deutsche industriebank german market outlook 2014 mid cap financial markets in times of macro...

German Market Outlook 2014 Mid Cap Financial Markets in Times of

Macro Uncertainty and Tightening Bank Regulations

For contact details please see contact list at the end of this report

Contents

Global Economic Outlook and Prospects for the German Economy 2

Corporate Germany: at Crossroads to Financial Markets? 10

German Private Equity Market 13

Corporate Market 17

Corporate Schuldscheindarlehen: Tongue Twister Goes Abroad 19

Leveraged Market: Borrower Friendly is back 21

European High-Yield Market: Coming in Strongly 22

Mid Cap Bond Market 26

Credentials 29

Contact Details 30

Visit us and Meet us 31

Disclaimer 32

2013 A Good Year

for Germanys Financial Markets

The following highlighted snapshots of the financial markets in 2013 reflected the healthy state of Germany's economy:

A 21% DAX outperformance over its European peers surpassed only by the 33% and 22% performances of the MDAX for mid-caps and SDAX for small caps, respectively

A 33% growth in buyout transaction volumes with DACH involvement driven by the return of larger transactions

Over 8bn raised in the Schuldschein market with a record number of foreign issuers entering the market

Ca. 3bn capital raised in mid-cap bond markets despite concerns about defaults and weak creditor protection.

However, the strong loan market performance needs to be benchmarked against a lackluster credit demand given the slow capital expenditure.

2014 Where did all the Risks go?

Will the memory of a dooms day sovereign debt crisis in mid-2012 fade away?

No noticeable headwinds and continued liquidity provision through central banks result in optimistic outlook:

German GDP growth expected at 2% in 2014

Pick-up in capital expenditure and investment to bolster growth, in particular overseas

Likewise, increased M&A and buyout activities given improved outlook, still attractive valuations and ample "dry powder"

Further deleveraging in the banking sector driven by Basel III and ECB stress tests.

Consequently, we expect a steady increase in issuance activities by mid-cap companies across Europe including the German Mittelstand.

We would like to take this opportunity to thank

our clients for engaging in numerous interesting

discussions, exploring ample business

opportunities and offering constructive feedback

regarding how to further shape our business,

and better address our clients needs. We look

forward to working with you in 2014!

German Market Outlook 2014

December 12th, 2013 2

Global Economic Outlook and Prospects for the German Economy

Industrialized economies still struggling with possible stagnation concerns

Global growth is set to recover in 2014 on the back of strong industrial output growth of emerging markets, a stabilizing Eurozone as well as robust growth in the US. Germany,by virtue of being an exceptionally open economy with a strong industrial base, should benefit from this development. As a result, the growth in the German economy should accelerate from 0.6% in 2013 to around 2.0% in 2014.

In 2013, the industrialized world and its policy makers have struggled to shake off the remaining concerns over possible balance sheet recessions and their deflationary impact. The consequences of ambitious fiscal consolidation measures in the Eurozone have further magnified such concerns and have delayed any significant recovery in business and consumer confidence. As a result, key central banks have continued to initiate extraordinary monetary policy measures in an effort to support their respective economies. This has led to a significant increase in central bank balance sheets and real money balances especially in the US, Japan and Great Britain.

Credit growth poses concerns for Eurozone growth prospects, but the 2014 outlook has improved

Credit allocation to the private sector is still shrinking in many Eurozone countries, thereby enforcing balance sheet adjustments for households and corporations. However,the pace of economic decline has moderated and the Eurozones GDP appears to have turned the tide, showing positive growth in the second and third quarter of 2013. Given the reduced need for further fiscal tightening in 2014 and signs of a revival in confidence, we expect a moderate recovery in the Eurozone economy, suggesting a sizeable turnaround in the Eurozones contribution to the global growth in 2014. In addition, the US economy is expected to grow around one percentage point higher next year, while the Chinese growth continues to surprise on the upside despite concerns over a possible property bubble and an inefficient allocation of savings. Not surprisingly, global growth is expected to be at least one percentage point higher in 2014 than what it was in 2013.

Fig. 1: Industrial Production

Source: CPB; IKB

Global growth continues to be driven by industrialization of emerging markets

Since the beginning of the new millennium, the industrial output of emerging markets has emerged as the major global growth driver. In the 1990s, the growth was primarily driven by industrialized economies mainly due to their service industrys growth and to a smallerextent by their industrial output. Since then, around 75% of global growth dynamics can be attributed to the industrial output growth of emerging markets. As a result, the current global growth dynamics strongly favor open economies with a high industry/GDP ratio, that is, economies that can participate particularly well in the global production of primary and secondary industrial goods.

40

60

80

100

120

140

160

180

1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

Index (2005=100)

World Advanced Economies Emerging Economies



Fig. 2: Average GDP Growth and Industry Share of GDP

1) Average 2005 to 2012 2) Average 2005 to 2010

Source: Eurostat

German economy has globalized on a broad scale and should benefit from the expected global recovery in 2014

The German economy is one of the most open economies in the world. The country also has a stable industrial base, with output in excess of 20% of GDP. Both of these features suggest that Germany has not only focused on export markets to ensure adequate demand for its products. The economy has also adjusted its supply side to be in tune with a changing global environment and increased competition. This is evident from the high percentage of foreign production found not only among DAX companies, but in particular among mid-sized German companies. Companies supply and demand profiles bear evidence of an economy that has globalized on a broad scale. Not surprisingly, the German economy is in a particularly favorable position to benefit from the reviving global growth dynamics in 2014.

Fig. 3: Exports and Imports as % of GDP (2012)

Source: E.I.U.; IKB

Confidence revival induces recovery in investment spending across the Eurozone, favoring German exports

Over the last two years, the growth in the German economy was driven by foreign as well as domestic demand, with net exports to GDP falling marginally to around 7%, just short of the pre-crisis peak of 8% in 2008. The reasons for the relatively reserved export growth include a general reluctance among many European economies to raise their investment spending, which is a major demand component for Germanys industrial exports. Given the increasing revival in confidence across Europe, we expect investment spending to recover in 2014, albeit from fairly low levels, given the ample spare capacity. The decline in real investment spending appears to have turned around in the second quarter of 2013, as is evident across all major Eurozone economies.

-2

-1

0

1

2

3

4

5

10 15 20 25 30 35

Ave

rag

e G

DP

gro

wth

in

%1

)

Average share of industry as % of GDP2)

Latvia

Greece

FranceUK

Spain

Belgium

Netherlands

Portugal

DenmarkItaly

Germany

AustriaSw itzerland

Finland

Hungary

Sw eden

Croatia

Slovenia

Estonia

Czech Rep.Bulgaria

Lithuania

Poland

Romania

Slovakia

0 10 20 30 40 50 60

USA

Japan

China

France

Italy

UK

Germany

Exports Imports



Fig. 4: Real Investment in Equipment

Source: Eurostat; Federal Statistical Office; IKB

German GDP growth expected to reach around 2% in 2014

Falling inflation, solid wage rate growth and a robust labor market have ensured healthy real income growth for German households. Not surprisingly, domestic demand,especially private consumption has become a stable growth driver in the last two years. This trend is likely to continue, as accelerated GDP growth will create enough room for productivity gains to unfold without exerting excessive pressure on the labor market. Therefore, 2014 will be a year in which domestic demand and strong exports support Germanys growth prospects. The German economy grew at 0.7% in the second quarter of 2013, followed by 0.3% in the third. Leading indicators confirm a renewed revival of growth in the final quarter as well. Given the expected global growth dynamics as well as the pent-up demand for investment spending in Germany and the Eurozone, we believe a growth of around 2.0% in 2014/15 is fairly plausible.

Fig. 5: Outlook: GDP Growth

2011 2012 2013F 2014F 2015F

Germany 3.4% 0.9% 0.6% 2.0% 2.0%

Eurozone 1.6% -0.6% -0.4% 1.1% 1.7%

UK 1.1% 0.1% 1.4% 2.3% 2.3%

USA 1.8% 2.8% 1.7% 2.7% 3.2%

Japan -0.6% 2.0% 1.9% 1.6% 1.4%

China 9.3% 7.8% 7.7% 7.8% 7.6%

Source: IKB

Manufacturing sectors output growth set to accelerate in 2014

Many sectors of the German economy experienced negative output growth in the first half of 2013. However, a general revival has been witnessed in many sectors in the second half. Given the improving global prospects, we expect the output growth to further recover in 2014. This is especially the case for sectors such as automotive and machinery the two primary export sectors of the German economy both are rather sensitive to the local and global business cycles.

90

100

110

120

130

140

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Inde

x (2

00

0=1

00

)

Germany Eurozone



Fig. 6: Outlook: Sector Output Growth

2010 2011 2012 2013F 2014F 2015F

Food 1.0% -0.2% 0.0% 0.7% 1.0% 0.7%

Textiles and clothing 7.5% -0.4% -7.7% -0.2% 0.7% -0.3%

Wood and forestry 6.0% 12.4% -0.1% 1.8% 2.3% 2.0%

Paper 7.7% -1.7% -1.6% 0.5% 1.7% 1.6%

Chemicals and pharmaceuticals 11.0% 1.0% -1.9% 1.8% 3.0% 2.7%

Rubber and plastics 12.8% 4.4% -1.5% 2.9% 3.1% 2.7%

Building material (non-metallic mineral products)

6.6% 9.6% -4.0% -1.6% 1.9% 1.6%

Metal production 20.4% 2.2% -3.4% 1.6% 4.0% 3.3%

Metal products 14.1% 11.1% -0.9% 1.6% 4.3% 3.8%

Electrical engineering 16.3% 11.9% -2.0% -2.4% 4.5% 3.9%

Machinery and equipment 9.7% 13.8% 1.9% -0.6% 3.6% 3.0%

Automotive 24.9% 13.1% 0.2% 1.3% 5.6% 4.9%

Furniture, other manufacturing 5.0% 3.9% -1.2% -3.8% 1.0% 0.8%

Source: Federal Statistical Office; IKB

SWOT-Analysis

Glo

ba

lis

ati

on

Co

mp

eti

tiv

ene

ss

High level of globalization among German Mittelstand

Specialization has led to high level of global

competitiveness

Globalized market penetration allows participation in all growing markets

Fiscal consolidation largely completed

High personal saving rate hampers accelerated growth of private consumption expenditure

Demographics limit potential output growth

Renewed breakdown of investor confidence and continued deleveraging could hamper demand for investment goods

EU concerns over Germanys current account surplus could lead to domestic policies that

erode competitiveness

A minimum wage rate could affect labour market and consumer confidence negatively

Strong Industrial Base

Global Recovery

Le

gis

latio

nA

ge

ing

Po

pu

latio

n

Global recovery should favour an open economy

Increased recovery of investment spending supports German exports

Mittelstand increasingly globalized and less dependent on German labour market

Strengths Weaknesses

ThreatsOpportunity



Inflation, Interest Rates and Monetary Policy

Inflationary pressures in the Eurozone are well contained

Inflation in the Eurozone continues to surprise on the downside. Starting the year with an inflation rate of around 2% in January 2013, the annual change in headline CPI fell to 0.7% in October, largely due to energy prices. Credit allocation to the private sector has continued to put deflationary pressures, although this process should gradually reverse in 2014. As a result, inflation is expected to increase moderately over the next 18 to 24 months, but should remain well contained due to the rather moderate medium-term growth prospects for the Eurozone.

Fig. 7: CPI-Inflation in the Eurozone

Source: Eurostat; IKB

Possibility of negative ECB rates cannot be discarded

The ECB expects the headline inflation to remain well below 2% for 2014, possibly warranting further monetary policy easing to speed up the turnaround in the credit cycle. In this regard, the option of a negative deposit rate on banks excess liquidity held with the ECB continues to be debated. Whether such a move will trigger increased credit allocation is questionable, since interest rates are already at record low levels and the impediment to an increased credit demand is rather based on the lack of business and consumer confidence. Nevertheless, such a policy appears to be a possible option for the ECB. Another option the bank can exercise is to follow in the footsteps of the Bank of England regarding its Funding for Lending Scheme (FLS). In this case, the central bank provides relatively attractive funding to banks under the provision that such funds are used for lending to the real economy.

Money market rates to remain at current levels at least until the middle of 2015

The ECB has clearly stated in its forward guidance that rates will remain at the current or lower levels for an extended period of time. As the key ECB lending rate has been cut to 0.25%, concerns over the impact of a continued reduction in excess liquidity have been abated. Money market rates are essentially capped at around their current levels, a situation that should prevail at least until early to mid-2015. From then onward and on the assumption that the Eurozone economy and credit supply recover on expected lines, a forward-looking central bank might see a growing need for normalization in its policy stance meaning a reversal to real positive interest rates starting 2016.

Fig. 8: ECB and Money Market Rates

Source: Bloomberg; ECB; IKB

US labor market to improve slowly

The monetary policy in the US continues to be dictated by labor market developments. However, even with an economy growing in excess of 2.5% in 2014, it is unlikely that the unemployment rate will fall much below the Federal Reserves target of 6.5% before early

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013-1

0

1

2

3

4

5

YoY

% C

hange

2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 20130

1

2

3

4

5

6

in %

ECB Main Refinancing Rate 3M-Euribor Deposit Rate



2015. This, however, would be consistent with the Feds forward guidance, which points toward a reversal in the interest rate policy of the US Central Bank in 2015.

No quick termination of Feds QE program

The tapering of the Feds quantitative easing program (QE) should commence over the next couple of months. However, the Fed appears to be in no hurry for an early and complete termination, given the prospects for the US labor market. Further, the Fedsnext chief Janet Yellen follows closely in the footsteps of Ben Bernanke and considers an active policy of supporting the economic recovery as the Feds primary responsibility. According to Yellen, the surest way to an ultimately normal monetary policy is decisive policy action over the short-term.

Fig. 9: Long-term Interest Rates (10-Year)

Source: Bloomberg, IKB

Long-term bond yields should drift higher on both sides of the Atlantic

Besides the labor market prospects, the reaction of financial markets will be another important determinant for the pace of the Feds exit strategy. Long-term bond yields have reacted quite sharply to the initial announcement of a possible tapering, increasing by over 100bps in the US and inducing a global repricing of financial assets. Since then, and despite the Feds postponement, yields have not receded to their previous low levels. A forthcoming reduction of the QE program by the Fed is expected, reducing the risk of major surprises. Nevertheless, with an improving economic outlook, long-term bond yields in the US should drift higher in 2014, causing German bond yields to follow.

Fig. 10: Outlook: CPI Inflation, YoY % Change

2011 2012 2013F 2014F 2015F

Germany 2.1% 2.0% 1.5% 1.7% 2.0%

Eurozone 2.7% 2.5% 1.4% 1.4% 2.2%

UK 4.5% 2.8% 2.6% 2.4% 2.1%

USA 3.1% 2.1% 1.4% 1.9% 2.4%

Japan -0.3% 0.0% 0.3% 2.2% 1.5%

China 5.4% 2.7% 2.7% 3.1% 3.0%

Source: Bloomberg; IKB

Fig. 11: Outlook: Short and Long-term Interest Rates

25 Nov. in 3M in 6M in 9M End 2014

3M-Euribor 0.23% 0.22% 0.22% 0.22% 0.24%

3M-$-Libor 0.24% 0.26% 0.28% 0.28% 0.28%

10-Year Bund 1.72% 1.90% 2.00% 2.30% 2.50%

10-Year U.S. Treasury 2.73% 2.80% 2.90% 3.00% 3.20%

EUR Swap 10-Year 1.98% 2.20% 2.40% 2.70% 2.90%

US-$ Swap 10-Year 2.81% 2.90% 3.00% 3.20% 3.40%


2010 2011 2012 20131

2

3

4

in %

Germany USA



Outlook for the /US$ and other Exchange Rates

Feds policy has triggered significant financial market volatility

The Feds monetary policy continues to have a significant influence on global financial markets, as an increasing flood of US dollars chases financial returns around the globe. Unintended consequences of this policy have become evident in May 2013, when the Fed for the first time contemplated a reduction in its monthly asset purchases. Markets reacted quite sharply, especially in emerging economies, as a significant amount of US dollars found their way back into the US, causing a general depreciation of emerging market currencies.

Fig. 12: Federal Reserve Bank: Total Assets

Source: Fed; IKB

Feds policy to favor dollars strength in 2014

Financial markets in general, and foreign exchange markets in particular, will be shaped by expectations surrounding the Feds policy change in 2014/15. However, given current bond yield levels and the Feds forward guidance, the impact of tapering and eventual termination of the Feds QE program on asset prices should be contained. Nevertheless, US long-term bond yields are expected to drift higher, widening the interest rate differential between the US and other major economies. This, in turn, supports the possibility of a dollar appreciation in the first half of 2014.

Fig. 13: Long-term Interest Rate Differential USA vs. Germany


Euro to strengthen over the medium term

The Eurozones economic stabilization should fundamentally improve the sovereign risk profile of many of its member states in 2014 and beyond. This together with prospects of a sustained economic recovery, supports the notion that German bunds will continue to lose their attractiveness as a safe haven. This should prevent an excessive widening of the interest rate differential between the US and Germany, and support the /US$ exchange rate over the medium-term.

2007 2007 2008 2008 2009 2009 2010 2010 2011 2011 2012 2012 2013 20130

1,000

2,000

3,000

4,000

in U

S$

bn

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013-80

-40

0

40

80

120

160

bp

s



Short-term Euro weakness is likely and possibly wanted by the ECB

The forthcoming changes in the US monetary policy as well as favorable US growth prospects for 2014 increase the probability of a short-term dollar appreciation against the Euro. This should be a welcoming development for the ECB, as it eases deflationary pressures within the Eurozone. Over a period of time, the Euro should be supported by the recovering Eurozone economy, declining sovereign risk premiums and a gradual reduction of the US-Eurozone growth differential.

Fig. 14: Outlook: Selected Spot Exchange Rates

25 Nov. in 3M in 6M in 9M End 2014

/US$ 1.35 1.33 1.29 1.32 1.36

/ 0.84 0.84 0.85 0.85 0.89

/ 137 132 131 131 135

/CHF 1.23 1.23 1.24 1.26 1.30




Corporate Germany: at Crossroads to Financial Markets?

In Southern European countries, a credit crunch can be seen

Despite a revival in bank lending, falling margins and low default rates, German corporations will be increasingly looking to tap the capital markets. The reasons include long-term bank funding costs, regulatory aspects and a higher acceptance of market-based financing solutions. These range from increased usage of Schuldscheindarlehen over direct lending vehicles to bond issuance.

Large German corporations are currently enjoying a comfortable financing environment as rosy as it was in 2007 on the back of buoyant bank lending and capital markets.

This is in stark contrast to their Southern European peers where a situation similar to a credit crunch could be observed in the past 15 months; the loan supply to companies has been constantly declining in absolute figures.

This credit cutback has been driven by the local banks limited lending ability given their liquidity/refinancing constraints and the volume of non-performing loans and weak borrowers. In this macroeconomic environment, even better-rated companies are facing limited finance supply.

Fig. 15: Loans to the Non-Financial Sector

Fig. 16: CDS: 5-Years Senior Spreads


Source: Bloomberg

In Germany, corporations have changed their balance sheet structure from an equity ratio of 20% to 30%

As the ECB through its choice of policy instruments attempts to stimulate bank lending and credit provision in Southern Europe, German companies continue to enjoy the luxury of relaxed financing and lending conditions. However, they do not seem to derive full advantage of the financing environment. German corporations, especially manufacturers, have improved their balance sheet structure over the last decade from an equity ratio of less than 20% to approximately 30% (fig. 17). This was mainly achieved by increased retained earnings and also by mezzanine instruments accounted for as equity, thereby restraining themselves on both investment activities and credit growth.

Fig. 17: Equity Ratios of German Firms

Fig. 18: Share of Corporate Investments of GDP

Source: Federal Statistical Office

Source: Federal Statistical Office

2005 2007 2009 2011 2013-10

0

10

20

30

% Y

oY

Germany France

Italy Spain

2007 2008 2009 2010 2011 2012 20130

100

200

300

400

500

600

UniCredit Santander

Commerzbank

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

0

5

10

15

20

25

30

35

in %

Total Companies Manufacturing

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

10

12

14

16

18

20

22

in %



The share of bank loans in total liabilities was reduced from more than 20% to around 13%

In light of the ongoing uncertainty in financial markets and discussions about the Eurozones future, corporations have remained rather cautious in their investment decisions. Similar to 2012, investments in long-term assets such as machinery and equipment are expected to decline again in 2013. Muted investment activity was to a large extent funded out of operating cash flows, bringing down the share of bank liabilities as a percentage of total liabilities from more than 20% to 13% over the last 10 years.

Further, with concerns about the impact of Basel III regulations and possibly negative experiences among banks during the 2008/09 financial crisis, many mid-cap companies have started to look at capital markets as a way to diversify their funding sources (fig. 19).

Fig. 19: External Funding Structure of Companies in 2012


Corporate finance is in the midst of a structural transformation process: New financing solutions beyond the traditional bank loan are evolving

Consequently, in 2013, the German mid-cap financing market has been marked on the one hand by improved credit quality and muted demand for financing, and by an improved credit supply through a slowly recovering banking sector on the other.

With further economic recovery likely to occur in 2014, investments in new machinery and equipment are expected to rise steadily in 2014. In addition, export companies in many sectors are expected to focus on expanding their production and development capacities in growth markets such as Asia and North America for strengthening their market position.

Regulatory framework supports the trend towards market-based financing solutions

With the ongoing changes to the regulatory banking frameworks (Basel III) as well as the insurance industry (Solvency II), it will be interesting to see how long-term financing demand will be covered, and which instruments will provide long-term funding. The regulatory objective to create stronger banks requires higher core capital ratios, which can only be met through a further deleveraging of bank balance sheets. This will clearly affect the ability of the banking sector to meet the growing credit demand in 2014. The introduction of a net stable funding ratio will limit, especially long-term bank lending,which in Europe has been traditionally the dominant pillar of investment financing. With an increased link between ratings and risk-weightings, we believe this development will be most pronounced for corporations at the lower end of or below the investment grade space.

We, therefore, expect the trend toward market-based financing solutions and to some extent disintermediation of the banking sector, to gather pace in the coming years.

Financing solutions for the German Mittelstand

There is a need for adequate financing solutions for the German Mittelstand. Such financing solutions have been pioneered by us and other institutions over the last couple of years:

Expansion of the Schuldschein market: Historically, the Schuldscheindarlehen market (see the specific section for more details) has been an investment grade-focused market with a minimum issue size of c. 50m. Investors appetite to put money at work opened up this market for both crossover credits as well as smaller issue sizes (e.g. IKBs 30m issue for Analytik Jena AG in 2012).

Insurance-based solutions: With the long-term investment needs of the insurance companies and the Mittelstands long-term investment focus, numerous initiatives

32.0

19.0

6.0 5.0

-5.0

Trade credits,prepayments

Bondsetc.

Pensionprovisions

Sharesetc.

Loans-10

-5

0

5

10

15

20

25

30

35

in

bn



have been focused on matching insurance money with long-term mid-cap lending. IKBs Senior Secured Debt Fund Hidden Champions is a credit vehicle that combines the investment funding for mid-cap companies with the investment requirements of insurance companies.

Development of a mid-cap bond market: Mid-cap companies have in the past shied away from the disclosure requirements of public bond markets, while at the same time, the minimum issue sizes of 200m+ often exceeded the financing needs of the Mittelstand. With the introduction of dedicated mid-cap bond market segments, German SMEs can now cover funding needs through these channels and over 5bn worth of capital has been raised thus far. While these new market segments still face numerous issues in terms of documentation, underlying credit quality and overall liquidity, the emergence of dedicated institutional fund managers, various initiatives covering issuer quality and the ongoing need for yield will ensure the further development of this market into the little brother of the high-yield market for established German corporations. The recent successful and oversubscribed issues such as Alfmeier (30m) or Hrmann (50m) underpin the fact that investor appetite for such issues is still high.

Mid-cap mezzanine: With expansion and investment programs predicted for the German industry for 2014 and beyond often requiring additional risk capital, we also forecast an increased demand for dedicated mezzanine capital. The Valin Mezzanine Fund of IKB/Seer Capital is one of these dedicated funds, providing mezzanine capital to companies having up to 50m turnover and holding further growth potential.

Outlook 2014: Further diversification of funding sources

In summary, we expect a further diversification of funding sources in 2014, utilized by German corporations away from traditional bank lending given the increased funding needs and the desire to reduce dependency on banks and against the backdrop of continuing regulatory scrutiny for the financial industry.



German Private Equity Market

2013: overall M&A volume continues to rise

After a slow start into the year with the total German M&A volume of 5.8bn in Q1 (down -57% from 13.6bn in Q4 2012 and -52% from 12.0bn in Q1 2012), the pace picked up with 29.4bn and 23.4bn in Q2 and Q3 respectively. The aggregate YTD volume as of Q3 is up 32% as compared to Q3 2012 and already slightly above the entire year of 2012 (58.6bn vs. 58.1bn). The number of deals over that period amounts to 482 vs.692 for the entire year of 2012, implying an increase of 45% in average deal value during YTD 2013 as compared to last year. The increase is, among others, driven by three large sponsor-backed transactions in Q2.

Fig. 20: M&A Activity in Germany 20072013 (Value bn)

Fig. 21: M&A Activity in Germany per Quarter 20112013 (Value bn)

Source: Merger Market, Q3 2013


Buy-out activity increased 33% YTD compared with 2012 driven by three large deals in Q2

This years total buy-out volume reached 10.1bn until Q3, representing an increase of 33% over the same period last year. On a quarterly basis, the buy-out activity has followed a similar pattern, although more pronounced, with a total deal volume of 0.4bn as compared to 3.9bn in Q4 2012. Later, a significant rise of 8.9bn was witnessed in Q2 2013, accounting for 88% volume in YTD on the back of 26 transactions. Of this amount, nearly 7.9bn was contributed by only three transactions: CVC/ ista (Apr-13), Cinven/ CeramTec (Jun-13) and BC Partners/ Springer Science (Jun-13). On that basis,the buy-out activity as percentage of the total value has slightly decreased to 17.2%.

Fig. 22: Buy-outs in Germany 20072013 (Value bn)

Fig. 23: Buy-outs in Germany per Quarter 20112013 (Value bn)



Most buy-outs in industrials/chemicals, while highest value in TMT driven by a few large transactions

In terms of industry sectors, Industrials/Chemicals continue to represent the majority of buy-outs in Germany with 42.0% of all transactions, but with only 35.0% in terms of value. TMT was the most sought after sector in terms of value with 30.7%, which was also driven by the large transactions mentioned above.

86.2

65.1

39.8 39.2 38.4

58.1 58.6

695

586

488

557

650692

482

0

200

400

600

800

2007 2008 2009 2010 2011 2012 2013YTD

0

20

40

60

80

100

120

Value in bn No. of deals

14.4 14.2

6.23.7

12.013.5

19.013.6

5.8

29.423.4

161170

167152

183

147

173189

170

152160

0

50

100

150

200

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

2011 2012 2013

0

10

20

30

40

50

Value in bn No. of deals

23.9

14.0

4.2 3.25.6

11.510.1

27.8%

21.4%

10.6%8.0%

14.7%

19.8%17.2%

0%

5%

10%

15%

20%

25%

30%

2007 2008 2009 2010 2011 2012 2013YTD

0

5

10

15

20

25

30

35

Value in bn % of total M&A value

0.6

3.3

0.7 1.0 0.9

4.9

1.8

3.9

0.4

8.9

0.8

4.5%

23.1%

11.5%

27.0%

7.6%

36.4%

9.5%

28.6%

7.4%

30.3%

3.2%

0%

10%

20%

30%

40%

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

2011 2012 2013

0

2

4

6

8

10

Value in bn % of total M&A value



Fig. 24: Buy-outs in Germany by Industry (Value, YTD 2013)

Fig. 25: Buy-outs in Germany by Industry (# of Transactions, YTD 2013)



More buy-outs than exits sponsors increase German exposure

The primary buy-out activity in YTD 2013 has declined by around 45% as compared to the same period last year, while the secondary volume has more than doubled. Exits to strategics remained flat, resulting in an increase in sponsors net exposure to Germany.

Fig. 26: Average Mid-Cap: Senior Debt/EBITDA1)

1) European buy-outs of companies with 50m EBITDA or less

Source: Bloomberg

Growing willingness to invest in leveraged paper

Willingness of both banks and investors to invest in leveraged paper has continued to grow. For European issuers with EBITDA of 50m or less, the average senior leverage has increased by 1.1x to 4.4x senior debt/EBITDA this year as compared to 2012. While 2012 represented a break from the post-crisis trend resulting in increased risk awareness driven by the European sovereign crisis, leverage in 2013 has resumed the upward trend towards the 2007 high of 4.9x.

Key trend I: reduced funding costs

The continued decline in funding costs has added to these increased leverage levels and has also led to a significant increase in refinancings. In 2013 YTD, almost 50% of all leveraged loans were issued to recapitalize existing portfolio assets.

35.0%

30.7%

27.6%

3.6%1.8%

0.9% 0.3%0.2%

42.0%

17.4%

10.1%

7.2%

7.2%

5.8%

2.9%2.9%

2.9% 1.4%

TMT Business Services Industrials & ChemicalsFinancial Services Pharma, Medical & Biotech ConsumerEnergy, Mining & Utilities Construction LeisureAgriculture

4.9x

3.9x3.4x 3.5x

3.8x3.3x

4.4x

2007 2008 2009 2010 2011 2012 20130.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

Europe



Fig. 27: Weighted Average New Issue Spreads in Germany

Fig. 28: Sponsored New-Issue Leveraged Loan Volume 20042013

Source: S&P, Q3 2013

Source: S&P, Q3 2013

Key trend II: continued availability of funds

Private equity investors continue to raise significant amounts of funds, driven by investors search for return. According to Preqin, assets under management as a sum of the unrealized value of existing portfolios and dry powder, continued to increase by 5% in 2012. This reflects a slight decline of -1% in funds available for investment, which was overcompensated by the 8% increase in assets (unrealized value).

Fig. 29: Private Equity Assets under Management 20032012

Source: Preqin, 2013

Key trend III: reduced uncertainty

The funding costs of Europes weaker economies are used as an estimate of the current market assessment of the Euro sovereign crisis. The figure below illustrates that one significant contributor to overall market uncertainty has been reduced (or is being ignored for now). Spains spread for 10-year government bonds has reduced by over 400bps from the peak of the crisis in summer 2012 to around 200bps currently. This reduced uncertainty could increase buyers as well as sellers willingness to reach a deal.

Fig. 30: CDS for Spain/Italy 10Y Government Bonds 20072013 (bps)

Source: Bloomberg, November 2013

E+ 150

E+ 200

E+ 250

E+ 300

E+ 350

E+ 400

E+ 450

E+ 500

E+ 550

2007 2008 2009 2010 2011 2012 2013

RC/TLA TLB/TLC

44.4

103.0115.8

137.7

48.6

4.719.4

33.323.4

36.2

26.4

%

32.2

%

18.3

%

27

.2%

0.9

%

0.0%

19.7%

31.7%

37.0%

48.8%

0%

10%

20%

30%

40%

50%

60%

04 05 06 07 08 09 10 11 12 130

20

40

60

80

100

120

140

160

Leveraged loan volume (bn)

Recap/Refi as % of total loans

405 409 563806 1,011 1,075 1,067 994 1,007 997

465 554675

8981,265 1,204 1,413

1,783 2,0282,197

2003 2004 2005 2006 2007 2008 2009 2010 2011 20120

500

1,000

1,500

2,000

2,500

3,000

3,500

Dry powder US$bn Unrealized value US$bn

0

100

200

300

400

500

600

700

1 Jan 07 19 May 08 5 Oct 09 22 Feb 11 10 Jul 12 27 Nov 13

Italy CDS USD SR 10 Y Spain CDS USD SR 10 Y



Key trend IV: attractive valuations

Reduced uncertainty has not only facilitates M&A transactions, but has also led to a significant appreciation among equity capital markets around the globe. Since the beginning of this year, DAX and MDAX have gained 21% and 33% respectively after rising 25% and 31% in 2012. On this basis, valuation levels have increased further. On an average, EV/EBITDA (1-year forward looking) increased by 0.8x, increasing sellers willingness to exit non-core assets (strategics) or to consider early exits (sponsors).

Fig. 31: DAX EV/EBITDA

Fig. 32: Performance of DAX and MDAX 20112013



Outlook 2014: more of the same

It appears as if all the ingredients are available for maintaining the positive M&A momentum into the next year, releasing some of the pent-up demand for the post-crisis M&A activity. Reduced uncertainty from the abatement of the economic crisis provides a more stable environment for both buyers and sellers. In combination with a favorable funding environment, financial sponsors should continue to take their share in the rising M&A activity, potentially even increasing their contribution. Rising asset valuations combined with cheaper funding and higher leverage should increase the likelihood of corporate sellers and financial buyers coming to terms. However, a reemergence of the sovereign debt crisis or an economic slowdown would negatively impact the overall trend.

12.6x

6.0x

8.1x6.8x

6.0x7.0x

7.8x

2007 2008 2009 2010 2011 2012 20130.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

14.0x

EV/EBITDA 1 Year Forward

60%

80%

100%

120%

140%

160%

180%

Jan-2011 Dec-2011 Dec-2012 Nov-2013

DAX MDAX



Corporate Market

Fig. 33: Corporate Loans Volume (Western Europe)

Fig. 34: Pricing (Western Europe)

Sources: LPC

Sources: LPC

Key Trends 2013 The Western European loan market managed to arrange a loan volume of 268bn as of September 2013 YTD, which is 18% below the previous year. The loan market was quite dynamic, reflecting the competition among European banks to maintain their important role. The major trends in YTD 2013 were:

Refinancing transactions drove the loan market (82%), while use of proceeds for M&A activity remained at a low level (5%).

Pricing tightened for A and BBB range corporations from 115bps to 44bps and from 185bps to 82bps between January and September 2013 respectively. Within an 18-month period, margins have been squeezed even more with -143bps and -131bps for same rating spectrum.

Maturities for large Blue Chips extended from 3 to 5 years toward 5 years with two 1-year extension options.

The Investment Grade volume in Western Europe amounted to more than US$700bn and was almost equally divided between loans and bonds. Historically, the average split was at around 80:20 in favor of loans.

In the German small and mid-sized corporate market, we have observed an increasing number of non-IG corporations were able to convert bilateral baw commitments in up to 3-year credit lines.

Outlook 2014 The competitive environment among banks will remain intense for large and mid-sized Investment Grade companies. Particularly on the back of Basel III implementation, more banks will be active in the German mid-cap market segment, which would substantially improve funding costs for IG corporations.

With respect to the overall loan vs. bond volume for corporate financing, we expect the split to shift in favor for loans given the strong loan market dynamics. However, corporations have learned their lessons to quickly adjust to market changes and switch horses.

Institutional investors are positioning themselves to play a more important role through their direct lending activities. However, competitive pricings and longer maturities offered to IG corporations will slow down the rollout of direct lending activities.

This competition among lenders has led to tightening margins during 2013 YTD for larger IG corporations. We would expect this margin pressure to remain in place until an exogenous factor affects the risk/return profiles of banks. In addition, we would expect this trend to roll down the rating scale toward crossovers.

However, the refinancing volume will decline since many Blue Chip corporations have already taken advantage of the favorable market environment in 2013. Subsequently, we would expect an increasing number of refinancing transactions

0

50

100

150

200

250

3Q

09

1Q

10

3Q

10

1Q

11

3Q

11

1Q

12

3Q

12

1Q

13

3Q

13

0

20

40

60

80

100

120

140

160

Count

Volu

me (b

n)

DACH Other Deal Count

2009 2010 2011 2012 2013E+0

E+50

E+100

E+150

E+200

E+250

E+300

Spre

ad

A Pricing BBB Pricing

(-131bps)

(-143bps)

213bps

82bps

186bps

44bps



with a lower average deal size as larger mid-cap companies would try to benefit from the increasing bank appetite and aggressive terms.

In 2014, the trend for longer maturities will intensify and slowly move down the scale into the mid-cap space.

On the back of these developments, refinancings will continue to play a dominant role in corporate land. We would expect more IG mid-cap companies to focus on early refinancings in order to take advantage of the current favorable market conditions. Thus, an increasing number of early refinancings should be observable.

Furthermore, we expect the volume of M&A-driven deals to increase, though from a rather low starting level. Corporations have improved their operational performance and are now exploring strategic opportunities.

KfW financing programs for capital expenditures will play a more important role for prosperous small and mid-sized companies. Depending on the economic climate, volumes are expected to cross the 23bn threshold in 2014 vs. around 20bn in 2013.

For small and mid-sized companies, we see a continuing trend for borrowers to push for 35 year credit lines based on a standardized documentation, while trying to avoid the syndicated loan product as financing instrument of choice.



Corporate Schuldscheindarlehen: Tongue Twister Goes Abroad

Current developments and outlook

Over the last 10 years, the Corporate Schuldschein market in Germany has attracted strong demand from investors. With a total issuance volume of approximately 8.3bn in 2013, the positive long-term trend remains intact.

Around 65 transactions were completed on best efforts basis in the current year which is similar to 2011. Especially in the last two years, Corporate Schuldschein transactions with a minimum volume of 5075m were executed with more than one arranger in order to increase transaction certainty. A considerable number of private placements below 30.0m (also bilateral transactions) were not included in the market volume.

While a public rating can be utilized for marketing a Corporate Schuldscheindarlehen, the majority of issues were marketed on an unrated basis. It will be interesting to see whether this changes in 2014, on the back of an increasing footprint of continental European agencies such as Euler Hermes and higher awareness of the Schuldschein product by insurance companies that often require ratings.

Many corporations have taken advantage of the Corporate Schuldschein market as first time issuers sometimes using Schuldschein as a first step toward capital markets, and thus showing capital market readiness.

We estimate the total volume of outstanding Corporate Schuldschein volume to be in the range of 6070bn currently, and the corporate Schuldschein market redemptions to be approximately 5.06.0bn in 2013. A large number of these redemptions have been replaced by new issues.

Approximately 25% of the Corporate Schuldschein issuers were foreign companies. Foreign issuers from European countries have frequently tapped the Corporate Schuldschein market and have successfully executed transactions.

Additionally, besides Euro tranches, the market also saw a couple of transactions that include US dollar tranches (e.g. Software AG, Biotest AG).

Transaction maturities extended from around 3 to 5 years in 2012 toward 5 to 10 years in 2013, depending on the industry a trend that we expect to continue in 2014.

The investor universe remains broadly unchanged and dominated by banks in the shorter maturities. However, as an implication of Basel III, we expect institutional investors such as insurance companies and pension funds to assume increasing importance. Consequently, issuers will have to continue to broaden and diversify their investor base.

In 2014, we expect no change regarding investors interest and liquidity, and estimate the issued volume to be in the range of 8.510.0bn.

Fig. 35: Total Corporate Schuldschein volume 2004 YTD 2013

Source: IKB; Bloomberg

3,0004,500 5,000

5,500

18,900

7,020

3,725

7,059

11,985

8,346

2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

4,000

8,000

12,000

16,000

20,000

in

m

Total SSD volume



Fig. 36: Average Schuldschein Volume per Transaction 2009 YTD 2013

Source: IKB, Bloomberg

Fig. 37: Issuance Volume by Rating 2009 YTD 2013

Source: IKB, Bloomberg

111.4 116.4 108.6

131.7 126.8

2009 2010 2011 2012 20130

20

40

60

80

100

120

140

in

m

0

50

100

150

200

250

2009 2010 2011 2012 2013

0

500

1,000

1,500

2,000

2,500

3,000

3,500

in

m

N.R. BBB A AAA/AA iTraxx Main



Leveraged Market: Borrower Friendly is Back

Leveraged Volume & New-Issue YTM

Fig. 38: Leveraged Loans

Fig. 39: New-Issue Yield to Maturity

Source: Company, IKB analysis

Source: Company, IKB analysis

Key Trends 2013 The European Leverage Market looks back at 2013 as a strong year. Volumes increased from 65bn in 2012 to a volume of 117bn YTD October (80% increase). Main deal purposes were refinancings (41%), acquisitions/M&A (24%) and recaps (9%).

However, on the loan side, repayments (14bn) exceeded new institutional issues since July (12bn) and the forward M&A pipeline is limited.

Deal structures were driven by:

Strong evolution of high-yield financing structures with issue levels of 60bn and a proportionate share of 51%

A total volume of 6.4bn in the larger deal segment (EBITDA 100m plus) has been syndicated at least partially cross-border based on strong US investor liquidity as of October YTD. Cross-border deals are characterized by bullet structures and a covenant-lite nature

Clubby deal flow continues in the mid-cap space (EBITDA up to 30m). Direct lending funds are increasing their presence in this segment, competing with bank financings, but are often more expensive

We observed the revival of the European CLO issuance with around 6bn worth of new vehicles in YTD (six-year high), which is still a small volume as compared to 2007 levels (32bn).

Outlook 2014 In light of a stable macro environment, we expect borrower-friendly terms to persist over the medium term, as long as investors are vying for deals.

It remains to be seen how far borrowers will be able to push the envelope regarding reduction of margins and fees, loosening covenant sets, headroom and dividend language and simultaneously stretching leverage.

Loan structures will remain bullet-driven with a strong focus on the institutional investor class (and therefore a reduced share available for banks).

However, we expect a set-back of market conditions in late Q1 or Q2 2014 since i) the market is likely to become overheated, and ii) concerns around the European sovereign debt remain unresolved.

Investment banks share in the leverage space will presumably continue to be strong based on the open high-yield window with the product having entered the smaller deal size area of 200m plus.

Mid-cap transactions with a deal size below 150m continue to be clubby, given the involvement of debt advisors hired to optimize terms (avoiding market flex language and reducing management time required for syndication).

Question remains whether M&A activity will support the overall positive momentum.

42.3 43.927.3

51.00.0 0.0

1.4

6.444.4 35.7

36.4

60.2

2010 2011 2012 Jan-Oct13

0

20

40

60

80

100

120

140

Volu

me (b

n)

Loans Cov-Lite Loans

HY Bonds

86.7 79.665.0

117.5

4%

5%

6%

7%

8%

9%

10%

11%

1Q

11

2Q

11

3Q

11

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

3,80

4,00

4,20

4,40

4,60

4,80

5,00

Yie

ld

Leve

rag

e

Loan Debt/EBITDAHY Senior Secured BondsTLB Yields



European High-Yield Market: Coming in Strongly

2013: a record year in high-yield issuance

European high-yield bonds are the new favorite among investors, attracting higher inflows as compared to leveraged loans since 2012. Leveraged loans saw their peak time in 2007.

Driven by low interest rates and an improved economic outlook for Europe, the European high-yield bond market has seen another record year in terms of new issuance in 2013, by surpassing the previous high of 2010. Despite slightly weakened momentum in H2 2013, issuance is on its way to cross the 70bn mark, with a total of 199 issues as of November 30, 2013, and more than 200 expected by the end of this year.1

The average bond size is 352m in YTD 2013, which is slightly bigger than the average size in 2012 (331m), but well below the levels of 2011 (389m) and 2010 (379m). The higher risk appetite of investors did not only lead to attractive overall financing conditions, but also to an increase of more aggressive structures including subordinated bonds (mostly PIK-toggle notes).

The majority of the issuance (54% by number of counts) was used for the refinancing of bank and other debt, followed by M&A (19%), recap (14%) and general corporate purposes (14%).

Fig. 40: European High-Yield Bond Volume

1) YTD 30.11.2012 2) YTD 30.11.2013

Source: LCD

Southern Europe: issuance activity picking up

In terms of geography, the UK, Germany and France continue to be the top three most active countries, together accounting for around 50% of the total European high-yield volume in YTD 2013. We have also observed the increasing share of issuers from Southern European countries, e.g. Italy (8.7% of total volume), Spain (5.1%), Portugal (4.6%) and Greece (3.6%). With investors in search of high-yield opportunities, issuers domiciled in these countries are also taking advantage of the positive market momentum to raise debt and diversify away from contracting bank lending markets. Recently, bonds from first-time Italian issuers such as Astaldi, Teamsystems and Marcolin (IKB acted as joint-bookrunner) came to the market.

Both sponsored and non-sponsored companies increased issuance activities in 2013

After the booming years of LBO transactions in 2007, bond issuance activities of PE-sponsored companies dropped in 2008 and 2009, but recovered in 2010. In the past four years (2010YTD 2013), non-sponsored issuers were responsible for around 6070% of the total European high-yield bond volume each year. In 2013, the bond issuance volume from both PE-sponsored and non-sponsored companies, in particular traditional family-owned businesses diversifying their funding sources, increased substantially. This clearly shows that high-yield bonds are becoming the favored financing product for corporations to raise money.

1 LCD European High-Yield Weekly Review, November 29, 2013, by S&P Capital IQ

2.4 3.810.0

18.8 16.4 16.7 14.2

30.417.4 17.6 2.6

14.5

25.219.3 18.4 18.0

32.1

2.9 2.7

0.4

1.3 1.6

5.1

0

50

100

150

200

250

2006 2007 2008 2009 2010 2011 2012 2012 20130

10

20

30

40

50

60

70

b

n

Secured Unsecured Subordinated # of Bonds

22.7 24.2

2.6

24.5

44.4

35.7

67.6

33.136.4

1) 2)



Of the 149 issuers we counted in YTD 2013, 49 (or 33% by count) were public companies, while 100 issuers (or 67% by count) were in private ownership.

Fig. 41: Share of Total High Yield Volume

Fig. 42: Bond Volume by Ownership

1) Southern Europe includes Italy, Spain, Portugal and Greece. 2) YTD as of November 30

th.

Source: LCD European High-Yield Weekly Review, November 29, 2013

We note the following trends regarding the European high-yield bond issuance:

High-yield corporate bonds are becoming a favored financing instrument for both issuers and investors due to their high liquidity, more transparent prices, less complicated documentation and reporting requirements (compared with credit agreements), and good yield potentials. Some companies have even installed an all-bond financing structure.

The traditional role of banks as the dominant external financing source is being challenged. Unlike public companies that have access to equity capital market to raise additional equity, an increasing number of private companies will be forced to redesign their financing structure. Since banks are faced with more rigid rules to meet Basel III requirements, the share of bank loans in percentage to total liabilities, especially for private companies, is expected to continue to decrease in the future.

With the stabilization of economic activity in the Southern European countries and growing investor confidence, companies from these countries are seen as attractive issuers, due to the relatively higher coupons.

iTRAXX Crossover at five year low

Due to high inflows into high-yield funds, and driven by the appetite for higher yield by investors, corporate credit spread tightened substantially, whereas the synthetic iTRAXX Crossover reached its lowest level for 5 years in November 2013. After a temporary spread widening in June, on the background of market uncertainty and high volatility in all markets, the iTRAXX stood at 320.6 on November 29th. The lowest level of the iTRAXX was reached in February 2007 with 171. We see some additional room for further spread tightening.

Primary yield A similar trend can be observed in the average primary yield of the bonds. The bond break price has picked up slightly for the last three months, at 101.1, indicating strong ongoing demand by investors.

200620072008200920102011201220130%

20%

40%

60%

80%

100%

UK Germany

France Southern Europe

Other

1)

2)06 07 08 09 10 11 12 YTD

12YTD13

0

10

20

30

40

50

60

70

80

Sponsored Non-Sponsored

2) 2)



Fig. 43: iTRAXX Crossover

Fig. 44: Average Primary Yield by Rating

Source: Bloomberg

Source: LCD

Maturity wall promises high activities in the next years

According to Bank of America Merrill Lynch, between 2015 and 2018, bonds of a total volume between 33.3bn and 47.9bn will mature each year

2. Since many companies

take advantage of the positive market dynamics and refinance their bonds already more than one year before maturity, and a large part of the bonds carry call provisions, it can be expected that 2014 will be another good year in terms of issuance activities in the high-yield space. The same applies for the years thereafter, unless a real catalyst occurs and dampens the market.

Fig. 45: Maturity Wall of European High-Yield Bonds

Source: Bank of America Merrill Lynch European High-Yield Bond Index

Outlook 2014 With the iTRAXX Crossover trading at a very low level, the question remains whether 2014 will be another strong year with good returns in the high-yield market. Is the high-yield market already overheated? How long can the rally continue? Which event could be a market trigger and mark the turning point?

Macroeconomic picture supportive and strong liquidity in the market

The macroeconomic picture in Europe is positive and even some Southern peripherals are on a recovery path. Interest rates are expected to be kept low in the next 1 to 2 years. Hence, high-yield bonds will continue to be an attractive asset class. Given the improved macroeconomic outlook for 2014, especially a strong German economy and stabilization in the Eurozone as a whole (see section Global Economic Outlook and Prospects for the German Economy), corporations are expected to benefit from an improving macroeconomic environment and improve their operating results. Liquidity continues to be another supporting element in this equation.

2 Bank of America Merrill Lynch European High-Yield Bond Index.

Dec-2008

Dec-2009

Dec-2010

Dec-2011

Dec-2012

Dec-2013

0

200

400

600

800

1,000

1,200

1,400

ITRX XOVER CDSI GEN 5Y Corp

1H

09

20

09

2Q

10

4Q

10

2Q

11

4Q

11

2Q

12

4Q

12

2Q

13

3M

E 2

2/1

1/1

3

0%

2%

4%

6%

8%

10%

12%

14%

B BB

0.004.02

33.60 33.2836.74

47.88

25.6729.63

15.50

2013 2014 2015 2016 2017 2018 2019 2020 2021 orLater

0

10

20

30

40

50

60

b

n



Balance sheet of companies: in a healthy state

Overall, companies are in a healthy shape: Most of the companies have a good equity cushion and have streamlined their cost structure. Capex spending has increased, but is still at a comfortable level in relation to the current operating cash flows. M&A activities should pick-up in 2014, but given the strong balance sheet of many companies, we think increased M&A activities would not have a negative impact on the credit profile of the companies. We therefore see no significant impact, whether positive or negative in nature. Rating movements should be limited to specific names.

Refinancing supportive for the high-yield market

Given the maturity wall of many companies, refinancing will be one of the core themes for 2014. In view of the favorable financing conditions, new issuance in the bond market is expected to remain high.

Conclusion We currently see no relevant macroeconomic nor fundamental triggers concerning the overall credit quality of the companies on the near-term horizon. With the iTraxx Crossover not having reached its tightest point, we even see further room for spread tightening. One of the key factors is liquidity in our opinion and here the focus will be laid on the tapering process in the US.



Mid Cap Bond Market

Record level of bond issuance in the mid-cap bond market

In the German mid-cap bond market3 , we have counted 44 new issues with a total placed volume of 2.5bn YTD. Although an increasing number of companies are seeking bond financing as an alternative to bank loans, the average bond volume declined by 4.4m to 31.2m4 compared to 2012. An increasing number of smaller issues are being placed, whereas at the same time, the realized volume (86.8% YTD November 2013 and 94.6% in 2012) has also come down.

Frankfurt, with its three sub-segments (Entry Standard, Open Market and Prime Standard), has become the leading market with 35 bonds placed in YTD. Thus, Frankfurt has surpassed other markets such as BondM (Stuttgart), which brought the first bond back in 2010.

Fig. 46: Mid-Cap Bond Issue Volume

Source: Bloomberg

Mid-cap bond market as an excellent platform for SMEs

With lower IG and non-IG companies still facing some constraints on the lending side in terms of volume and covenants, the mid-cap bond market provides (in principle) a good platform to raise funds for the purpose of refinancing or growth financing.

Investors are becoming more skeptical

However, after a wave of negative news flows, e.g. issuer insolvencies, rating downgrades, operating result deteriorations, investors are becoming increasingly cautious and selective toward this asset class. Hence, it is more difficult to place new issues now, as is reflected in the lower placement quote of 86.8% (placed volume/targeted issue volume) in YTD 2013. A number of announced issues have also been downsized or even pulled out.

Low liquidity in the secondary market

Another problem arising from the relatively smaller issue volume is the lower level of liquidity in the secondary market. Even in the absence of any adverse fundamental news, bond prices may be pushed down several points. In our view, a minimum issue size of c. 30m should be adhered to.

Low recovery rate in case of insolvency

So far, nine issuers (or 7.4% of total issuers) have filed for insolvency with an average recovery rate expected below 10%. Around 40% of total bonds are trading below par with c. 11% trading in the distressed area (bond price < 75%). Approximately 60% of the bonds currently trade above par and over 21% of these bonds trade over 105. These data points underline our view of an increasing level of sophistication among bond investors. Bond picking on the basis of fundamental analysis are therefore, crucial for this market segment.

3 German Mid Cap bond market Universe comprises segments of the Frankfurter Wertpapierbrse (Prime Standard, Entry Standard and Freiverkehr),

Mittelstandsmarkt Brse Dsseldorf and BondM in Stuttgart 4 Excluding 6 larger bonds listed in the prime standard segment

795

1,7162,260

2,880

7131,510

2,1382,499

051015202530354045

2010 2011 2012 YTD 20130

500

1,000

1,500

2,000

2,500

3,000

3,500

m

Planned Issue Volume Placed Volume Number of Bonds

89.7%

88.0%

94.6%86.8%



Fig. 47: Planned Mid-Cap Bond Size5

Fig. 48: Mid-Cap Bond Price6

Source: IKB research

Source: IKB research

Mid-cap German bond coupon low

It is worth noting that some mid-cap bonds with lower sales, EBITDA numbers and smaller issue sizes (even below 20m) were priced at yields around 6.5% to 8.5%, that is, at a level similar to the high-yield market. This raises the question whether some of these bonds are fairly priced vis--vis the bigger high-yield issuers.

Smaller segments underperforming the liquid high-yield indices

Figure 49 shows that smaller and less liquid indices (MiBOx, BondM Index) seem to underperform their larger European high-yield peers. The smaller ones have come under severe pressure especially in the last quarter, whereas the iBoxx Euro High Yield Index rose slightly.

The Larger Mid-Cap Bonds-Index, which we calculated and includes mid-cap issues with an issue volume of minimum 30m, delivered a slightly better performance than its mid-cap peer indices. However, this index also suffered from a similar correction in November 2013.

Fig. 49: Performance of Bond Indices (High-Yield vs. Mid-Cap)

1) Simple average of the rebased bond prices of mid-cap bonds with a minimum issue volume of 30m, excluding the insolvent issuers, e.g. Getgoods, SIAG, Solarwatt, Centrosolar, FFK Environment, etc.

Source: Bloomberg

Market begins to mature

As the mid-cap bond market begins to mature, we have observed an encouraging trend toward stricter covenants and higher bond security over the past few months. The market is becoming more professional and investors are becoming more selective in their investment decisions. As issuers and arrangers are working together to ease investor concerns, we expect further improvement of standards for mid-cap bonds in the mediumterm.

Covenants become stricter

So far, most of the mid-cap bonds carry the standard covenants such as negative pledge, cross default, change of control clauses and call rights. More restrictive covenants such as limitations on net leverage, asset deals, dividend payments, and the security packages are increasingly found in recent deals. IKB has advocated these changes for

5 Targeted volume. From the 122 bonds we analyzed, 38 bonds, or 31.1% of total were not completely placed.

6 Bond price as of 28.11.2013.

17%

22%

38%

23%

>=100 Mio. >=50-100 Mio.

>=20-50 Mio.



some time now and with a more professional class of dedicated funds targeting this segment, investors are pushing forward in the same direction.

Key question: how to win the institutional investors

The mid cap bond market will increasingly play an important role for small to medium-sized companies in Germany, but given similar developments in other countries also across Europe as a whole. The key question remains how investors will position themselves in light of trading losses and defaults on existing issues and given the inherent illiquidity of the market.

In our view, still a lot needs to be done to attract a healthy base of institutional investors to the mid-cap bond market. In our view, measures should include a stringent documentation template in line with the high-yield market and adapted to the needs of mid-cap companies from a legal and accounting perspective, liquidity provision through lead arrangers, a higher level of rating scrutiny and last but not least larger issue volumes of 30150m.

Outlook 2014 For 2014, we expect a lower number of new issues, but with better credit quality and stricter documentations benefiting investors. The average bond volume is expected to increase, and the total volume of the market is expected to be around the level of 2013.



IKB Credentials



Contact Details

Financial Markets

Capital Markets & Derivative Sales

Institutional Sales

Tobias BodamerHead of Institutional Sales

Phone: +49 (211) 8221-8027

E-Mail: [email protected]

Christian CzayaPhone: +49 (211) 8221-8025

E-Mail: christian.czay [email protected]

Thomas FlgelPhone: +49 (211) 8221-4258

E-Mail: thomas.f [email protected]

Katja LangoschPhone: +49 (211) 8221-4342


Klaus PillenPhone: +49 (211) 8221-4688


Anne Mee Ra VallersnesPhone: +49 (211) 8221-8041

E-Mail: anne.v [email protected]

Ken WroblewskiPhone: +49 (211) 8221-4153


Jrg ZeidlerPhone: +49 (211) 8221-4319


Syndicate

Trading

Thomas EckertHead of Trading

Phone: +49 (211) 8221-4672


Michael BauerPhone: +49 (211) 8221-3243


Mark ErlerPhone: +49 (211) 8221-3265


Theo KerssenfischerPhone: +49 (211) 8221-4433

E-Mail: theo.kerssenf [email protected]

Mehdi KhouadjaPhone: +49 (211) 8221-4517


Klaus MllerPhone: +49 (211) 8221-4324


Sebastian RennwanzPhone: +49 (211) 8221-4163


Dr. Frank SchaumHead of Credit

Phone: +49 (211) 8221-4722

E-Mail: f [email protected]

Credit Products

Dr. Kurt DemmerChief Economist

Phone: +49 (211) 8221-4488


Economic Research

Dr. Klaus BauknechtPhone: +49 (211) 8221-4118


Dr. Carolin VogtPhone: +49 (211) 8221-4492

E-Mail: carolin.v [email protected]

Marion ScherzingerHead of Investment Research

Phone: +49 (69) 79599-9632


Investment Research

Dr. Nicolaus LoosHead of Leveraged Finance &

Sponsor Coverage

Phone: +49 (69) 79599-9649


Haiyan DingPhone: +49 (69) 79599-9557

E-Mail: haiy [email protected]

Leveraged Finance & Sponsor Coverage

Philipp HowaldtPhone: +49 (69) 79599-9514


Marco SamiiPhone: +49 (69) 79599-9677


Frank GleitzPhone: +49 (69) 79599-9606

E-Mail: f [email protected]

Gajen BalachandranPhone: +49 (69) 79599-9623


TorstenAulHead of Syndicate

Phone: +49 (69) 79599-9626


Ina BurghardtPhone: +49 (69) 79599-9603


Lekha GeevarughesePhone: +49 (69) 79599-9768

E-Mail: lekha.geev [email protected]

Stefan WeisserPhone: +49 (69) 79599-9704

E-Mail: stef [email protected]

Tilo KrausHead of Financial Markets

Phone: +49 (69) 79599-9558


Darius GarkischPhone: +49 (211) 8221-4610


Milon JenssenPhone: +49 (211) 8221-8443


Jochen MchtlingerPhone: +49 (69) 79599-9684


Dr. Jrg SchrderPhone: +49 (211) 8221-4101


Jean-Marc TappyPhone: +49 (211) 8221-4112

E-Mail: jean-marc.tappy @ikb.de



Visit us at our Offices

Dsseldorf (Headquarter) Berlin

Wilhelm-Btzkes-Strae 1

D- 40474 Dsseldorf

Phone +49 211 8221-0

Fax +49 211 8221-3959

Charlottenstr. 35/36

D-10117 Berlin

Phone +49 30 31009-0

Fax +49 30 31009-3800

Frankfurt Hamburg

Eschersheimer Landstrae 121

D-60322 Frankfurt (Main)

Phone +49 69 79599-0

Fax +49 69 79599-3860

Gertrudenstr. 2

D-20095 Hamburg

Phone +49 40 23617-0

Fax +49 40 23617-3820

Munich Stuttgart

Seidlstrae 27

D-80335 Munich

Phone +49 89 54512-0

Fax +49 89 54512-3884

Lffelstrae 4

D-70597 Stuttgart

Phone +49 711 22305-0

Fax +49 711 22305-3870

Madrid Milan

Palazzo Reale

Paseo de la Castellana, 9-11

E-28046 Madrid

Phone 0034 20 91 700-1116

Fax 0034 91 700-1463

Via Dante 14

I-20121 Milan

Phone 0039 02 7260-161

Fax 0039 02 7260-1650

Paris London

6, rue Cambacrs

F-75008 Paris

Phone 0033 1 703977-77

Fax 0033 1 703977-47

80 Cannon Street

GB-London EC4N 6HL

Phone 0044 20 709072-00

Fax 0044 20 709072-72

Meet us at the Following Events

IKB German Credit Conference: 14th15

th May 2014 in Dsseldorf

Structured Finance Conference: 12th13th November 2014 in Karlsruhe

Deutsches Eigenkapitalforum: 24th26th November 2014 in Frankfurt



Disclaimer

The information in this document (Document) is indicative and is provided for information, presentation and discussion purposes only. The Document has been prepared by IKB Deutsche Industriebank AG, Dsseldorf, (IKB) for IKBs use only within the Federal Republic of Germany (Germany), other member states of the European Economic Area (EEA) and Switzerland. Neither IKB nor any of its officers or directors will accept or assume any responsibility for any distribution or delivery outside the EEA or Switzerland. Neither this Document nor any copy of it may be taken, transmitted or distributed, directly or indirectly, in or into any other country by any recipient and this restriction specifically includes Japan, Canada and the United States of America, its territories or possessions and U.S. persons (as defined in Regulation S under the United States Securities Act) except pursuant to an exemption there from. Neither this Document nor any copy hereof may be distributed in any other jurisdictions where its distribution may be restricted by law and persons into whose possession this Document comes should inform themselves about, and observe, any such restrictions. Distribution of this Document in the United States, Canada, Japan or any such other jurisdictions may constitute a violation of United States, Canadian or Japanese securities laws, or the law of any such other jurisdictions.

The Document is not an offer, or a solicitation to offer, to invest, or to procure an investment in assets of whatever kind, or to issue or sell or procure the issuance or sale of such assets. This document is exempt from the general restriction on the communication of invitations or inducements to enter into investment activity and therefore its contents have not been approved by an authorized person as would otherwise be required by section 21 of the Financial Services and Markets Act 2000. This document is directed exclusively to market counterparties and intermediate customers as defined in FSA rules or to persons who are authorized persons or investment professionals as defined in Article 19 of the FSMA 2000 (Financial Promotion Order) 2001. No other persons should receive any information in this document. It is a condition of your attending this Document that you fall within, and you warrant and undertake to IKB that (i) you fall within one of the categories of persons described above, (ii) you have read, agree to and will comply with the terms of this disclaimer and (iii) you will conduct your own analyses or other verification of the data set out in the Document.

The information contained herein does not purport to be complete. No representation or warranty, express or implied, is made by IKB or any of its officers or directors as to the accuracy or completeness of such information, and nothing contained in this Document is, or shall be relied upon as, a promise or representation or advice by IKB or any of its officers or employees. IKB does not provide any investment services or ancillary services according to the Directive 2004/39/EC of the European Parliament. Any investment decision you take is in reliance on your own analysis and judgment and/or that of your advisors and not in reliance on us. This Document must not be viewed as research and its contents do not constitute advice, including investment advice. The information contained in the Document is for background purposes only and is subject to material updating, completion, revision, amendment and verification. Various factors could cause actual future results, performance or events to differ materially from those described in these statements, including as a result of changes in (among other things) general economic conditions, the conditions of the financial markets in Germany, in Western Europe and in the United States, the performance of the IKBs core markets and changes in laws and regulations. Opinions expressed herein are subject to change without notice and may differ from, or be contrary to, the opinions expressed herein. You may use the information in this Document for discussion purposes only and not make an offer to sell or issue or a solicitation of an offer to buy or issue assets. The Document is proprietary information of IKB, some of which is also confidential and should not be copied, distributed or passed on, directly or indirectly, to any other persons. The Document and any further confidential information made available to you are being supplied to you solely for your information and may not be reproduced, forwarded to any other person or published, in whole or in part, for any other purpose.

This Document includes forward-looking statements which may include, without limitation, statements relating to IKB. These statements are based on the assessments of IKB as of the date of creating this report. Words such as "believes", "anticipates", "expects", "intends" and "plans" and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. IKB does not intend to update these forward-looking statements except as may be required by applicable laws. By their very nature, forward-looking statements involve inherent risks and uncertainties, both general and specific, and risks exist that predictions, forecasts, projections and other outcomes described or implied in forward-looking statements will not be achieved. Therefore their validity is restricted to the date of publication. We caution you that a number of important factors could cause results to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements. These factors include those set out in our most recently published financial statements as well as: (i) market and interest rate fluctuations; (ii) the strength of the global economy in general and the strength of the economies of the countries in which we conduct our operations in particular; (iii) the ability of counterparties to meet their obligations to us; (iv) the effects of, and changes in, fiscal, monetary, trade and tax policies, and currency fluctuations; (v) political and social developments, including war, civil unrest or terrorist activity; (vi) the possibility of foreign exchange controls, expropriation, nationalization or confiscation of assets in countries in which we conduct our operations; (vii) the ability to maintain sufficient liquidity and access capital markets; (viii) operational factors such as systems failure, human error, or the failure to properly implement procedures; (ix) actions taken by regulators with respect to our business and practices in one or more of the countries in which we conduct our operations; (x) the effects of changes in laws, regulations or accounting policies or practices; (xi) competition in geographic and business areas in which we conduct our operations; (xii) the ability to retain and recruit qualified personnel; (xiii) the ability to maintain our reputation and promote our brands; (xiv) the ability to increase market share and control expenses; (xv) technological changes; (xvi) the timely development and acceptance of our new products and services and the perceived overall value of these products and services by users; (xvii) acquisitions, including the ability to integrate successfully acquired businesses; (xviii) the adverse resolution of litigation and other contingencies; and (xix) our success at managing the risks involved in the foregoing. We caution you that the foregoing list of important factors is not exclusive; when evaluating forward-looking statements, you should carefully consider the foregoing factors and other uncertainties and events.

By accepting the Document you agree to be bound by the above provisions. To the maximum extent permitted by law, IKB (and any of its officers and employees) does not accept any responsibility for or makes any representation, express or implied, or gives any warranty with respect to the use, the accuracy, correctness or completeness of the information provided during the Document and in any written material distributed during the Document and does not accept any liability, including, without limitation, any liability arising from fault or negligence, for any loss arising from the use of this Document or its contents or otherwise arising in connection with it. Additionally, IKB will not provide notice of nor correct any errors or inaccuracies contained herein.

deutsche industriebank german market outlook 2014 mid cap financial markets in times of macro...

Documents

german market outlook

corporate market

german economy

leveraged market

schuldschein market

german gdp growth

german private equity

global growth