Rarity the ace card in Förderbank pack
In a new issue market creaking under the weight of supply from Europes sovereign and quasi-sovereign borrowers, Germanys NRW.Bank is something of a curiosity.
Far from increasing its funding requirement in 2009, NRW.Bank is expecting to borrow a total of just Eu12bn, compared with as much as Eu18bn in recent years.
Superficially, it seems curious that against the backdrop of a brutal downturn in Germany, Europes third largest development agency is trimming its funding requirement. Measured by assets, the only European agencies larger than NRW.Bank are KfW and the EIB, which between them will raise considerably more in 2009 than they did last year.
Germanys economy is expected to contract by 6.2% in 2009, according to the latest depressing prognosis from the Bundesbank. That jaw-dropping decline means that much of the responsibility for oiling the wheels of recovery will be borne by the countrys 20 development banks, especially given that commercial banks in Europe are hardly rushing to open their loan books.
"This is precisely the time when development banks are most needed," says Klaus Rupprath, head of capital markets at NRW.Banks Düsseldorf headquarters. "For SMEs in particular, development banks are much more important now than they are in good economic times."
According to NRW.Banks head of investor relations, Frank Richter, the banks lending to SME borrowers has remained robust in 2009. Its overall issuance in the primary market, however, has declined for two reasons. First, lending to social housing and municipal projects is down.
Second and rather more complicated, Rupprath explains that NRW.Bank adjusts its overall annual financing requirement in line with the borrowing plans of the Land (state) of North-Rhine Westphalia.Rated Aa1/AA-/AAA, North-Rhine Westphalia is the largest of Germanys 16 Länder, accounting for about 22% of the countrys GDP and for 6% of the output of Euroland. Its GDP of Eu540bn makes North-Rhine Westphalias economy larger than countries such as Belgium, Sweden and Poland; and its annual funding requirement, which in recent years has hovered around the Eu18bn mark, puts it on a par with a number of European sovereign borrowers.
The borrowing strategies of NRW.Bank and the state of North-Rhine Westphalia are inextricably linked. To many analysts, because the development agency has an explicit and permanent guarantee from its owner (the Land owns 64.8% with the balance held by local municipalities) its credit quality is identical.
The two borrowers often conduct roadshows together, and they also co-ordinate their borrowing schedules very efficiently to ensure that there is never any danger of over-supply from the North-Rhine Westphalia credit.
Partly for the same reason, as well as to cap overall public sector borrowing, the Land itself and its development agency are aiming to restrict their aggregate annual borrowing to around Eu35bn. "The turmoil in the economy at the moment is leading to an increase in the state governments borrowing needs, which will be about Eu3bn-Eu4bn higher than originally anticipated," Rupprath explains. "That is why we have told the markets that because we are the same credit they should expect us to be issuing considerably less than we have in previous years."
Rupprath adds that NRW.Banks business model allows it to adjust its annual borrowing requirement because its financing needs are more modest than its issuance strategy would suggest. "We only need to borrow about Eu3bn-Eu4bn for development purposes," says Rupprath. "Everything we borrow above that is reinvested mainly in the government sector throughout the world, but with a very strong focus on Europe. So that makes our annual funding strategy quite flexible."
The relationship between the annual borrowing requirements of Germanys other regional development banks and the health of the overall economy varies from Land to Land. In the case of Bavaria, it even varies from bank to bank, given the bewildering structure of the Lands public sector banking industry.
Bavaria, which is the only German Land to enjoy AAA ratings from all three agencies, has two local development banks. The older of the two, Bayerische Landesbodenkreditanstalt (BayernLabo), describes itself as "a state development bank that is legally dependent within BayernLB but independent in organisational and commercial terms." The only regional development bank with a AAA rating from Standard & Poors (S&P), BayernLabos principal mandate is to "promote social housing and metropolitan construction in Bavaria". The bank is also active in financing the Bavarian public sector.
From an investors perspective, this highly concentrated mandate is important for two reasons. First, as Manfred Pongratz, head of accounting and finance at BayernLabos headquarters in Munich, explains, it means that the banks annual funding requirement of about Eu2bn is extremely modest. Second, it means that the correlation between the banks lending and the broader macro-economy is also very low.
Instead, BayernLabos lending and refinancing is influenced chiefly by demographic and migration trends, both of which point towards growing demand for housing in Bavaria.
"Bavaria is one of the rare states in Germany where the population is growing, and Munich is a very popular place for people to live," says Pongratz. The result, according to a recent BayernLabo presentation, is that an estimated 557,000 apartments will need to be built in Bavaria between now and 2025, which will keep BayernLabos lending and funding stable, but modest.
Bavarias other state development bank, LfA Förderbank, was set up in 1951 and describes itself as "the financial institution of the Free State of Bavaria with the task of promoting industry and trade." That makes LfA, which is rated only by Moodys (Aaa), much more closely correlated to the fortunes of the German economy.
Indeed, along with supporting SMEs, the development of infrastructure and protection of the environment, LfA lists "helping enterprises to weather a crisis" as one of its main responsibilities.
Albert Brandl, head of financial markets at LfA in Munich, says that the relationship between Germanys macro-economy and LfAs funding requirement appears to be very strong.
A complication, however, is that in common with other German development banks, LfAs lending is not advanced directly, but via commercial banks in accordance with the house-bank principle. "At the moment, some of the commercial banks remain very cautious about granting new loans," says Brandl. "So although there is a high level of demand for funding from SMEs, so far this year our lending has remained at the same level as in 2008."
The result, says Brandl, is that LfAs overall funding requirement for 2009 is expected to be roughly in line with last years, suggesting a total of between Eu3.5bn and Eu4bn that will need to be refinanced via the capital market. "We also have a special programme based on guarantees from the Free State of Bavaria, but that doesnt require refinancing in the capital market," he adds.
Two into one?
Observers peering into Bavaria from the outside could be forgiven for scratching their heads as to why the Land needs two separate development agencies, one focused principally on housing and the other largely on SMEs.
True, Bavaria is a large economy. Home to industrial giants like Siemens and BMW, it exports more than Norway and its GDP in 2008 was more than that of Greece and Finland combined. All told, Bavaria accounts for 17.9% of Germanys GDP and for 15.1% of its population. But that still means that Bavaria is smaller than North-Rhine Westphalia, which makes do with a single development institution dealing with the twin challenges of financing social housing and SMEs.
Munich-based bankers concede that the question of why Bavaria needs BayernLabo and LfA working in tandem with one another is a fair question. "Its a highly political question," says one. "I cant tell you why we have two banks when other states have one institution covering real estate and commercial support. A merger would make sense, and personally I think that over the next five years we will see a lot of new ideas and consolidation in the development banking sector."
If and when it comes, consolidation is unlikely to have much of an impact on the total financing requirement of the regional development banks, which remains modest. Karlsruhe-based L-Bank, which is the other regular borrower from the sector, is expecting to raise between Eu6bn and Eu9bn in 2009.
Elsewhere, Investitionsbank Berlin (IBB) raised an unusually high Eu4.8bn in 2008. But as Michael Wolters of the banks treasury department explains, that total was chiefly a reflection of demand for short-dated paper that is repo-eligible with the ECB, as IBBs issuance is.
In response, IBB was very active last year in the market for maturities of less than one year which partly refinanced money market financing, much of which was due to be rolled over the same year. More typically, IBBs annual funding requirement is in the range of Eu1.5bn-Eu2.5bn.
Back-of-an-envelope calculations would therefore suggest that the regional development banks aggregate maximum funding requirement in 2009 will be below Eu30bn. In practice, the total is likely to be considerably lower than this, or well below half of KfWs total annual borrowing.
That is an undemanding total, and is unlikely to be driven much higher even if the outlook for Germanys embattled economy darkens. "The state-owned development banks play an important role for their local economies by providing credit for a number of start-ups and other projects that cant raise commercial bank finance," says Guido Bach, director responsible for international public finance (IPF) and Förderbanks at Fitch Ratings in Frankfurt. "But that doesnt mean that they are prepared to act as bail-out banks or lenders of last resort."
The view is shared by Michael Dawson-Kropf, head of the German banking team at Fitch Ratings. "Id expect demand to be falling at the moment because investment demand is falling," he says. "But it is also important to remember that the development banks role isnt to stimulate demand because they all work on the house-bank principle. They set up programmes and others distribute the lending. The distributors are the savings banks, the co-operative banks and the big private banks and if they dont push the development banks programmes, there will be very little distribution."
The regional Förderbanks low borrowing requirements are one obvious and key way in which they differ from a prolific issuer such as KfW or even one with a more digestible programme such as Rentenbank. It also means that most of them are able to enjoy a degree of scarcity value, which Pongratz says has been especially helpful for BayernLabo, which to date has only issued one internationally-targeted benchmark.
This was a Eu750m seven year deal led in October 2007 by BayernLB, Commerzbank and HSBC, which was healthily oversubscribed and placed mainly in Germany, Austria and Switzerland. This was tapped in September 2008, bringing the transaction up to Eu1bn.
"2007 was the start of our public bond issuance, and I think we generated a surprisingly high degree of international demand for the transaction, which we marketed in Switzerland and Austria," says Pongratz. "With an overall funding need of roughly Eu2bn per year, we may have room for one benchmark transaction every one or two years, but we will certainly maintain our scarcity value."
L-Bank also believes that relative rarity value is an important part of its armoury in the international capital market. "We raised a little over Eu10bn in 2008, and we expect this years funding to be slightly lower, in the range of Eu6bn-Eu9bn or Eu7bn-Eu10bn," says Sven Lautenschläger, international funding officer at L-Bank in Karlsruhe. "We dont see ourselves facing an increase similar to other agencies.
"Particularly in the euro and the domestic German market we continue to see strong demand for our credit. L-Bank remains a relatively rare borrower, so although investors lines are filled up with some credits that is not the case with L-Bank or with the Land of Baden-Württemberg." The Land has a funding target in 2009 of Eu6.5bn.
Certainly, it was domestic demand that underpinned L-Banks only euro denominated benchmark of 2009 to date, which was a Eu1bn five year deal led in January by Barclays Capital, Dresdner, JP Morgan and LBBW. Priced at 45bp over swaps, and launched against the backdrop of considerable market fragility at the start of the year, the ultimately successful L-Bank deal was reported to have been a tough sell.
Baden-Württemberg itself, which was also in the market in January, paid 35bp over swaps for the Eu2bn five year portion of its two-tranche issue, and 45bp for the 2019 Eu1.25bn of the deal, led by Deutsche Bank, HSBC and LBBW.
As well as having a manageable overall funding requirement, L-Bank has very clear targets in terms of the maturity profile of its debt. "Our preference in our benchmark transactions is for maturities only out to five years," says Lautenschläger, "because that it approximately the average duration of our assets."
"We have also put in place a commercial paper programme which we have made very active use of since the end of April," Lautenschläger adds. "We have issued CP in euros, dollars and sterling which has given us very attractive funding levels in the shorter dated market."
NRW.Bank also began this year with very clear objectives regarding the maturity profile of its issuance. In 2008, much of its focus was on building up its Short Term Bond Issuance (STERM) programme of liquid short-dated paper with a minimum size of Eu1.5bn in maturities of up to 24 months. Under the STERM programme, NRW.Bank issued three benchmarks in 2008 two for Eu1.75bn with maturities of 18 and 20 months, and one for Eu2.25bn with a 24 month maturity. All three helped NRW.Bank to cultivate its investor base outside the domestic market, with 75% of STERM 1 placed with non-German investors. Roughly half of STERM 2 and 3 were distributed outside Germany.
"This year a clear strategy for us has been to build up our yield curve by doing more in the three to five year range and also to place a 10 year benchmark," says Rupprath. By the end of April, it was mission accomplished in terms of NRW.Banks maturity targets for the year, although there was a notable shift in the geographical distribution of these benchmarks.
The banks first two benchmarks of the year were a Eu1.5bn three year transaction at 50bp over swaps in February and a Eu2bn five year issue priced at 70bp over the following month.
In both cases, the lead management group said much about the expected distribution of the transactions. BNP Paribas, JP Morgan, UniCredit and WestLB led the three year deal, about three-quarters of which was placed with domestic accounts. There was an even more domestic flavour to the group of leads on the five year transaction, which was made up of Barclays Capital, Commerzbank, Dresdner, DZ Bank, LBBW and Unicredit. That deal generated orders of well over Eu2bn, with 83% of the increased transaction sold domestically.
A similar pattern emerged at the end of April, when NRW.Bank completed its euro curve with a Eu1bn 10 year benchmark led by DZ Bank, HSBC, LBBW and UniCredit, which was priced at 80bp over swaps. Just under 80% of this deal was placed in Germany, which as Rupprath readily concedes, is a very high share.
By contrast, when NRW.Bank printed its previous 10 year benchmark, in 2007, only 46% of the Eu1bn deal led by Deutsche, Goldman Sachs and WestLB was distributed domestically. "If you look at our benchmarks prior to the Lehman bankruptcy, we typically placed no more than about 42%-45% in Germany," says Rupprath. "That shows how important the German or German-speaking investor base has become. My expectation is that we will continue to see domestic investors playing a dominant role for at least the next six months, but I would hope that in 2010 there will be a revival in international demand."
Arnold Fohler, managing director and head of DCM origination at DZ Bank in Frankfurt, says that the high level of domestic placement in NRW.Banks 10 year benchmark was neither a surprise nor a disappointment. "In fact it was anticipated by the borrower and reflects the tectonic shifts we have seen in the last few months. These shifts have closed some historic order flows and opened some new ones," he says.
"Central banks and sovereign wealth funds are still investing in this market. But where they may previously have put in a lead order of Eu300m they may now only be putting in orders of Eu50m. That means that borrowers that enjoyed widespread distribution in the past are now much more dependent on the domestic bid."
That has been true for sovereign borrowers throughout Europe in 2009, with benchmarks for borrowers like Greece supported by very strong domestic demand. But the process has probably been more pronounced among German public sector borrowers simply because of the sheer size and influence of the local institutional bid.
In the case of NRW.Bank, the most graphic example of this came in March, when its Eu2bn five year deal generated more than 190 orders, which was the highest number ever for a benchmark from NRW.Bank.
The unprecedented granularity of that demand was reflected in the fact that 85 of those orders were for less than Eu5m, while only two were for more than Eu50m.
Fohler says that this trend is common to a number of top-rated German borrowers, for some very clear reasons. "If you look at a borrower like Rentenbank, historically a tiny proportion of its overall funding was raised from German investors, because it was so successful in marketing its name internationally," he says. "With international demand having fallen so far, German investors are stepping in for two reasons.
"First, they are coming in because supply has fallen so much in their beloved Pfandbrief market, at least in benchmark format. As risk-averse investors they are therefore looking at the top-rated agency and Förderbank paper instead."
"Second," he adds, "whereas in the past these banks were issuing at sub-Euribor rates, they are now offering Euribor plus, which is obviously very appealing to local investors."
Other borrowers from the Förderbank sector have also seen conspicuous changes in the composition of investors participating in their benchmark deals, which mirrors the more general recent changes in the structure of demand for sovereign, supranational and agency bonds.
L-Banks Lautenschläger says that diminishing central bank demand, for example, is being compensated for by rising participation from bank treasuries. "Because banks can now buy agencies and other highly rated credits in the Libor plus area they can use our bonds for liquidity management purposes at zero cost, which is why we have seen such strong demand from treasuries," he says.
Fair enough. But if such a high proportion of a euro benchmark is sold to domestic accounts, does it not suggest that a German issuer is better off issuing a domestically-documented Schuldschein? Fohler thinks not, first because most of these borrowers issue Schuldscheine anyway. Second, he says that "because Schuldscheine are still seen as relatively illiquid instruments it is still not possible to place them as broadly as bonds," he says.
For a borrower like NRW.Bank, that may be a very legitimate long term view. Even given this years unusually low funding target, the magnitude of its typical annual borrowing needs is such that it needs to maintain a constant presence in the international capital market.
The same can hardly be said of borrowers like the Bavarian-based duo of LfA and BayernLabo. "Never say never, but we think that a benchmark of Eu1bn or Eu1.5bn is too much for us, and in any case the market for benchmarks is very expensive at the moment," says Brandl at LfA. "For the time being we will remain a niche player depending on plain vanilla funding which means customised bonds, debentures and Schuldscheine. Our borrowing needs are too small for us to set up an MTN or CP programme."
A similar story would seem to be true for BayernLabo. "Of course we recognize that we need to diversify our sources of funding," says Pongratz. "But a development bank needs to be very careful on the cost side." He adds that the average spread that BayernLabo has been paying in the Schuldschein market in 2009 for maturities over 10 years has been slightly over 40bp, which is very competitive.
Another regional Förderbank unlikely to be launching a benchmark issue any time soon is the Berlin-based Investitionsbank Berlin. Wolters of the banks treasury department says that with a medium to long term annual funding requirement of about Eu1.5bn-Eu2.5bn IBB will continue to finance itself largely through domestically-targeted private placements, Schuldscheine and registered bonds.
"Because we have no explicit rating from the agencies we work implicitly on the excellent rating of our guarantor, which is the Land of Berlin," says Wolters. "That means that our natural investor base is mainly in Germany and German-speaking countries."
Aside from remaining committed to euro denominated benchmark issuance, the most active borrowers from Germanys regional development bank sector say that other currencies are also an important component of their long-term borrowing plans.
At L-Bank, Lautenschläger dismisses the suggestion that with an annual funding requirement of below Eu10bn there is no need for it to cast its borrowing net much wider than the euro market. "The dollar market has always been an important part of our funding strategy," he says. "We have always made it clear that our aim is to launch one euro and one dollar benchmark each year, which we have done for the last seven or eight years."
This years dollar benchmark was a $1bn two year transaction led in February by Bank of America Merrill Lynch, Citigroup, HSBC and Morgan Stanley, priced at 90bp over mid-swaps. Almost half of this issue was sold in Europe, with 30% placed in the Americas, and central banks accounted for 57% of final distribution.
In the dollar market, L-Bank issues in Eurodollar format and in maturities of no longer than five years. "I think that maturities of two, three and five years are appropriate for us," says Lautenschläger. "Were not currently using our US shelf registration, so we cant tap into the domestic US investor base. That means our main focus has to be on non-US accounts such as central banks and their preference is for shorter dated dollars."
NRW.Bank has adopted a similar strategy towards the dollar market. Following a $1.25bn five year benchmark in 2005, it returned to the dollar sector in 2006 with another $1.25bn deal led by Barclays Capital, Morgan Stanley and RBS. Priced at 34bp over Treasuries, demand for the 2006 transaction was led by demand from Asia (29%) and Germany (23%).
Rupprath concedes that the dollar market has not been a strong point for NRW.Bank. As he says, much of the problem for the regional Förderbanks that would like to be more active issuers in a broader range of currencies is their split credit ratings. For them, life would be so much easier if the other rating agencies followed the Fitch school of thinking.This is that Germanys constitutional mechanism of Länderfinanzausgleich (federal equalisation system) means that all Länder should carry the same AAA rating as the sovereign. And as the regional development banks are unconditionally guaranteed by their Länder owners, it follows that all the Förderbanks are rated AAA by Fitch. Fitchs conviction that the Länder and the regional Förderbanks they own are of identical credit quality is reflected in its approach to rating the two sets of borrowers. Its Frankfurt-based analyst, Guido Bach, now has responsibility for covering international public finance (IPF) as well as the regional development banks. "Because our ratings on the development banks are so strongly linked to those of the Länder we think it makes sense to bring coverage of the two together," says Bach. "Because the Länder are the banks guarantors it is essential to have a view on the performance of the states."The Förderbanks themselves confirm that the performance of the Länder is a more important influence on their spreads than other considerations such as the fluctuating fortunes of the Landesbanks. "Our spreads have not been influenced at all by sentiment towards the Landesbanks," says Pongratz at BayernLabo, which is a likely candidate for being associated by investors with BayernLB. "Our spreads have been much more closely linked to the credit quality of the Free State of Bavaria."
Thats fine for a borrower based in and exclusively exposed to a state with Bavarias demonstrable credit quality. The snag for many other regional banks are that they are hostage to the Moodys and S&P approach to rating the Länder. In contrast to the Fitch philosophy this differentiates between the various states and does not regard the Länder as enjoying the same credit quality as the bund.
The result has been that as states such as Baden-Württemberg and North-Rhein Westphalia have surrendered their AAA ratings in recent years, so too have regular borrowers such as L-Bank and NRW.BANK. The consequence is that they have become split-rated borrowers which has cut off their access to some significant sources of funding altogether.
Most notably, it has led to the loss of repo-eligibility that they needed to access the Kangaroo market, which has been a small but important source of funding diversification for a number of German public sector banks in recent years.
Although there is no technical reason why the Förderbanks split credit ratings should mean that they are barred from accessing the dollar market, they complicate the process mightily, even in Eurodollar format. "I wouldnt rule out a dollar deal this year," says Rupprath. "There has been interest in a few names of the highest quality, but it may still be a little too early for a borrower like us with a split rating. If we were to return to the dollar market this year, it would certainly be with euro documentation, rather than in SEC-registered format. That means our main focus will continue to be on central banks and on some US offshore accounts."
L-Bank will also maintain its focus on euro documentation in the dollar market. "Because we are AA+ with a positive outlook, and guaranteed by a local rather than a sovereign government, we tend to be second or third in line when it comes to issuing in non-core markets," says Lautenschläger.
"We have to monitor demand very carefully, because the cost of tapping into the US domestic market is not small. Although we have a shelf registration in place, updating it would entail costs of Eu300,000-Eu500,000, and I need to keep in mind the balance between those costs and the additional arbitrage we could generate by accessing the domestic US investor base."The persistence of split ratings is especially frustrating for development bank borrowers that have done so much to spread the word about the strength of their credit quality. "We have worked hard over the last few years to transmit the message that the Land of North-Rhine Westphalia has changed considerably over the last 20 years," says Rupprath. "In 2007 and 2008 our share of German GDP grew, which has been helpful. In the past we were a little weaker than most other Länder. Today we are a little above the average."