it more difficult.

Radeke, Deutsche: That’s probably true.

EUROWEEK: Has there been any change in the political temperature in terms of commitment to maintaining the status quo in the German banking industry? Moody’s recently drew attention to "concerns that the relatively high systemic support assumptions factored into the long term debt ratings of Germany’s public sector banks may be challenged in the context of weakening political will to support bank bail-outs".

Tegtmeier, NordLB: I think that at the moment the politicians have many more severe problems to worry about. We’re no longer talking about a banking crisis. We’re now talking about a sovereign crisis. So the discussion about whether one banking pillar makes more sense than another or whether one bank has €1bn or €2bn more or less capital is not the main topic on the political radar.

Bertram, BayernLB: I don’t believe this view of Moody’s is shared by the banks’ owners; nor do I believe it to be representative of the market view. Most of the owners have made it clear to the agencies that they are fully behind their institutions. If we were to have another crisis in two or three years time, the priority for most of the owners will be on repairing their banks rather than letting them go bust.

Although Germany has done a lot from a legal perspective to make the winding-down of banks possible, I believe that owners will ultimately continue to stand behind the banks. This seems to have been ignored by some of the rating agencies.

Rudolf, UniCredit: I don’t think there is any political will to dismantle the three pillar system of German banking. But we now have nine Landesbanks and if we imagine what the banking system will look like in a few years time we will probably have fewer than that. But the existing system has proved to be very stable.

EUROWEEK: Is there still a very strong regional flavour to German banking?

Huber, LBBW: In the Landesbank sector, not really. Landesbanks are naturally strong in their home region, but none focuses purely on that area. If they see opportunities in other areas they certainly look to take advantage of them. We’ve been doing this for years, which is why we have offices in cities such as Düsseldorf.

Teuber, HSH Nordbank: This may be in contrast to what the European Commission is requiring. In our case, it is requiring us to focus more on the regional side again. As a major bank in the north German area this is the area where we are focusing most of our attention.

Schenk, pbb: The European Commission has also approved our business plan, which very clearly does not focus purely on Germany. Our international business remains a very important part of our business model.

EUROWEEK: HansJörg, what is your view on the prospects for consolidation in the German market over the next few years?

Patzschke, Natixis: The discussion about consolidation in the German banking system is a very old one. I agree with Franz that we will see fewer Landesbanks in five years than we do today, but I won’t bet on the number. I also agree that the three pillar system is a good and solid one, and to the best of my knowledge there are no plans to change it. u

  • 28 Sep 2011

Bookrunners of International Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
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1 Citi 68,616.74 313 9.80%
2 HSBC 62,421.06 355 8.91%
3 JPMorgan 58,555.18 253 8.36%
4 Deutsche Bank 32,702.37 137 4.67%
5 Standard Chartered Bank 30,732.40 217 4.39%

Bookrunners of LatAm Emerging Market DCM

Rank Lead Manager Amount $m No of issues Share %
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3 HSBC 15,707.62 42 5.64%
4 Bank of America Merrill Lynch 12,634.55 50 4.53%
5 Santander 11,584.64 45 4.16%

Bookrunners of CEEMEA International Bonds

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1 JPMorgan 26,997.79 92 6.61%
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4 Deutsche Bank 10,385.92 29 2.54%
5 Standard Chartered Bank 10,214.05 48 2.50%

EMEA M&A Revenue

Rank Lead Manager Amount $m No of issues Share %
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5 Citi 95.36 35 5.16%

Bookrunners of Central and Eastern Europe: Loans

Rank Lead Manager Amount $m No of issues Share %
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1 ING 3,133.69 26 8.77%
2 UniCredit 2,986.04 23 8.35%
3 Credit Suisse 2,801.35 8 7.84%
4 Sumitomo Mitsui Financial Group 2,594.98 10 7.26%
5 SG Corporate & Investment Banking 2,301.01 20 6.44%

Bookrunners of India DCM

Rank Lead Manager Amount $m No of issues Share %
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1 AXIS Bank 12,906.34 183 21.63%
2 Standard Chartered Bank 5,764.36 47 9.66%
3 ICICI Bank 5,706.63 152 9.56%
4 Trust Investment Advisors 5,552.05 162 9.30%
5 HDFC Bank 2,786.90 77 4.67%