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Yield hunt drives Euro-DM changes

01 Nov 1997

The nature of the Euro-Deutschmark sector has undergone significant change over the past 18 months. Although it remains dominated by higher-rated issuers, there has been a marked increase in volumes of lesser-rated, riskier products.

Emerging market bonds, asset-backed product, even high yield corporate debt are becoming increasingly frequent features of an increasingly diverse marketplace that has firmly established itself as Europe's most global capital market.

And traditionally risk-averse Deutschmark-bloc investors are being forced to look further afield to boost returns in an historically low interest rate environment.

AS INTERNATIONAL debt market issuance powered ahead in 1996 and 1997, the Euro-Deutschmark sector followed suit. New issue volume in Euro-Deutschmark bonds last year struck a record DM77.7bn, equating to just over 11% of global primary bond market activity.

Volumes have fallen during 1997, with DM61.3bn issued in the first 10 months of the year.

But while the headline figures paint a picture of a faltering market, the structure of the market has changed dramatically. A steep yield curve has cramped activity at the 10 year end of the market, and an increasingly active hunt for yield among Deutschmark investors within the context of European currency convergence has ensured a relative scarcity of supply from developed sovereign and supranational borrowers.

Erich Pohl, head of global markets at Dresdner Kleinwort Benson in Frankfurt, says: "What we have seen over the last couple of years is that, as convergence has taken place in Europe, many of the issuers which did benchmark funding in Deutschmarks have returned to their domestic markets where spreads to Germany have narrowed so significantly."

Others point out that the slowdown in the Deutschmark sector over the first half of 1997 has been across the board, and not necessarily confined to sovereign or supranational borrowers.

One London-based syndicate manager says; "Between 1992 and 1997, the Deutschmark sector accounted for around 13% of Eurobond issuance; in the first six months of 1997 this fell to about 10%. But that is a function largely of the currency movement and the fact that everybody seems to have been jumping on the bandwagon of the dollar market, which has been the safe haven."

Not that sovereign or supranational borrowers have withdrawn entirely from the Deutschmark sector -- Denmark, Austria and Spain have all tapped the market in recent months. But the extent to which central bank investors in particular have been starved of Deutschmark-denominated sovereign paper became apparent at the start of July, when a 10 year deal from Italy, led by Deutsche Morgan Grenfell and SBC Warburg and priced at 18bp over the Bund, was increased from DM2bn to DM3bn in response to weight of demand.

This was the first benchmark deal from an EU sovereign for eight months -- Spain launched a DM2bn 10 year deal at the end of 1996 at 24bp over Bunds -- and was Italy's first fixed rate Deutschmark deal since January 1993.

The response to the Italian benchmark transaction was overwhelmingly positive, with one market participant saying at the time that it was "without question the deal of the year in Deutschmarks."

To Pohl at Dresdner Kleinwort Benson, the decline in issuance by sovereign and supranational issuers has been -- and is likely to continue to be -- compensated for by new activity from other borrowers in the Deutschmark sector.

"As the benchmark issues from sovereigns have declined," he says, "so issues from new borrowers such as emerging market credits have grown. We opened up the market in 1995 with a Brazil issue and it has continued to expand ever since."

That emerging market credits became flavour of the year in Deutschmarks in 1996 is immediately evident from the statistics. As a Salomon Brothers report published in July -- entitled How Big is the Deutschmark Bond Market? -- points out: "More than 14% of the volume of bonds launched by emerging market borrowers in 1996 was issued in Deutschmarks, and the new issue volume more than doubled year to year."

This new issue volume in 1996 was driven predominantly by Latin American credits which were looking to set up a bridgehead to European investors after establishing their name recognition and built up yield curves in the dollar market. Leading the way was Argentina, which came to the Deutschmark sector 10 times last year, raising more than DM5.5bn and building an entire yield curve stretching to 30 years -- with the first transaction from a Latin American credit at that maturity -- in the process.

Following 1996's frenetic activity from Latin American issuers in the Deutschmark sector, it is perhaps unsurprising that investors this year have started to show signs of Latin American fatigue.

"After the Mexican crisis," says Renée Fraunhofer, assistant vice president in the fixed income department at Commerzbank in Frankfurt, "spreads widened dramatically, and now that they are falling again the retail investors who drive the market are no longer getting the sort of returns they have come to expect.

"People got to coupons of 9% or 10% from Latin American issuers and now you are seeing Argentina offering investors coupons of 7%. Issues from banks such as Unibanco and Banco Nacional which are maturing this year offered coupons of 10.25% and 9.75%, and when this paper matures retail investors will want to re-invest in the same quality at the same coupon, which nowadays is almost impossible."

This does not mean that the emerging market story in Deutschmarks is running out of steam. "The appetite for emerging market issuers is still there," says Fraunhofer. "For example, the emerging market fund industry is growing rapidly in Germany. Last year ADIG [Commerzbank's mutual fund subsidiary] launched a new emerging market fund with a target for collecting subscriptions of DM60m, and it ended the year with DM120m."

While the expansion of the emerging market fund industry in Germany still means that this sector of the market is dominated (indirectly, rather than directly) by retail investors, Fraunhofer estimates that technically the split between institutional and retail demand for any given emerging market transaction in Deutschmarks is typically 70%:30% in favour of retail accounts.

The key shift for the coming year, thinks Fraunhofer, will be a continued migration of investors from Latin American to eastern European credits. She says: "Everybody holds Argentina and Brazil in their portfolios so we are now seeing diversification, with people looking much more at the Eastern names."

The process began and accelerated in 1996, with Poland raising DM250m in a five year deal via led by Deutsche Morgan Grenfell and Credit Suisse First Boston (CFSB), and exotic newcomers such as Estonia's City of Tallin dipping an oar into the Euromarket for the first time with a DM60m transaction led by Nomura last April.

Demand among German investors for high yielding eastern European emerging market names was anything but sated by 1996's flood. This was amply illustrated by the demand for Russia's DM2bn debut issue in international markets in March.

Led by Credit Suisse First Boston and Deutsche Morgan Grenfell, this seven year issue was the largest ever Euro-Deutschmark debut by an emerging market borrower and therefore needed to hold out an attractive spread -- which it did, with a 370bp pick up over the 2004 Treuhand, which was a pleasant surprise in the light of the pre-launch price talk that had indicated the possibility of a spread as low as 300bps.

The coupon of 9%, meanwhile, which represented a 2% premium to an existing seven year deal from Argentina, was optically irresistible to retail accounts starved of high coupons.

Other highlights from eastern Europe this year have included a seven year deal from Slovenia in May led by Dresdner Kleinwort Benson and CSFB, the size of which was lifted in response to investor demand from DM300m to DM400m. This was in spite of a pricing level at 43bp over the Treuhand which some market participants complained was aggressive.

Romania's debut international deal, a DM600m five year bond led by CFSB and Deutsche Morgan Grenfell, followed a week after Slovenia, and this deal was also increased from its initially planned size of DM500m.

Another newcomer to the Deutschmark sector from eastern Europe this year has been Croatia, which issued its debut DM300m seven year bond in July via CFSB and Deutsche Morgan Grenfell, priced at 95bp over the Bund.

Says Pohl: "When we did Slovenia some people said it was on the tight side, but it was just a blow out. I think that shows that there is clearly more room for diversification of German investors' portfolios, and that there is demand for the right issuers to come and tap the Deutschmark market. I believe eastern European issuers will be using the Deutschmark more and more for their funding needs."

Eastern Europe and Latin America, however, have not been the only supply source of emerging market credits in the Deutschmark sector. In May came the first ever issue in Deutschmarks from a private Turkish bank, with a DM150m three year bond from Ottoman Bank led by JP Morgan and UBS. Also in May, renascent Lebanon arrived in the Deutschmark sector for the first time with a DM250m five year deal offered at 175bp over the Bund and led by Commerzbank and Société Générale.

The following month saw a further variation on the emerging market theme in the shape of a DM500m five year benchmark transaction for China, led by Credit Suisse First Boston and Deutsche Morgan Grenfell. And in July Commerzbank led a DM200m five year deal for the China International Trust and Investment Corp (CITIC), which is viewed as offering quasi-Chinese government risk.

While the slew of emerging market issues in the Euro-Deutschmark market has done much to offer yield-starved investors a welcome pick up in terms of basis points over alternative instruments, Frankfurt-based investment bankers insist that the development of this sector is symptomatic of a much wider shift towards the discovery of value through much more focused credit analysis and evaluation.

Dresdner's Pohl is confident about what lies ahead for the Euro-Deutschmark sector: "We feel that the main opportunities will be in what we call the credit spread business. Throughout continental Europe banks have traditionally relied on funding corporates by using their own balance sheets. Although that is still going on to an extent, they are now in the process of reconsidering their strategies and concentrating more on their return on equity.

"As a result, I think there will be tremendous growth potential in the corporate sector, especially at the lower investment grade level, be it through straightforward bond issuance, the medium term note market or securitisation."

Perhaps the most striking development this year, however, has been the highly successful introduction to the German capital market of high yield debt instruments.

As an SBC Warburg report on the sector published at the start of August explains: "The demand for a European high yield market is being driven by tightening spreads, the removal of bond portfolio restrictions on high yield credits, increasing competition between fund managers, and the development of the European equivalent to US mutual funds."

On the financing side, the report continues, demand is being driven by corporate restructuring, privatisations, telecom/media build-out activity, significant MBO/LBO equity-fund activity and a trend towards larger transactions.

Merrill Lynch kickstarted the German high yield market in April, when it launched a DM157.5m 10 year deal for the B2/B+ Swiss sanitary plumbing company, Geberit Beteiligungs, which was priced at 420bp over Bunds and was more than five times oversubscribed.

To Werner Humpert, vice president of Merrill Lynch Capital Markets in Frankfurt, the success of Germany's debut high yield bond was clearly attributable to yield starvation.

"Investors have been pushing further and further down the credit spectrum," he says. "They have tried emerging market credits, but spreads have fallen and people just are not happy any more with 20 year Argentine risk at 200bp over Bunds. They are looking for something new, something with a genuine yield pick up."

The Geberit issue was followed in fairly quick order by a DM200m deal arranged by Salomon Brothers for Impress Metal Packaging, which offered investors a 410bp pick up. Impress is the holding company of a group of entities comprising the former metal packaging businesses of Pechiney International and Schmalbach-Lubeca.

Morgan Stanley has also played an active role in the development of the German high yield bond market, arranging a brace of issues so far this year. The first of these was a DM175m seven year transaction for Exide Holdings Europe, the Europe's largest manufacturer of car and industrial batteries.

Priced at 375bp over the government curve -- at the tighter end of its price talk range of 375bp to 400bp over the seven year Bund -- the issue's size was increased from its originally planned DM150m and was two times oversubscribed, with European investors accounting for 80% of the placement.

Morgan Stanley's second foray into the fledgling German high yield market came in August, when it arranged a split-tranche deal for Central European Media Enterprises (CME), a borrower described in the issue's prospectus as "the leading commercial television company in central and eastern Europe."

The weight of demand that the issue generated quickly became apparent on its launch day of August 14. The original plan had been for the company to raise dollar funding in a single tranche of $125m, but with demand for higher yielding Deutschmark assets reportedly so strong, this was then altered to a split tranche deal raising $100m and DM100m at launch on August 14.

By the end of the launch day, however, the size of the seven year non-callable Deutschmark tranche had been upped to DM140m, with the price fixed at 312.5bp over the Bunds, precisely in the middle of its pre-launch range of between 300bp and 325bp over the government curve.

Towards the end of September, Goldman Sachs and Chase Manhattan led a similarly successful DM575m high yield issue for ITT Promedia. The strength of demand for this issue was immediately illustrated through its increase from an originally planned DM300m, and in its spread performance following its launch. Priced at 365bp over Bunds -- towards the upper reaches of the 350bp-375bp price talk, the issue had traded in to 337bp over after the first few hours of trading.

Aside from the clear votes of confidence these issues have been given at the primary level, it is equally clear that they have enjoyed considerable support in the secondary market. By early August, for example, the Geberit issue was bid at 255bp over the Bund (equating to a spread tightening of 165bp), while the Exide issue had traded in by 35bp to 375bp over.

John Wotowicz, executive director at Morgan Stanley in London, is bullish about the prospects for further expansion of this new market, saying that he expects 10 deals by the end of this year. Importantly, he says, the high yield issues which Morgan Stanley has arranged have met with a strong response from local investors, although a case study on the Exide deal published by Morgan Stanley suggests a broad international placement of the high yield bonds.

This shows that 34% of the paper was placed in the UK and 21% in the US, with Switzerland accounting for 14%, Germany for 8%, France for 7%, and Italy and Spain for 5% each.

Other -- and possibly more impartial -- observers appear to share Wotowicz's enthusiasm. A report on Europe's emerging high yield sector, published in August by JP Morgan, notes: "The view seems to be that there are perhaps three or four deals to emerge [in Europe] this year (making perhaps 10 in total) with a greater total number expected in 1998. With increasing investor comfort with complex credits and the emergence of a stable core of dedicated high yield investors, we see every reason to expect demand and issuance to grow steadily into the medium term."

Less generous in terms of its pick up, but still defined by one its lead managers, Deutsche Morgan Grenfell, as a high yield transaction, was an issue which followed at the end of August for the paper company, Haindl Papier. Priced at 100bp over the 2007 Bund, and joint-led by Bayerische Vereinsbank, this transaction was almost entirely pre-sold prior to its launch with domestic institutions, according to Ralf Buschmann, head of origination for German financial institutions at Deutsche Morgan Grenfell in Frankfurt.

While the advent of a German high yielding market has been welcomed by investors and investment bankers, some analysts advise investors to exercise a degree of caution towards the sector. The SBC Warburg report, while acknowledging how well the market has performed in the first few months of its existence, says there are risks.

"Eager new European high yield investors cannot yet achieve the level of diversification -- which is central to the investment philosophy -- achieved by US specialist funds in the US dollar high yield market. As specific risks cannot be adequately diversified away in a portfolio context, there is a risk of contagion if any of the European high yield names were to default (that is, one default would lead to a widening of the whole sector)."

The report continued: "While US dollar-based high yield funds have played an important part in the development of the European market, it is not clear what proportion of the market has found its way into dedicated high yield portfolios."

Another area which is rapidly developing in Germany as a way of providing investors with much needed added yield is the market for asset-backed securities. This was given an important fillip in May when the German Banking Supervisory Authority, the Bundesamt für das Kreditwesen (BaK), released a circular laying out the basic framework for German banks to securitise their own assets.

Bank Gesellschaft Berlin (BGB) was the first German-based bank to arrange a public securitised issue for a domestic financial institution following the distribution of the circular (see box), although this was not the first of its kind -- Rheinische Hypothekenbank launched its DM523m GEMMS securitisation deal in April 1995, and a number of other small, non-public issues have also been structured.

As a note published by Merrill Lynch shortly after the release of the BaK circular points out: "This represents a major change of heart for the authority from a position that appeared to be very much opposed to securitisation not so long ago. Since it has now moved its position such a long way, it is not surprising that the resulting guidelines appear more restrictive than other jurisdictions. Nevertheless, there is now a framework for banks to work with, and we expect several banks to proceed with securitisations of their own assets in the near future."

"It was not a new law," says Humpert at Merrill Lynch in Frankfurt. "It was a circular released by the supervisory authorities which at the end of the day has the same effect. Its results were two-fold. First, it drew enormous attention to the asset-backed sector among investors. Second, it has led virtually all the German banks to focus on the sector and to start trying to identify possible classes of assets which they can use for asset-backed transactions."

When the BaK circular was released, the Deutschmark sector had in any case seen a number of asset-backed transactions from non-German issuers, and the demand these generated among investors suggested that the potential for the sector's rapid expansion was considerable. Volkswagen started the process at the start of 1996, with the first public bond market securitisation for a German company, a DM500m issue backed by auto leases led by Deutsche Morgan Grenfell.

Merrill Lynch soon afterwards set the ball rolling for transactions backed by bank assets rolling in April 1996, leading the DM1bn three year Citibank Credit Card Master Trust 1 Series deal, which carried a triple-A rating and offered a 7bp pick up over three month Libor.

"That basically opened up the market and offered the additional advantage of being a product which was not around," says Humpert. "At the time it was almost impossible to find triple-A rated floaters in Deutschmarks offering a Libor-plus spread."

The successful opening of the market by Merrill Lynch allowed other investment banks to build upon the foundations established last April. Issues for MBNA and Dean Witter Discover followed soon afterwards, and in August 1996, Goldman Sachs extended the maturity on Citibank's credit card-backed issues with a five year DM1bn deal priced at 9bp over Libor. The previous month, Salomon Brothers had added to the scope of the rapidly expanding asset-backed market in Germany, arranging a DM1bn fixed rate deal for Capital Credit Card Corp, which it followed in September of the same year with a six year DM1.25bn deal for BA Credit Card Corp.

A more recent deal, led again by Merrill Lynch, was another Citibank transaction for DM1bn, which was fixed rate and extended the maturities available in the Citibank credit card-backed programme to 10 years.

In comparison to this deal, Humpert says that the first transaction, as more of a "commodity" floater product, was easier to place. By contrast, he says that this year's deal was a 10 year fixed rate deal which was launched into an already crowded market.

"There were all kinds of banks issuing at the time," he explains, "and one week prior to our launch Italy came out with a DM3bn 10 year deal at 18bp over the Bund, which threatened to make life difficult for us. In the event, we were overwhelmed by the success of the issue. We were confident about it, but the success was amazing given that it was priced at 25bp over the Bund, which represented a pick-up over Italy -- which enjoys the benefit of being zero-weighted -- of just 7bp."

Humpert says that the deal was groundbreaking in another respect: "It was the first time that we sold the B-notes in Germany as well. Previously, B-notes had tended to be sold as private placements in the US to investors who were much more familiar with the product. But this time we placed the B-notes which were priced at 47bp over Bunds -- that is, 22bp over the A-notes -- not only to German investors, but also to accounts in Austria and Switzerland."

Globaldrive was a more recent borrower in the Deutschmark securitisation market, launching its first issue in September via JP Morgan. The European securitisation division of Ford Motor Credit priced its DM1bn deal at 6bp over three month Libor. It was fully subscribed, with around 45% of the paper placed in Germany.

At Lehman Brothers in Frankfurt, Matthias Wittenburg, director of fixed income syndicate, is also bullish on the future prospects for the asset-backed market in Germany.

He says: "We will clearly see further issues this year. A lot of US borrowers are eyeing the market, and it is only a question of time before more of them follow Citibank because it is such a natural development for the Deutschmark market. Local investors are becoming much more sophisticated and it is now obvious to them that a product which gives them to chance to buy triple-A rated paper at well over Libor is going to be very attractive."

Others agree that the changing nature of the German investor base is opening up a wide range of opportunities in all aspects of structured finance. At ABN AMRO in Frankfurt, for example, Thomas Geller, managing director of debt syndicate, says that a very clear focus for him is now the structured finance market, although he refuses to be drawn on deal specifics. "German investors are not half as dull as people outside Germany always seemed to think they were," he says.

From the supply point of view, bankers are generally bullish about the outlook for securitisation in Germany, with the Merrill Lynch report pointing out: "Germany is the largest European economy and, as such, could potentially support the biggest securitisation market in Europe. Likely asset classes include consumer and corporate loans and leases, trade receivables, residential mortgages and commercial real estate."

The same report also suggests that there will be obvious limits to how far securitisation in Germany can go.

It notes: "While securitisation is unlikely to provide finance for residential mortgages that is as competitive as the Pfandbrief market there are private banks that may look to securitise their residential mortgages for balance sheet and portfolio management reasons."

However, the report says: "Credit cards, the source of the currently outstanding $190bn credit card ABS market in the US, will not be a significant securitisation asset class in the foreseeable future. They do not have anything like the same level of market penetration as [they do in] the US, and German cards are frequently structured as charge cards."

To a degree, the high yield corporate bond and the fledgling German asset-backed market have to date been dominated by the US banks in Germany. In part, this is for the obvious reason that techniques which have been developed, tried and tested in the US can be transplanted fairly easily into the German market.

But the major German banks insist that they are ready and able to join the party. "We certainly do have the investor base," says Pohl at Dresdner, who spent eight years with Morgan Stanley in London before returning to Frankfurt.

"We have made substantial investments recruiting people for our credit derivatives activities and expanding our securitisation desk. So we have the know-how and the customer base, and we know how to trade these things. We feel that the cake is a large one and that there will be plenty of business to go around."

The most obvious signal of Dresdner's commitment to the fast expanding securitisation market was its recent hiring of Bruce Bantz from NatWest in London. Bantz, a former employee at Citibank and NatWest who was involved in last year's groundbreaking £1bn securitisation deal for Pendeford Mortgages. EW

Rating fears prevent growth of German corporate bonds

BANKERS SEARCHING for opportunities in Germany's corporate bond market have traditionally been faced with a major problem: they are very hard to find.

As a report on the German bond market published at the start of this year by Deutsche Morgan Grenfell notes: "At the end of May 1996, only three bonds (issued by VIAG, Autobahn Tank & Rest and Harpener) with a total volume of around DM2.7bn were in the market. The share of corporate bonds in the domestic bond market has always been negligible. Corporate bonds are usually not eligible as collateral for Lombard borrowing, unless explicit permission has been granted by the Bundesbank."

According to Ralf Buschmann, head of origination for German financial institutions at Deutsche Morgan Grenfell in Frankfurt, the lack of corporate bonds is a natural consequence of the markets.

He says: "If you look at the margins which have been available in the syndicated loan markets over the last two to three years, it has made no sense at all for German corporates to tap the bond market. The fall in margins has come to a halt and, combined with a decrease in margins in the bond market, bond issues have become more attractive again for German corporates."

Given the enthusiasm with which some bankers have piled resources into developing the high yield bond market, it is perhaps surprising to find foreign investment bankers in Frankfurt curiously unexcited about the potential for the German corporate bond market.

"The corporate bond market will remain a difficult area for international banks," one complains. "Frankly, if we had five different business activities that we could develop, and the corporate bond market was one of them, it would be bottom of the list. German corporates still get ridiculously cheap money from their house banks and, in any case, most of them are unrated -- so bonds would be impossible to sell internationally."

This is perhaps surprising in the light of the strength of appetite which has been shown by investors (albeit primarily retail and not confined to Germany) for non-German corporate issuers in the Deutschmark sector.

This became most apparent in September 1996, when Nestlé and Unilever both came to the Deutschmark market in the same week with deals hailed as blow-outs, which the retail sector absorbed within minutes.

There have been other similarly successful issues this year from non-German corporates in the Deutschmark sector. In May, for example, IBM (via IBM International Finance NV) made its first visit to the market since 1991 with a DM200m five year bond led by Deutsche Morgan Grenfell triumphantly hailed by its lead manager as a blow out.

FOLLOWING a long dearth of German corporate issues, car rental firm Sixt reinvigorated the market when it launched a DM200m five year deal in November 1996 via Bayerische Hypobank, which met with sufficient demand to justify a top-up of DM50m the following week.

In April BMW tapped the market with a rare DM200m five year transaction led by Deutsche Morgan Grenfell. Also in April Porsche excited the bond market with a DM200m five year deal led by Deutsche Morgan Grenfell, which was three times oversubscribed. A successful and highly popular gimmick with this issue was the printing of bonds depicting a Porsche car. As one banker says of the retail-targeted transaction: "The idea was that anybody who could afford to collect Porsche cars could probably also afford to collect Porsche bonds."

The most groundbreaking corporate deal of 1997 so far, however, has been the parallel bonds issued by Siemens earlier in the year. The electronics group's three-pronged parallel, launched in February, has since been cited by several bankers as a early candidate for deal of the year.

The Deutschmark component of the bond, a 10 year DM750m tranche, was raised from its originally targeted DM500m, and even then was hugely oversubscribed. Launched at 17bp over the 2007 Bund, within two days its spread had tightened to 13.5bp over the government curve.

Some bankers argue that it was the scarcity value of such a prized corporate as much as the euro-related structure which was behind the success of the Siemens deal. "Siemens sold quite well," says Jürgen Schneider, director of investment banking at WestLB in Düsseldorf. "But it was not the parallel structure which sold the bond. It was the Siemens name."

Another recent contribution to the development of Germany's corporate bond market was made by the national railway company, Deutsche Bahn, which issued a DM1bn 10 year bond in September via Deutsche Morgan Grenfell and Dresdner Kleinwort Benson. It was the national railway operator's first visit to the bond market since 1995, when it had tapped the market for the same amount and via the same bookrunners at 18bp over the Bund.

September's deal was priced at 17bp over the 2007 Government issue, and was clearly welcomed by investors who view the credit as quasi-federal government risk. This, say bankers, more than made up for the lack of a rating on the issue.

"It would be good if Deutsche Bahn had been rated," says Buschmann. "But the rating agencies require a certain track record as far as balance sheets are concerned and, as Deutsche Bahn has been completely restructured, the old balance sheet of Deutsche Bundesbahn would have had no meaning for the ratings agencies."

Perhaps this offers Deutsche Bahn a tailor-made excuse for not having a rating, but local bankers argue that in general German companies are dragging their feet as far as ratings are concerned.

"German corporates are terrified of being undressed in front of the ratings agencies," is how one Frankfurt-based banker expresses it, while another points out that several companies sat up and took petrified notice earlier this summer when, horror of horrors, Siemens suffered the humiliation of having its long-term debt rating chopped by Moody's from the triple-A it had always enjoyed since acquiring its rating for the first time 18 months previously to AA1.

"That served notice not just that Germany's top companies may not be given the best rating possible," says one banker, "but also that ratings can change for the worse." *

BGB adds to asset-backed supply as interest picks up

ANYBODY VISITING the gleaming headquarters of Bankgesellschaft Berlin (BGB) in the eastern section of Berlin could be forgiven for assuming that the building -- in common with much of the area east of the old Berlin Wall -- is brand new. In fact, the refurbished building is one of Berlin's oldest, dating back to the late 1920s.

By the same token, when BGB became Germany's first bank to arrange a securitised transaction for a German financial originator -- following the publication by Germany's Banking Supervisory Authority (BaK) of new guidelines on securitisation in May -- casual observers could have been forgiven for interpreting it as an entirely new initiative from the bank.

The truth is that the BGB securitisation team -- which is headed by Gerwin Scharmann -- is, in a German context, a veteran of the securitisation market.

"I have been working on securitisation since the early 1990s," says Scharmann, who joined BGB from Westdeutsche Landesbank (WLB) which put together what is commonly regarded as Germany's first securitisation transaction -- the KKB Consumer Loans No 1 issue.

Scharmann puts his own experience of the German securitisation market into perspective when he says: "I remember being able to buy triple-A securitised bonds at Libor plus 40bp."

Those days, he says, are long gone, with a more diverse and sophisticated local investor base more than happy with securitised deals offering a single digit pick up over Libor.

Compressed spreads in the German securitisation market, feeding through to much lower issuing costs, provide a clear reason why an increasingly wide range of originators are now looking to tap the securitisation market.

Scharmann says: "When I was doing presentations on securitisation four years ago, and talking to clients about the prospects for using securitisation as a funding base, it was a much more difficult process than it is today.

"Now it may only cost five basis points over Libor for triple-A notes, and 50bp or 60bp over for the single-A piece, which is only a mall portion of the overall package. So today originators will be looking at all-in costs of around 20bp over Libor, whereas four years ago it would have been closer to 60bp."

The second reason why German issuers are looking more favourably at the potential of the securitisation market is that the recent circular released by the BaK has removed the dangers of originators falling foul of the supervisory authority.

As Scharmann and others point out, prior to the release of the circular there was no legal impediment to the issuance of securitised transactions in Germany.

"The crucial question board members at potential issuers always asked themselves," says Scharmann, "was whether or not issuing a securitised transaction would mean that they risked having a dispute with the BaK."

Although Rheinhyp demonstrated in 1995 with its pioneering GEMMS issue that it was prepared to argue with the BaK if need be, most would-be originators felt that risking a wrangle with the authority would be unwise.

With this potential objection removed since the release of the BaK's groundbreaking circular in May, the path was clear for BGB to launch the first public securitised deal for a German financial originator -- although the Berlin-based bank had been working on the structure of the issue since the previous November.

This, according to Scharmann, was the main reason why the DM50m asset-backed tranche of German Car Loans No 1 for ABC Bank -- a small consumer bank established in 1929 -- was structured as a loan rather than a bond.

"When we started work on the project we had no way of knowing what the BaK would say this year," he explains, "and the customer was very clear that he wanted to conform by 100% to whatever new guidelines the BaK was going to issue. Doing a loan rather than a bond gave the customer this safety net, but from a structural point of view it was just like a public bond transaction."

Scharmann adds that the issue was oversubscribed and that: "When the details of the transaction first hit the press we received many enquiries from investment banks and potential investors asking if they could participate."

He continues: "We had to tell them that, as it was a relatively small tranche of DM50m, we had already assembled a group of investors and that it was more or less a closed shop. But the next tranche will be a bond and we may invite some other investment banks to participate if they can sell the deal on to other investors."

Looking to the future, Scharmann says that he is "extremely bullish" on the outlook for securitisation in Germany.

"I believe we will see many more transactions backed by financial receivables," he says. "Because all the banks are now recognising that their attractiveness should be measured not by the size of their balance sheets but by their return on equity."

Any mechanism which can free up capital as efficiently as securitisation, therefore, should meet with a warm reception from all German banks -- be they private sector giants such as Deutsche Bank, the Landesbanks or cooperative banks.

But supply, says Scharmann, will not be restricted to originators from the financial services industry: "The number of corporates which are now looking at the market is unbelievable."

The downside of this, however, is that the market has become fiercely competitive.

"Everything is now coming down to pricing," he explains, "and in the corporate market we have seen ridiculous pricing with all-in costs guaranteed at around Libor plus 20bp."

In part, this is a reflection of the speed and energy with which local banks have been building up their securitisation expertise and marketing the product to potential originators.

As Scharmann says, a few years ago only West LB and Deutsche Bank appeared to be interested in the product; today, it is difficult to find a major German commercial bank which does not profess to have some capability in the securitisation market.

Top bookrunners of international DM bonds
(January 1 to November 3, 1997)
RankManagerAmt ¥bnNoShare %
1Deutsche Morgan Grenfell19,404.484818.35
2Credit Suisse First Boston9,562.67329.05
3Dresdner Kleinwort Benson9,280.73168.78
4SBC Warburg Dillon Read8,775.16308.30
5Merrill Lynch5,986.50235.66
7Morgan Stanley Dean Witter4,838.64284.58
8ABN AMRO Hoare Govett4,208.33143.98
9JP Morgan4,170.00143.94
11Bayerische Vereinsbank3,097.2692.93
12Goldman Sachs3,096.66122.93
14Lehman Brothers2,910.00112.75
16Salomon Brothers2,060.00111.95
17Rabobank Nederland2,000.0091.89
18HSBC Markets1,850.0061.75
19Bayerische Landesbank1,800.0071.70
20ING Barings1,725.0051.63
22DG Bank1,200.0041.14
23Société Générale1,033.3350.98
Source: Capital Data/Euromoney Bondware
Top issuers of international DM bonds
(January 1 to November 3, 1997)
RankManagerAmt ¥bnNoShare %
3Deutsche Bank4,626.1474.38
4Republic of Turkey3,000.0032.84
5Republic of Italy3,000.0012.84
6Kingdom of Denmark2,750.0032.60
7Republic of Argentina2,500.0022.36
8Sudwestdeutsche Landesbank2,400.0042.27
9Bayerische Vereinsbank2,400.0022.27
10United Mexican States2,250.0022.13
11Russian Federation2,000.0011.89
12Den norske Bank1,800.0031.70
13Dresdner Bank1,597.4031.51
14ING Groep1,500.0021.42
15Allianz AG Holding1,500.0011.42
15Asian Development Bank1,500.0011.42
15Deutsche Ausgleichsbank1,500.0011.42
18General Electric Co1,300.0041.23
19Rabobank Nederland1,250.0041.18
20General Motors Corp1,250.0031.18
21Compagnie Bancaire1,250.0021.18
22Landwirtschaftliche Rentenbank1,200.0051.14
23Merrill Lynch1,130.0061.07
24SBC Warburg Dillon Read1,066.8281.01
25Citibank Credit Card Master Trust 11,064.0021.01
Source: Capital Data/Euromoney Bondware

01 Nov 1997