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Germany in the Global Marketplace | April 2013 | EUROWEEK 1

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EUrOWEEK

2 Foreword Germany’s pivotal position in Eurozone markets: The view from the Federal Ministry of Finance

6 The economy Pre-crisis medicine works wonders for post-crisis Germany

12 europe’s economic engine Europe’s man for a crisis well set for EU recovery 16 germany’s relaTionship wiTh europe Reluctant EU leader puts economics first

19 BundesBanK proFile A voice of orthodoxy in an age of monetary apostasy

23 BanKing sysTem Anglo-Saxon banking? Nein, danke!

30 FinanZagenTur proFile Europe’s rock solid sovereign keeps things simple

36 german puBlic secTor roundTaBle 2013 Bond markets hold no fear for top tier borrowers

45 länder Finance Some Länder are more equal than others

48 german puBlic secTor deBT Unyielding: Europe’s premier debt market can only get stronger

50 BanK Finance Domestic bliss — banks bask in core Europe glow

52 BanK Finance roundTaBle Broadening funding horizons in a deleveraging market

62 securiTisaTion Compact ABS market in danger of shrinking even further

64 Blue-chip companies Stable, safe and well-spread: blue-chips revel as safe haven

66 leVeraged Finance and high yield Bonds Banks retreat from lending? Not in German leveraged finance

68 Financing The miTTelsTand Industrial heart keeps beating calmly as financial world changes

72 german corporaTe Borrowers’ roundTaBle Companies extend reach into markets as banks ease back

82 equiTy capiTal marKeTs Good times for Germany — but where are all the deals?

84 FinanZpaTZ FranKFurT Europe’s engine room not enough for Frankfurt to challenge London

87 exporT Finance Germany the hot centre of a hot export finance market

90 properTy sTocKs Destination Germany: economy fires up listed property sector

92 germany in Figures: an economic snapshoT

Contents: Germany in the Global marketplaCe

Page 84

Hapag-Lloyd’s Hanover Express is guided into port

Foreword

2 EUROWEEK | April 2013 | Germany in the Global Marketplace

As the largest economy in the European Union, Germany has been a key contributor to the common effort to reverse the crisis

of confidence in Europe. A vibrant capital market for German and European investment products is a central institutional ingredient to the successful fulfillment of this task, and I will outline below what makes this market attractive to international investors and how we intend to further foster this appeal.

The competitiveness of the German economy has been the main factor in helping us overcome the successive crises of the past five years, protect employment and grow. Indeed, real GDP growth, at 4.2% in 2010 and 3.0% in 2011, more than made up for the effects of the global financial crisis of 2008. Growth was positive again last year to the exception of the fourth quarter, and this trend will extend into 2013, when we expect growth to be driven mainly by internal consumption and investment. The ongoing rise in employment — itself the combined fruit of continuing reforms of the labour market, the export performance of German companies and our decision to overhaul the German energy market — will benefit the economy as well.

The recent economic success of German companies, especially those among the small and mid-sized businesses that make up our renowned Mittelstand, has few equals in the global economy. German companies are well positioned on the world’s fast-growing markets. They are reaping the benefits of a flexible wage-setting, of stable financing conditions and a sophisticated public infrastructure. German equities recovered very quickly from their two recent major setbacks — the first following the Lehman Brothers insolvency, and the second in the latter half of 2011 due to concerns surrounding the Euro crisis. Since then, German enterprises have provided healthy returns for investors and stakeholders in general, and continue on their upward path.

Among the main drivers of this success is research and development. This government acknowledges the importance of R&D for the wider economy. At around 2.9% of GDP, German expenditure in this area ranks at the top of the

European Union league table. Public as well as private investment in research and development will continue to ensure that German business retains its innovative edge. Consequently the government has significantly expanded the funding of R&D in the last four years.

In the public domain, Germany’s debt instruments are among the safest, and most liquid worldwide. The yield on our 10 year Bund security ranges well below 2%, and our 30 year bond pays a rate of well below 3%. For a large sovereign borrower, these are very close to the respective risk-free rates. Our markets for public bonds and private investment instruments continue to enable international investors to build exposure to the Eurozone at minimal risk. This is a benefit to the Eurozone as a whole. It underpins the role of the Euro as a stable reserve currency and supports Euro capital markets by supplying a stable anchor.

A commitment to fiscal disciplineThe health and competitiveness of the German economy and the country’s low financing costs are not only closely interlinked, but they also bear important lessons for the whole of Europe. Our continent needs more, not less, private entrepreneurship, and it needs less, not more, public expenditure. Healthy public finances are a condition of sustainable economic growth. Market confidence in this approach to fiscal and economic policy encourages us in our position that sound fiscal policy and economic growth are not contradictory but rather reinforce each other in the medium term. We are fully aware that all members of the European Union, including ourselves, need to be more successful on this front in the future than we were in the past.

In this context, I would also point to another case where serious economic reform coupled with budgetary prudence is bearing fruit: Ireland. Market sentiment towards the sovereign Irish signature has turned around and improved considerably, and it is our view that the Irish example shows the way. We need to pursue that avenue together with our partners that are also currently benefitting from EFSF programmes.

Germany’s pivotal position in Eurozone markets: The view from the Federal Ministry of Finance

By Steffen Kampeter, Parliamentary State Secretary

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Foreword


A level playing field for regulationIn terms of lessons learned from the recent crises, we need to recognize the overwhelming importance of the quality of financial market regulation for the functioning of capital markets. In this area, work remains to be done. Progress needs to be co-ordinated at the level of the European Union as a whole, if not on an even wider scale, in order to be successful in preventing future market breakdowns.

In the early hours of 13 December 2012, the finance ministers of the European Union, gathered in Brussels, took a major step forward by agreeing on a common text to establish a Single Supervisory Mechanism. Negotiations with the European Parliament, national approvals and implementation are the next priorities. The Single Supervisory Mechanism is a logical next step in improving the framework for a common European capital market. It will ensure a consistent application of regulatory standards and will enable supervisors to reach a common understanding of the soundness of the banking sector.

In this context, the clear delineation of responsibilities in line with the principle of subsidiarity is essential for the German government. Once the Single Supervisory Mechanism is established, the ECB will be responsible for the supervision of those credit institutions which are deemed “significant” — around 150 credit institutions in the Euro Area according to today’s data. The competence for supervising the remaining banks will remain at the national level. We expect the ECB to start to carry out its supervisory functions not before March 2014.

Regulatory reform at the European level will then need to follow on from there. In this context, the European Council has already in principle envisaged the project of a Single Resolution Mechanism, for which the European Commission has been tasked to submit a first proposal in the course of the year 2013.

We have done a lot, and continue to do a lot, to improve our economic competitiveness and thus our attractiveness to investors. The two crucial issues that will stay in focus over the coming months and years are, first, the global backdrop for our efforts to regain a solid economic footing for the Eurozone, and, second, the implications that the crises have had for the global framework of price stability.

Deficit reduction remains crucialThe global outlook remains uncertain and the

temptation to ignore the lessons of the past is increasing. In large parts of Europe, we are facing subdued confidence levels and tepid growth. While the economic situation elsewhere may be improving, G20 nations must not waver in their commitment to halve their deficits by 2013 — a commitment that looks now in danger of being broken by some. We have agreed to stabilize our public debts by 2016 and should do so. Moreover, we should develop these commitments to fiscal stability even further and set ourselves new deficit and debt goals beyond 2016. The European Union member states are already bound to bring down their debt levels to below 60% of GDP under the EU’s fiscal rules. In this spirit, the finance ministers of the G20 pledged at their recent meeting in Moscow to develop credible medium-term fiscal strategies that build on our existing commitments by the St-Petersburg summit in September.

Secondly, confidence in financial markets requires that the European Central Bank’s commitment to price stability should not be

questioned. Price stability is the ECB’s first goal. Everything else, including growth and financial stability-related policy targets, is subordinated to it. Therefore, it must be clear that extraordinary monetary policy measures can only be temporary. The European Central Bank has played, and

continues to play, an important role in our efforts to overcome the recent crises. But a lasting solution will not come from monetary policy but primarily from fiscal and structural adjustments in the individual Member States, as well as on restructuring, cost-cutting and shrinking of balance sheets in their banking sectors. In fact, while the extraordinary policy measures bought time to solve the problems, they have done so at a cost. This implies that if the time bought was not used effectively to solve the issues at stake, we would be worse off.

In this context, there can be no serious disagreement that exchange rates are no meaningful policy target. Regarding the Euro, its moderate appreciation in recent months has coincided with rising confidence in the Eurozone. I would also caution against a tendency we have seen in recent years — and not just in Europe — to blame self-inflicted woes on currency movements. Exchange rates and warnings of “currency wars” can be no excuse not to address domestic economic challenges.

To sum up, we in Germany intend to fully play our part in the effort to make Europe more attractive to investors. Considering the challenges that had to be faced in the past years, this Government has been highly successful in maintaining the international repute of the German and European capital markets, and we intend to continue in that spirit over the coming years. s

A lasting solution will primarily come from fiscal and structural adjustments in the individual Member States, as well as on restructuring, cost-cutting and shrinking of balance sheets in their banking sectors ”

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The economy


“Not eveN die-hard opti-mists expected this,” noted a Com-merzbank briefing published in response to a surge in Germany’s widely-followed ifo business cli-mate index in February. the rise, from 104.3 to 107.4, was way higher than even Commerzbank’s above-consensus forecast, and seemed to support the view that the 0.6% fall in Germany’s GdP in the fourth quarter of 2012 was an aberration.

“the surprising setback in the last quarter of 2012 was not the start of a recession,” says tor-sten Windels, chief economist and head of research at Norddeutsche Landesbank (NordLB) in hannover. “We expect positive growth of 0.3% in the first quarter of 2013 and 0.8% for the year as a whole.”

others are even more bullish about Germany’s growth poten-tial for the next 12-24 months. Jörg Krämer, chief economist at Com-merzbank, says that he is now pen-

cilling in 1% growth in 2013 and 2.5% 2014. the irony, for a country committed to prescribing contin-ued austerity in southern europe, is that Germany probably has an italian to thank for an economic outlook that is almost unsettlingly bright.

Stefan Schilbe, chief economist at hSBC trinkaus in düsseldorf, says that he expects to see a sub-stantial recovery in 2013, under-pinned chiefly by a strong rebound in business investment. “the cor-porate sector was extremely reluc-tant to invest in 2012 because of perceived risk of a break-up of the european single currency,” he says. “Until Mario draghi’s oMt speech in September, the investment plans of large as well as small German companies were on hold because they had no idea how many coun-tries would remain within the mon-etary union.”

the eCB’s reassurance about the

euro, says Schilbe, has encouraged German companies to revive those plans. this should help lift the business investment to GdP ratio from a level that at the end of 2012 fell beneath the lows of 2009. he adds that there is certainly no shortage of very keen-ly priced credit avail-able to support those investment projects. German banks, which have pulled back on much of their over-seas lending, are fall-ing over themselves to lend to the Mittel-stand, so much so that Moody’s, for one, has expressed concerns over the sustainabil-

ity of some German bank fran-chises. For larger German compa-nies, as Schilbe says, the corporate bond market is also probably more accommodating than it has ever been.

Export machinethe revival of investment pro-grammes and growing confi-dence about the prospects for europe will help the accelera-tion of a largely export-led recov-ery. an update published by Lom-bard Street research in February forecasts growth of between 0.75% and 1% between the fourth quar-ters of 2012 and 2013, driven over-whelmingly by exports. Lombard Street’s Charles dumas notes that real export growth of 2%-3% will be supported initially by an uptick in Chinese demand which, he observes, has been the engine of the German exporting machine in recent years.

The irony, for a country committed to prescribing continued austerity in southern Europe, is that Germany probably has an Italian to thank for an economic outlook that is almost impossibly bright.Philip Moore reports.

Pre-crisis medicine works wonders for post-crisis Germany

The odd couple that worked: Italian efficiency and German flair

The economy


“exports to advanced nations are barely up from 2007,” notes the Lombard Street update. “exports to China are up by over 100%, and to other emerging mar-kets by more than two fifths, the latter being markets basically dependent on the Chinese boom.”

German-based economists say that the importance of China should not be over-egged. “one of the miracles of the German economy since 2005 has been the flexibility of the Mittelstand,” says Windels at NordLB. “We have been surprised at how successful the Mittelstand has been in expanding its exports to asia, Latin america and other markets in africa.”

Conventional wisdom among Germany-bashers is to argue that it is easy enough to boost your exports when the value of your cur-rency is pinned down by wildly inappropriate interest rates. there is obviously some truth in that, with low eCB rates and a weaken-ing euro clearly supportive of Ger-man growth. But to attribute the success of Germany’s exporters entirely to an undervalued curren-cy is to show a churlish disregard for how the country’s corporate sector has reinvented itself over recent years, and for the flexibility that its once stubbornly immobile unions have shown.

Agenda 2010 pays off“the long term recovery in Ger-many began with the labour mar-ket reforms under Schroder,” says Stefan Bielmeier, economist at dZ Bank in Frankfurt, in reference to the agenda 2010 reform pack-age introduced by former Chan-cellor Gerhard Schroder in 2003. introduced at a time when Ger-many was being somewhat prema-turely written off as the sick man of europe, agenda 2010 was based on the development of a strong part-nership between government and industry which allowed for adapt-able wage bargaining and moderate wage settlements.

agenda 2010 also introduced the practice of short-term working ben-efits, under which workers who lost wages were eligible for government assistance when their hours were reduced. that, say economists, equipped the German corporate

sector to navigate its way through the recession of 2009 without gen-erating widespread unemploy-ment. “today, we still benefit from agenda 2010, which made the cor-porate sector much stronger,” says Bielmeier.

Gernot Griebling, head of bond research at LBBW in Stuttgart, agrees that the labour reforms of the early 2000s have been pivotal to the recent strength of the econ-omy. “the turnaround we saw after 2009, when the economy shrank by 5%, was astonishing,” he says. “one of the reasons we have record employment levels today is the Grand Coalition’s short term work-ing initiative, which created a win-win situation for companies and employees.”

others outside Germany agree. according to the oeCd, “past reforms of the labour market con-tributed to the strong resilience of employment during the past recession by raising working hour

flexibility and reducing structural unemployment.”

Low unemployment explains why the German consumer, long maligned for failing to contrib-ute much to growth, has been an increasingly important engine of the economy in recent years. econ-omists expect domestic consump-tion to become an increasingly important feature of German eco-nomic growth, in part underpinned by rising wages. NordLB’s Wind-els says that unions are pushing for some very chunky increases in pay this year, with the iG Metal union demanding a rise of between 5% and 6%.

Windels expects the unions to achieve a little over half of this ambitious increase, with metal and autoworkers predicted to secure pay rises of at least 3%. “Within the framework of an inflation rate of 1.8%, this would suggest a real rise of 1.5% or 1.6%, which will be a good engine for consumption.”

Learning to live with inflation?true enough. equally, however, it would be an engine for some highly un-German inflationary pressures, with dZ Bank’s Bielmeier saying his forecast for inflation over the next 12 months is above consensus, at 2.6%. Not so long ago that would have horrified the mandarins at the Bundesbank. today, however, economists say that Bundesbank officials have a more pragmatic and

“One of the miracles of the

German economy since 2005 has

been the flexibility of the Mittelstand”

Torsten Windels, NordLB

Euroland – CDS-Spreads

Source: NordLB

0

100

200

300

400

500

600

700

01/2008 07/2008 01/2009 07/2009 01/2010 07/2010 01/2011 07/2011 01/2012 07/2012 01/2013

bp

Italy Spain Belgium France Germany USA UK

Euroland — CDS spreads

Source: NordLB

The economy


neighbourly attitude to inflation than some of their more hawkish predecessors. “even the Bundes-bank has recognised that having a higher inflation rate than the rest of the eurozone is not necessar-ily destabilising, but an important part of the broader european read-justment process,” says Windels at NordLB.

Besides, for the time being at least, Germany-based econo-mists say they are relaxed about the inflationary threat. “Ger-man households are very price sensitive,” says Schilbe at hSBC trinkaus. “the market for necessi-ties, for example, is highly compet-itive, with aggressive discounters meaning that there is very limited scope for price increases.”

that may be. But over the long-er term, it is hard to see how Ger-man competiveness can remain untouched by inflationary pres-sures. “in the last two years, wage growth has been higher than pro-ductivity growth, which inevitably means that unit labour costs have risen,” says Bielmeier.

“that could have an unfavour-able effect on competitiveness over the longer term, but for the time being German companies are strong enough to live with this reduction.”

Some of the centrepieces of agenda 2010, says Commerzbank’s Krämer, are now being rolled back.

“We’ve seen pressure put on employers’ associations to raise temporary workers’ pay,” he says. “this is not yet a problem because competitiveness is still very high, but it may become a problem 10 years down the road. Who knows? in 10 years’ time we may need a new reform package — perhaps called agenda 2040.”

it is not just rising wages that

will encourage more consum-er spending, according to local economists. rising prices in the residential real estate market, a laggard in europe for many decades, is also helping to put a spring in the step of the Ger-man consumer. “house prices in Germany fell on a nominal basis between the mid-1990s and 2006,” says Schilbe.

“the upswing that we’ve seen since then is very positive for pri-vate consumption.”

Fair enough. But are rising prop-erty prices not another potential source of inflationary pressure? Schilbe thinks not. “even after the cumulative rise of 10% that we’ve seen since 2006, valuations in the residential housing sector are still extremely low relative to price to income and price to rental ratios.”

Modest valuations relative to other european countries, twinned with a low home ownership ratio and easy access to credit, he adds, should keep the residential prop-erty market strong without creating inflationary pressures.

Too good to be true?robust growth, low inflation, ris-ing wages and an unemployment rate bettered in the eurozone only by Luxembourg and austria — it all sounds like an impossibly vir-tuous circle. throw in a dax blue-chip equity index that recently broke through the 8,000 level and it is small wonder that Merkel is so popular. that is more than can said for her hapless junior coalition partner, the Free democratic Party (FdP). european politicians have been called some fairly juicy things recently, but the FdP has been the object of some especially barbed comment from the local press. the Suddeutsche Zeitung, for example, has described the party as being as “unpopular as athlete’s foot and halitosis combined.”

Certainly, the FdP’s showing in recent polls does not bode well for its chances at the next German fed-eral election in September. accord-ing to a poll published in Bild in February, the FdP has 5% of the vote, compared with 29% for the opposition Social democrats and 15% for the Greens. Merkel’s Chris-tian democrats would still capture

a towering 40% of the vote if Ger-man voters were to go to the polls tomorrow.

true, the Bild poll was taken shortly before italy’s omnisham-bles in February, and some argue that Merkel’s survival prospects were dealt a considerable setback by italy’s hopelessly inconclu-sive election. in a bulletin written immediately after the release of the results, Brendan Brown, head of economic research at Mitsubi-shi-UFJ Securities, cautioned that Merkel was potentially one of the biggest losers from the italian elec-tion.

the notion that Merkel faces an anxious run-up to the German elec-tion in September is waved away by local economists.

“there is no great political risk in Germany,” says Bielmeier at dZ Bank. “Given the recent polls, there is a high likelihood that Mrs Mer-kel will be the next chancellor. the only question mark is over who will be her coalition partner.”

Beyond giving her a nod of approval for her management of the economy, the German elector-ate is also clearly ready to give Mer-kel credit for her masterful han-dling of the euro crisis. it is hard to understate her achievement, so far, in pleasing most of the people most of the time. “Mrs Merkel has man-aged to tread the tightrope of rec-onciling the interests of the domes-tic populace who are opposed to bail-outs with those of the coun-tries most in need of the bail-outs,” says andrew roberts, head of euro-pean rates strategy at rBS.

Not only is the frumpy pas-tor’s daughter odds-on to retain her position as leader of europe’s largest economy. it is also unlike-ly that Merkel will be dislodged from the position she held in 2011

“Until Draghi’s OMT speech, the

investment plans of large and small

German companies were on hold”

Stefan Schilbe, HSBC Trinkaus

“The German recovery began with

the labour reforms under Schroder”

Stefan Bielmeier, DZ Bank

The economy


and 2012 atop the Forbes list of the world’s 100 most powerful women. although she may face some competition at the top of this roster from hillary Clinton and Brazil’s dilma rouseff (sec-ond and third respectively in the 2012 ranking), she may not lose much sleep over the challenge of Lady Gaga (14th).

Crisis never far awayMerkel will, however, continue to face a formidable range of exter-nal and internal challenges over the longer term. Foremost among these, very obviously, is the poten-tial for an intensification of the cri-sis in europe — which as the messy outcome to the italian election has reminded everybody, is very far from over. Further economic dis-tress and political turmoil at the periphery of the eurozone, and per-haps even closer to its core, can only add grist to the mill of indi-viduals like Bernd Lucke and his adherents.

Lucke, a former long-standing member of Merkel’s CdU, is in the process of setting up alterna-tive für deutschland, a new politi-cal party with some very influen-tial followers. Lucke’s eurosceptic group calls for the dissolution of the euro and its replacement either with national currencies or smaller currency unions.

While Lucke’s group presents no political threat to Merkel, Ger-

many-based economists caution against underestimating the dan-gers — not just to Germany — that would be created by a wider popu-lar clamour for the reinstatement of the deutschmark. at LBBW, Griebling says that a return to the deutschmark would make the downturn of 2009 look “like a Sun-day afternoon walk”.

“the eurozone crisis still pre-sents an enormous risk for Germa-ny,” he says. “Few people under-stand that a break-up of monetary union and a return to the deutsch-mark would leave the German banking sector bankrupt. Because their assets would be denominated in weaker currencies, the German banks’ equity would be wiped out, and the government would be una-ble to recapitalise the system.”

Scary stuff. But the threat from europe probably does not come from Bernd Lucke, a break-up of monetary union and the unthink-able consequences of a rebirth of

the deutschmark. the more prob-able and immediate threat is one of interest rates remaining inappro-priately and dangerously low for an economy growing as robustly as Germany.

“eCB rates are clearly much too low for Germany,” says Commerz-bank’s Krämer. “i’m not forecast-ing that it will happen, but i think we need to be aware that just as low rates created a huge bubble in Spain, theoretically the risk that the same could happen over the next five to seven years in Germa-ny.”

Krämer is confident that there are sufficient firewalls in place to prevent this disaster from unfold-ing. these range from the differ-ences in the psyche of the German and Spanish consumer, through to the relative openness of the Ger-man economy and the low level of home ownership in Germany.

Schrumpfnation Deutschlanda much longer term challenge for Germany, say local economists, may be its demographic crisis, which is so severe that there is even an expression for it. Schrump-fnation deutschland hyperbolical-ly means ‘shrinking Germany’ and refers to the process by which the population is projected to fall from over 80m today to between 65m and 70m by 2060.

“While the annual population growth rate in the US and the UK is about 1%, in Germany in the last few years it has declined by between 0.1% and 0.3% per annum,” says Griebling at LBBW. “if this continues, it will weigh heavily on German consumption, which is why more needs to be done to encourage immigration, as countries like Canada and australia have done.”

the German demographic dilem-ma needs to be seen in perspective. it is nowhere as serious or damag-ing as Japan’s, and immigration levels have risen in the last two years.

But as Griebling says, it will become increasingly important for Germany to strike a balance between encouraging rising num-bers of immigrants and ensur-ing that the majority of these are skilled workers. s

“A return to the Deutschmark

would make the downturn of 2009 look like a Sunday

afternoon walk”

Gernot Griebling, LBBW

Unit labour costs (index Q1/2000=100; source: Eurostat)

90

100

110

120

130

140

150

160

I/00 I/01 I/02 I/03 I/04 I/05 I/06 I/07 I/08 I/09 I/10 I/11 I/12

Index (I/2000=100)

Euroland Germany France Italy Spain Portugal Greece Ireland

Euroland – Unit Labour Costs

Source: NordLB

Euroland — unit labour costs

Source: NordLB

EuropE’s Economic EnginE


Germany and the rest of europe have a symbiotic relationship: peripheral countries need a strong Germany as the engine to keep the broader european Union mov-ing, while Germany needs stronger neighbours because its economy is heavily tied to exports.

Janet Henry, chief european econ-omist at HSBC, notes that the Bun-desbank “isn’t particularly gung ho” on its estimates for long-term poten-tial growth, expecting just over 1%. “There are years when Germany grows at a significantly stronger rate than that — 2011 was over 3%. In years when the world trade cycle is grow-ing very rapidly, you will see Germany growing much faster, but it also means it is very vulnerable to any weakness in global demand,” she says.

“It’s still a cyclical economy. Domes-tic demand and, in particular, con-sumer spending, do remarkably little.”

and this is why the rest of europe matters so much. “If the economic sit-uation in europe outside Germany is a lot weaker than we expected, it will have an impact on Germany too,” says reinhard Cluse, chief economist for europe and emerging emea at UBS. “Germany will remain an outperform-er but will suffer with a weaker exter-

nal environment.” and that is exactly what was hap-

pening in 2012. “The German export sector is suffering from the euro cri-sis,” says Stefan Bielmeier, chief econ-omist at DZ Bank. “most european countries are in recession so demand for German products has declined.”

The corollary is that, in this slightly brighter start to the year for the euro-zone, any positive news about the euro is also positive for Germany con-fidence and, hence, investment and the economy. “If you picked up the German newspapers one year ago, every day you would have found arti-cles about the euro breaking up,” says ralph Solveen, deputy head of eco-nomic research at Commerzbank in Frankfurt. “you will hardly find any-

thing like that in the papers now. The uncertainty has been reduced and you will see a pick-up of investment again, which was the weak part of the Ger-man economy last year — it fell for five consecutive quarters.”

Beyond EuropeJust how reliant on exports to the eurozone is Germany? Gernot Grie-bling, in macro research at Landes-bank Baden-Wurttemberg, puts the eurozone member states at 37% of total German exports in 2012. That’s certainly significant — it’s the big-gest single bloc — but it’s not as high as it once was. The eurozone used to account for 50% of German exports at the time the euro began. “This portion is shrinking, and I am sure this is likely to continue,” says Griebling. “Germany was successful in offsetting the nega-tive impact of the euro crisis, especial-ly for exporters, as German corpora-tions are extremely successful in the emerging economies.”

Others agree. “If you take the euro area as one market, it’s the most important for Germany, but the share has shrunk significantly and others have increased,” says Solveen at Com-merzbank. “If you look at the periph-eral countries, the share is around 10% of German exports. That means many other markets are much more impor-tant for Germany: eastern europe and asia, for example, both have a higher proportion than the peripheral countries. The influence of the weak peripheral countries on the German economy is rather limited.”

Barbara Boettcher, head of the eco-nomic and european policy team at Deutsche Bank in Frankfurt, notes how “export orientation is focusing on faster growing emerging markets. The product portfolio in Germany exactly fits the needs of those markets: invest-ment products to back the catching-up process. These products entail high technology and are not very price-sen-

Nobody would suggest Germany is enjoying its best economic performance, but it remains the outperformer of the eurozone and its most important engine. Chris Wright examines how sustainable this position of strength is.

Europe’s man for a crisiswell set for EU recovery

“It’s still a cyclical economy. Domestic

demand and consumer spending do remarkably little”

Janet Henry, HSBC

2008 2009 2010 2011 2012 2013 2014GDP 1,1 -5,1 4,2 3,0 0,7 0,8 2,2

Private consumption 0,8 0,1 0,9 1,7 0,6 0,7 1,0

Public consumption 3,2 3,0 1,7 1,0 1,4 1,5 1,1

Investment 1,3 -11,6 5,9 6,2 -2,5 -0,2 4,6

Exports 2,8 -12,8 13,7 7,8 3,7 3,3 6,5

Imports 3,4 -8,0 11,1 7,4 1,8 2,8 6,0

Trade balance1 0,0 -2,9 1,7 0,6 1,0 0,5 0,7

Inflation2 2,8 0,2 1,2 2,5 2,1 1,6 1,7

Unemployment3 7,8 8,1 7,7 7,1 6,8 6,8 6,6

Budget balance4 -0,1 -3,1 -4,1 -0,8 0,2 -0,4 -0,2

Current account4 6,2 6,0 6,2 6,2 7,0 6,7 6,7

Year on year increase in %; 1Growth share 2HICP; 3in %; 4in % of GDP

Economic forecast — Germany

Source: NordLB Economics & Strategy

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TO_Collage_Euroweek_0313_V03.indd 1 16.03.13 10:03



sitive, which makes German exports more resilient to the depreciation of the euro.”

The suggestion is, then, that although Germany’s economic for-tunes are intrinsically linked to the health of the rest of the eurozone, there has at least been some success in achieving export diversification.

Europe’s safe havenWhile a weak eurozone hampers exports, it does cement Germany’s standing as a safe haven for bond investors, something which grew stronger still after the UK followed the US and France in losing its aaa rating. Other top-rated countries do exist in europe — Finland is one — but none can match Germany and its deep and liquid bond markets.

This has certain advantages, most obviously that the cost of borrow-ing has become absurdly low: 10 year yields were at 150bp in mid-march, reinforcing Germany’s position as europe’s economic engine. If Germany ever reaches a time when it can’t bor-row, then nobody else in the world is likely to be able to either.

While marvelous for the state treas-ury, it hasn’t been so great for inves-tors. “The impact on capital inflows was that two year Germany bond yields became, in nominal terms, negative by the summer of 2012,” says Griebling. “When you go to universi-ty or look in a book you are told this is impossible, but German Bund yields for two years were minus 0.1 or 0.2% by last summer. nominal yields are the lowest since the era of Bismarck, 140 years ago.”

It’s an imbalance with the rest of europe, and one that became particu-larly acute last year, but there is lit-

tle one can do about it. Investors are highly astute at analysing the health of an economic balance sheet and Ger-many’s looks better than any. “Germa-ny obviously is a safe haven econo-my, that’s why its interest rates are so incredibly low,” says Henry at HSBC. “The eCB, with its commitment to OmT [Outright monetary Transac-tions, the purchases of secondary sov-ereign bonds], has tried to ease frag-mentation in the eurozone but both the price and availability of credit are still major problems in the periphery. Germany is one of the few economies in the euro area not facing any kind of credit crunch.”

There seems little threat to Ger-many’s aaa status. “The rating of Germany is in my view rather stable, driven by the business model of the German economy, which still depends mainly on the industrial sector,” says Bielmeier at DZ Bank. “The fiscal posi-tion has improved significantly in the last two years because of a very strong performance in tax income. It’s visible in borrowing costs and in the perfor-mance of the bond markets overall here in Germany.”

Safety firstThe relative strength can’t last forever, but despite recent flows into peripher-al countries, there is still a lot of appe-tite for safety. “Germany’s safe haven status will continue, although inter-national investors can’t put all their money into Germany,” says Henry. “Further down the road, as the euro-zone makes further progress on inte-gration, you would expect German rates to be higher as peripheral rates fall, but that’s not going to be a major theme in 2013.”

Bielmeier adds: “Definitely if the

euro crisis comes to an end, then the safe haven status might lose a bit of its attraction, but overall the bond market in Germany should continue to benefit from the very high structural perfor-mance of the country.”

In fact, funds have been coming out of Germany and into peripheral markets, as risk appetite has begun to return in 2013. Spain in particular has begun to look like it might survive the crisis in reasonable shape — while still offering attractive yields. Interestingly, German yields haven’t budged despite the movement of capital. Germany doesn’t necessarily suffer just because money goes into peripheral states, because the fact that it does so implies greater health in the eurozone, which only strengthens Germany’s economy.

So where next? “From the bond mar-ket perspective, this is a safe haven, and has the credibility to remain one,” says Cluse. “Investors have to ask two questions: what happens when the world recovers and global allocation spins back to equity and risk assets? Then there might be room for bond yields to rise, including Germany. and the other is if european integra-tion continues and more of the burden is put on Germany’s shoulders, there might be elements of mutualisation of debt that could hurt the Bund market.”

The surplusany economic analysis of Germany swiftly turns to the country’s strong current account surplus. any discus-sion of it in a european context notes that it would be helpful if there was rather more balance in Germany’s trade relationships with the rest of the continent. “It would certainly make it easier for the rest of the eurozone to grow their exports a bit more quickly if Germany was growing more rapidly,” says Henry.

However, addressing the surplus is easier said than done. “as a macro-economist, if you look at the imbal-ances in foreign trade, it’s hard to see that there will be more stability in the next year,” says Torsten Windels, chief economist at nordLB in Hanover. “you would have to look for balanced foreign trade, more consumption and more imports. I have no idea how to persuade German consumers to spend more.”

Or as Cluse puts it: “I read martin Wolf in the Financial Times writing that Germany needs to consume more.

Germany: Foreign Trade (National Accounts, swda, in €m, Source: Eurostat)

Source: NordLB

50,000

100,000

150,000

200,000

250,000

300,000

350,000

1991Q

1

1991Q

4

1992Q3

1993Q2

1994Q1

1994Q4

1995Q3

1996Q2

1997Q1

1997Q4

1998Q3

1999Q2

2000Q1

2000Q4

2001Q3

2002Q2

2003Q1

2003Q4

2004Q3

2005Q2

2006Q1

2006Q4

2007Q3

2008Q2

2009Q1

2009Q4

2010Q3

2011Q2

2012Q1

2012Q4

-12,000

0.0

12,000

24,000

36,000

48,000

60,000

72,000

84,000

96,000

Current Account (rhs)

Exports (Goods and Services)

Imports (Goods and Services)

NSA = not seasonally adjusted; SWDA = seasonally and workdaily adjusted MAV12M = moving average 12 months; rhs = right hand scale; Q1 = First quarter of the year

Germany: foreign trade (National accounts, SWDA, in €m)

Source: NordLB



as an economist, I get it: it would be very helpful if you want to adjust cur-rent account balances across europe. But it’s also an issue of mentality, and in practice it will be very difficult to get the Germans spending to gener-ate a massive increase in demand that would help other eurozone countries.

“On the public sector side the gov-ernment is brutal about tight fis-cal policy; on the private sector side, spending aggressively is just not in people’s mindsets.”

Perhaps there is not much to be gained from trying to fix the surplus issue anyway. “In an ageing country, it is to a certain extent natural that you have a surplus,” says Boettcher. “and it is rather difficult to change the sur-plus if you see the demand for German goods: you can’t ask other countries to stop demanding German products.”

It is perhaps better to look at it from the other direction: peripheral coun-tries improving their own accounts with Germany. In this respect, pro-gress is being made. “Peripheral coun-tries such as Spain have substantially reduced their deficit with Germany in their latest current account,” says Boettcher. “Things are changing slow-ly, but you will never have a Germany

that will experience a severe current account deficit for a longer period of time, due to our economic structure and export orientation.”

also, some improvement in German consumption is expected, which will help those eurozone countries that export to Germany. “you have to reck-on on German wage growth, which has accelerated recently, and which is the reason for improving consump-tion,” says Bielmeier. “There are more than 41m people employed here in Germany.”

Immigration evolvesImmigration shows once again how the German economy is married to that of broader europe. economists agree that the nature of immigration has changed recently. “We have had a small rise in immigration by really educated people driven by the euro crisis,” says Bielmeier. “People from Spain and Greece have been driven to come to Germany. That’s definitely a positive development for Germany; for the other countries, it’s not such a pos-itive. Their high-potential employees have left the country.”

Windels expects more of this, and argues that there is actually a positive

impact for other countries. “We will have significant inflows from people abroad: Greece, Italy, Spain, Portugal, France,” he says. “If you have a low possibility of having more engineers in your country, you have to pay more money for them, and this will increase the wage dynamic in 2013-14: it will have a negative impact on the German companies sector, and will give more leeway for France or southern euro-pean companies sector, and I hope a more balanced position in europe.”

Looking at Germany’s economy within the context of europe helps to explain why the country has commit-ted so much to protecting the euro: it is so clearly in the country’s interest that it survives.

“The big problem for politicians is that nobody knows what would hap-pen if the euro broke apart,” says Solveen. “They have no experience for something like that. maybe the con-sequences would not be as harsh as many people fear, but it would harm the German economy significantly.”

The mood today suggests that dan-ger has passed, and that Germany and the eurozone can continue their mutu-ally beneficial relationship as europe slowly emerges from crisis. s

While Germany posted a weak fourth quarter, with a contraction of 0.6% over the previous quarter, economists expect better performance in the year ahead, and cer-tainly in 2014.

They vary on just how much they expect, and the numbers are never impressive, but they are at least universally positive.

at the bottom end, Deutsche Bank ex-pects 0.3% growth in 2013. economist Bar-bara Boettcher says that, given demograph-

ic pressures, “anything around 1.5% GDP growth implies Germany is almost exhaust-ing its growth potential.” Stefan Bielmeier, chief economist at DZ Bank, expects 0.5%, before an improvement in the second half of the year that will be visible in GDP growth numbers in 2014. reinhard Cluse, chief economist for europe and emerging emea at UBS, says 0.8%, while Gernot Griebling at lBBW expects 1% growth, provided emerg-ing economies hold up well.

Commerzbank’s ralph Solveen expects 1% growth in 2013 and 2.5% in 2014. he calls for “a significant positive reading in the first quarter, in contrast to many countries in the euro area, especially the peripherals.”

and he is not alone. “Sentiment indi-cators are suggesting that German GDP should turn positive in the first quarter,” says Janet henry, chief european economist at hSBC. “it’s hard to be confident of that anywhere else in the eurozone.” s

German forecast: cloudy but brightening later

Rank Export €m Imports €m Turnover €m Foreign Trade Balance €m Country of destination Country of origin Export+Import Export - Import1 France 104,476.1 Netherlands 86,595.9 France 169,235.6 France 39,716.6

2 United States 86,831.1 China 77,313.3 Netherlands 157,553.2 United States 36,255.8

3 United Kingdom 72,162.6 France 64,759.5 China 143,941.8 United Kingdom 28,635.7

4 Netherlands 70,957.2 Untied States 50,575.3 United States 137,406.4 Austria 20,643.6

5 China 66,628.5 Italy 49,160 United Kingdom 115,689.6 Switzerland 11,166.3

6 Austria 57,871.2 United Kingdom 43,526.9 Italy 105,149.9 United Arab Emirates 89,98.9

7 Italy 55,989.9 Russian Federation 42,457.1 Austria 95,098.8 Spain 8,844.9

8 Switzerland 48,829.6 Belgium 38,369.4 Switzerland 86,493 Poland 8,690.1

9 Belgium 44,585.4 Switzerland 37,663.3 Belgium 82,954.8 Turkey 8,092.8

10 Poland 42,183.1 Austria 37,227.6 Russian Federation 80,511.8 Sweden 7,242

Ranking of Germany’s trading partners in foreign trade

Source: DeStatis

Germany’s relationship with europe


One might think an election year would be an uncertain time for ger-many’s relationship with europe and the euro. For years, germany has been called upon to make ever-greater commitments to peripheral members of the eurozone to keep them in the single currency. With an election in September, surely there is a danger of a populist anti-austerity party desta-bilising Chancellor merkel’s progress, as was the case in the italian election when two-thirds of the vote went to candidates opposed to austerity?

But this would be to misunder-stand german sentiment towards the single currency. “in european affairs it doesn’t make any difference if we have Chancellor merkel or Stein-bruck,” says torsten Windels, chief economist at nordLB in hannover.

Why? Because, political support for the euro in germany is now all but universal. “the fundamental stance of german politics, to do eve-rything to stabilise the euro, should not change this year no matter what happens in the election,” says Ralph Solveen, deputy head of economic research at Commerzbank in Frank-furt. “nobody is against preserving the euro.”

this is a considerable shift in atti-tude. “in the beginning of the process [the european debt crisis] in 2010, there was a view in the parliament: we don’t want to pay for greece, for Portugal, for Spain, and we don’t want to have more institutions outside the german constitution,” recalls Wind-els. “We have learned since that we have no alternative, because our back-bone is europe. Our export markets in europe are much more important than those in north America. they have learned in Berlin: it’s not nice to pay for problems in europe, but it’s much more expensive to have a break-up of the eurozone.”

this point about exports is explored in greater detail in other chapters in

this report, but the crux of it is that eurozone countries still account for the biggest chunk of german exports, and therefore the health of those countries, and their member-ship of the single currency, is essen-tial to germany’s health.

“there is a very simple economic reason” for germany’s continuing support, says Stefan Bielmeier, chief economist at DZ Bank in Frankfurt. “Just over 40% of german exports go into the euro area. All the euro-pean countries are facing a chal-lenge of declining demographics, and to keep up our negotiating power in the globalised world, we need to put our full weight into the euro area. For germany, it would be much harder to push through its agenda on a glo-balised level without the euro.”

Commitment to the causeOn top of that, a huge and irreversible commitment has already been made. “We have already engaged so strongly in preserving the euro,” says Solveen, “with the credit given to other coun-tries, that if the euro were to break up, that money would be lost and the government would have a problem to explain where the $600bn, $700bn, $800bn has gone.”

to put it another way: germany has no choice and is in for the long haul no matter how hard that becomes. gernot griebling, in macro research at Landesbank Baden-Wurttemberg (LBBW) in Stuttgart, once calculated the claims of german banks against debtors in other eurozone states, be they private corporations, banks or the sovereigns themselves, and imag-ined what would happen if the euro-zone split and the legacy currencies returned.

“in the aftermath i would expect all other currencies to depreciate against a newly introduced german mark,” he says. “german banks would have to write off a large amount of their

claims against these debtors depend-ing on the amount those currencies depreciated, and if this was to hap-pen, then taken together the total tier one capital of the german banks would be wiped out.”

that would, clearly, be apoca-lyptic for german banking and the economy. “it would be a huge dis-aster, because the state would not be able to recapitalize the banks in these dimensions,” adds griebling. “You’re talking about something like €140bn-€150bn.”

the appreciation of the mark would also damage the german economy. “We would go into a deep recession in comparison to which the year 2009 was a Sunday afternoon walk. it is in the very best interests of germany to do anything to keep the eurozone together, even if the public would not agree.”

An uncomfortable leadergermany is back in a position of lead-ership in europe — not one it court-ed. “germany has assumed a pivotal role in the course of the euro crisis — a role that german politicians did not really wish to achieve in europe,” says Barbara Boettcher, head of the economic and european policy team at Deutsche Bank in Frankfurt. “ger-many is very committed to european integration because we do not want there to be just one leading country in europe, but instead a constructive co-

Germans know the score: they might not want to pay for problems in Europe but the alternative — eurozone break-up — would be far more costly. Meanwhile, the politicians have realised that to preserve the euro, Germany has had to become Europe’s leader — a position that, given the country’s history, makes many citizens uncomfortable. Chris Wright reports.

Reluctant EU leader puts economics first

“The fundamental stance of German

politics, to do everything to

stabilise the euro, should not change,

not matter what happens in

the election” Ralph Solveen, Commerzbank

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Germany’s relationship with europe


operation between small, medium and larger-sized countries to make europe a strong global player.”

Windels makes a similar point. “it’s complicated in europe, because you can’t lead europe from Berlin,” he says. “So we were in a new position. Berlin took two years to learn this new role. they didn’t want to have it, but from may 2010, they had it. After that, they have learned a lot, and today we are far away from where we began.”

this touches upon a discomfort in germany about any idea of being un-european or, worse, nationalist. “the country has to be europe-friendly, based on our history,” says Solveen.

this sensitivity also manifests itself in policy towards other eurozone countries. As Reinhard Cluse, chief economist for europe and emerg-ing emeA at UBS investment Bank, says: “Among the leading political class they are still very much con-scious of german responsibility and history, and they do not want to rock the boat. During the crisis in greece, you could see merkel did not want to be the one to push greece out of the eurozone.”

Windels at nordLB believes there was a pivotal moment in 2010, when “the leadership came to Berlin” on euroland. “there was a change in european policy,” he says. “the state debt crisis in greece was the first peak, from February to April 2010, and by April and may germany had decided: now it is time to save money. that is when leadership came to Ber-lin.”

there was a collective realisa-tion that markets would not toler-ate anything other than a reduction in debts. “if France, for example, had decided not to save money, or not to consolidate, they would have paid higher spreads a day later. this punishment by the markets has worked very well.”

germany was naturally placed to take the lead. “germany is a very strong economy with a very com-petitive corporate sector, and it had the trust of the markets and the leadership to save money,” adds Windels.

Uneasy or otherwise, germany is where it is: the safe haven and economic dynamo of europe, and the one that must marshall other nations to do what they need to do to preserve the euro. it is not

an easy position, although Boettch-er is impressed. “the electorate feels Chancellor merkel has been skillful in walking the fine line between the interests of germany and the other creditor countries, while trying to show fiscal solidarity with countries that are in trouble,” she says.

Balancing actgermany’s role in europe will con-tinue to require this balancing act be-tween supporting member states and cajoling them into action. Continuing support “will be linked to some kind of conditionality,” Boettcher says. “it would be difficult to sell financial support for other countries, to the extent that the german taxpayer is assuming liabilities, if we didn’t think there was commitment to reform and improved economic performance on the part of the recipient countries.”

Still, where once there was some antagonism between neighbours about fiscal targets, there is a sense now that the picture — and germa-ny’s likely attitude — varies from one country to another. “if the german government sees, for example, the Rajoy government in Spain make a huge effort to implement reform but still overshoot its fiscal targets, there will probably be a willingness to com-promise,” suggests Cluse. “the Span-ish government will still have to do more austerity, but the german gov-ernment will understand that a sof-tening of targets may be due and war-ranted.” that’s Spain. But the attitude won’t be universal. “But if in a coun-try like greece a new government comes in and says austerity is over, it will be extremely difficult for ger-

many or any core europe government to continue the programmes and transfers, because it’s just impossible to sell to local taxpayers,” says Cluse, adding that if italy’s new governmen wants to abandon austerity altogeth-er, it would be a problem, as public debt to gDP is at 125%.

hSBC’s chief european economist Janet henry says with no expecta-tions for further big developments in eurozone integration this year, that should help merkel as the election looms. “the domestic electorate and gaining re-election are more imme-diate priorities, rather than making rapid progress at the eurozone level. many of the key decisions on euro-zone integration will not be taken until 2014 or even later.”

Still, at the european Council meet-ing in June, the next major report on banking and economic integra-tion will be published. “You could see renewed tensions between France and germany,” henry says. “We need to see France move closer to germa-ny on fiscal discipline, the loss of sov-ereignty to Brussels, surveillance of budgets and adherence to fiscal tar-gets. So she [merkel] can’t afford to ignore the international side of things entirely, but it will not be the priority unless market pressure returns.”

Cluse notes it would be difficult for germany to take a hard-line stance if new eurozone problems arrive around election time, in case it poi-sons sentiment; and european bank-ing union also creates headaches. “i have heard officials in Berlin say: ‘we do not want banking union to be a fiscal union through the back door’,” he says.

But the mood in germany about europe is positive, with a sense of progress, even if one country is driv-ing it. “now we have more or less a consensus in the eurozone on con-solidation,” says Windels. he argues that germany has an advantage, in that the reform of Chancellor Schroeder’s second administration helped germany in a way that Presi-dent in hollande would now find useful for France. “it took four years for germany to learn what was nec-essary for the modernisation of the economy. mr hollande has one year to learn the same thing for France, to organize a strong economy. ger-many is leading, because of its eco-nomic power.” s

The periphery moves into trade surplus

Euro area periphery 5 trade balance, €bn, seasonally adjusted, 3mma

-14

-12

-10

-8

-6

-4

-2

0

2

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: Credit Suisse

The periphery moves into trade surplus

Source: Credit Suisse


BUNDESBANK PROFILE

In hIs endurIng classic, A Diction-ary of Modern English Usage, henry Watson Fowler wrote: “What is new is not necessarily better than what is old...The hardest worked cliché is better than the phrase that fails.” The same is sometimes true of insti-tutions. When writing about the deutsche Bundesbank it is difficult to resist citing the pithy comment of former european Commission presi-dent Jacques delors, that: “not all germans believe in god, but they do believe in the Bundesbank.”

When delors uttered those words in 1992, the Bundesbank was at the apogee of its powers. It was rightly regarded as the finest central bank in the world. The two oil price shocks of the 1970s had unleashed inflation and currency weakness in the us, France and uK, but the deutschmark and german price stability were largely unscathed. The enormous challenge of german reunification, the first post-war european monetary union, was a test passed with flying colours.

In germany, the Bundesbank is still treated as primus inter pares, the pre-eminent institution in all mat-ters regarding monetary and financial affairs. When germany’s new Finan-cial stability Commission had its first meeting on March 18, there were three members of the Bundesbank present around a table of 10: sabine Lautenschläger, deputy president, Andreas dombret, board member, and Karlheinz Bischofberger, head of the financial stability department (see interview on next page).

These three have the power to over-rule the other six voting members of the commission.

“It was important that the Bundes-bank is not bound by a simple major-ity vote. I don’t think it is likely that there will be a disagreement, but the principle of central bank independ-ence could not be compromised, even as we build new institutions,” says

Andreas dombret, member of the executive board of the Bundesbank with responsibility for financial sta-bility.

But this cherished independence and the adamantine monetary ortho-doxy that accompanies it, seems increasingly anachronistic to some. Central banks around the world have adopted quantitative easing as a means to boost economic growth, blurring the lines between fiscal and monetary policy. That may be dis-tasteful to the Bundesbank, but it is now part of the euro system of Cen-tral Banks.

At the eCB, the president of the Bundesbank, Jens Weidmann, is just one voice among the eurozone’s 17 central bank leaders. There is just one other german, Jörg Asmussen, on the 23-strong governing council of the eCB. he has never worked at the Bun-desbank.

The eCB’s Frankfurt eurotower is close to the Bundesbank and yet so far away. In 2011, this rift was made public. Bond buying crossed a line that Axel Weber, the Bundesbank’s former president and widely touted as the successor to Jean-Claude Tri-chet as the eCB president, thought was a step too far. he resigned his position in February 2011. Jürgen stark, a former vice-president of the

Bundesbank, also stepped down from the executive board of the eCB later that year.

Weidmann, Weber’s successor, has remained a voice of orthodoxy in an age of monetary apostasy. he has, in diplomatic terms, criticised the Long Term refinancing Operation for keeping zombie banks alive. But the biggest fight of all was over Outright Monetary Transactions (OMT). For purists, this comes perilously close to debt monetisation, which is illegal under european union treaties.

Another looming concern for the Bundesbank is the shape of the new single supervisory mechanism (ssM), one of the first steps toward a eurozone-wide banking union. This responsibility has already been entrusted to the european Cen-tral Bank, which has plans to hire as many as 800 staff by the time the new framework is expected to become effective in March 2014 and oversight begins that summer.

dombret offers qualified support. “In principle, a single supervisory mechanism is welcome, so long it applies high standards of supervision across the eurozone. If it is done right, it can help restore faith in the bank-ing system in europe. If it is done properly there will be many benefits. This is the challenge,” he says.

Heterodoxy is all the rage. Fashion rules. But the world needs the nagging, nurturing, normality of the Bundesbank more than ever before, writes Andrew Capon.

A voice of orthodoxy in an age of monetary apostasy


BUNDESBANK PROFILE

The Bundesbank is keen to retain its oversight of as much of the ger-man banking system as it can. even with 800 new supervisors in Frank-furt, national regulators will play a significant role for some time to come. Also, the details of the govern-ance of the new ssM are still to be concluded. There will be an inter-nal board operating within the eCB. But how this board is constituted is unclear.

dombret makes the point that banking supervision is not the same as formulating monetary policy. When the 23 member governing council of the eCB meets, it does so on a one member, one vote basis. But if an eu-wide bank supervisor makes an error, not all of the member states can be equally liable.

Ireland cannot bail out Cyprus. In the absence of an appropriate recov-ery and resolution mechanism, tax-

payers’ money from the richest coun-tries is likely to be on the line. This concern may be falling on deaf ears. Article 127 (6) of the Treaty says the board of supervisors should operate using a simple majority on the basis of “one man one vote”.

One thing underlying this con-cern is Target 2 imbalances. Target 2 is the euro payment and settle-ment mechanism, used to calculate the obligations of respective central banks. A surplus country has claims on others. Before the crisis, imbalanc-es were negligible, because banks in the periphery could fund themselves. now they are substantial. germany is the biggest surplus country with claims of around €600bn.

Yet another debate is the role non-eMu17 countries will play. dom-bret says: “You cannot regulate the us banking industry without hav-ing the Federal reserve Bank of new

York at the table. Likewise it will be strange not to have representation from the City of London at the ssM.” The International Monetary Fund is also keen that non-eurozone coun-tries have adequate representation on the ssM.

The next battle may be over mon-etary policy itself. Loose monetary policy helped create housing bubbles in the run-up to the financial crisis. dombret believes, however, that regu-lation was just as important. “Mon-etary policy cannot prevent a crisis rooted in the inadequate regulation of the banking system.”

Tougher regulation has resulted and very few central bankers would now subscribe to Alan greenspan’s much touted view that it is only pos-sible to clear up after a bubble has burst. But there are concerns that germany may be experiencing the negative side-effects of one-size-fits-

This January the Bundesbank was given the first new mandate in its 56 year history. The 1957 Bundesbank Act had one overriding principle, central bank independence, and a single objective, price stability. The Ger-man Financial Stability Act added an over-arching responsibility for macro-prudential supervision.

In the wake of the financial crisis, regula-tors around the world have recognised the threat of systemic risk. As Dombret puts it: “An important lesson from the crisis is that systemic risk is larger than the aggregated risk of all of the financial institutions in-volved; the whole is greater than the sum of the parts.” In the interview below he sets out Germany’s response to systemic risk and the role of the Bundesbank.

EUROWEEK: Can you explain how mac-roprudential supervision will operate in Germany?

Dombret: On January 1 the German Finan-cial Stability Act came into force. It estab-lished the Financial Stability Commission, and its first meeting took place on March 18. This commission will meet quarterly but there is the possibility for ad hoc meetings inscribed in the law. There will also be an annual report to the German parliament.

Three members of this Commission come from the German Ministry of Finance, three members are from BaFin [Bundesanstalt für

Finanzdienstleistungsaufsicht, the Fed-eral Financial Supervisory Authority] and three members from the Bundes-bank. All of these nine members have one vote, and the head of the FMSA [Bundesanstalt für Finanzmarktstabi-lisierung] is a non-voting member.

The Ministry of Finance provides both the chair and the vice-chair of the authority, and all decisions are taken according to simple majority. But no major decision can be taken contrary to the Bundesbank’s position as we have a special right of veto on warnings, recom-mendations, and the accountability report.

EUROWEEK: What powers will the Finan-cial Stability Commission have?

Dombret: The Commission can issue warn-ings about potential threats to the stability of the German financial system. It can also make recommendations to German public institutions, mainly the Federal government and Bafin. The Bundesbank will prepare those warnings and recommendations and the Commission decides whether to issue them or not. The addressees of such warn-ings and recommendations are bound to comply or explain. The addressees will have to report to the Commission on the planning and implementation of adopted measures, and the Bundesbank will assess their imple-mentation.

The Bundesbank has been given the mandate for the macroprudential supervi-sion and analysis. We are also the interface to the European level because Bundesbank president Weidmann sits on the steering committee of the European Systemic Risk Board. This Commission will look into issues that the Bundesbank and the ESRB bring to the table.

EUROWEEK: Was it important for the Bundesbank to have this veto in order to preserve its independence from govern-ment?

Dombret: Bear in mind that the Bundes-bank only has three out of nine votes. Thus, our veto right protects us against being out-voted on major decisions or against getting taken in by the government. However, I ex-pect that all three institutions involved will

Putting macroprudential regulation into practice“If at some point

there is a new crisis, people will look to

this Commission and ask, ‘did the

Bundesbank do its job?’”

Andreas Dombret, Bundesbank

Landesbank Baden-Württemberg

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BUNDESBANK PROFILE

all monetary policy, with interest rates being set with the weakest econ-omies of the eurozone in mind.

germany missed out on the hous-ing boom first time around. It was the only major economy in which real house prices declined in the decade after the turn of the millennium. But now land and house prices are rising fast, particularly in the big cities. In Berlin, Frankfurt and düsseldorf the price of newly built flats jumped 10% in 2011.

dombret believes economic weak-ness and low inflationary pressures justify the accommodative monetary stance of the eCB. Though he accepts that long periods of ample liquidity and low interest rates can fuel asset price booms, the danger has been moderated by the new macropruden-tial regulatory architecture. he also thinks it is premature to worry about a germany property bubble.

“The recent house price increas-

es we have seen are concentrated in larger urban areas. relatively good labour market and overall economic conditions contribute to this develop-ment. real estate debt is 40% of lend-ing exposure of german banks overall and 50% of the savings and co-oper-ative banks, so it is something we

monitor closely, especially given the low level of interest rates. But it is not the time to issue a warning. Credit to residential real estate is not growing rapidly, and lending standards are not declining, two things generally asso-ciated with property bubbles,” says dombret. s

co-operate very closely in order to contrib-ute to financial stability in Germany.

Moreover, it is important that the Finan-cial Stability Act institutionalises a mecha-nism for thinking about macroprudential is-sues on a quarterly basis. We have always had a close dialogue with both Bafin and the Ministry of Finance but this has now been given a sound institutional framework. I find this rather helpful. In addition, reporting to the Bundestag enhances accountability of the new Commission.

EUROWEEK: Will macroprudential regu-lation prevent future crises?

Dombret: Capitalism and crises are close relatives, but of course preventing future crisis is what we are trying to do. Putting this macroprudential regulatory frame-work in place should help us identify risks at an earlier stage. It is designed to try to ensure that, in future, losses of banks and insurance companies are not borne by the taxpayer.

This is one pillar of the new regulatory ar-chitecture. Another is Basel III, which means banks will hold more and better capital. I do not think anyone will argue that banks were adequately capitalised in the past. Recent-ly, a draft law has been introduced which is Germany’s response to the Liikanen Group and the ring-fencing of retail as well as in-vestment banking. That is also an important possible step forward in dealing with the too-big-to fail problem of banks.

EUROWEEK: What is the interaction be-tween macroprudential regulation and traditional banking supervision?

Dombret: The goal of macroprudential pol-icy is to maintain the health of the overall system, but it is not at all a replacement for traditional banking supervision and regula-tion. We do need healthy financial institu-tions, so we very much need micropruden-tial policies as well. What is new and what is recognised by regulators and central bankers in the aftermath of the crisis is that there also has to be an anchor of financial stability.

EUROWEEK: How does this new role for central banks dovetail with monetary poli-cy and price stability?

Dombret: Macroprudential policy should support monetary policy. It should give the setting of monetary policy greater room to manoeuvre. It is complementary to the goal of maintaining price stability.

The instruments of monetary policy are not always well suited to the goal of main-taining financial stability, and this is particu-larly true in the setting of a monetary union where one policy has to fit different finan-cial and economic systems that have tended to diverge rather than converge. Macropru-dential policy and regulation is even more necessary in this environment.

Thus, macroprudential and monetary policies need to complement each other to

deal with the sources of systemic risk. But the safeguarding of financial stability also includes many other stakeholders — regula-tors, supervisors, governments and market participants as well as investors.

EUROWEEK: Do you think regulators have successfully tackled the ‘too big to fail issue’?

Dombret: Not yet. I tend to believe this to be the biggest unresolved problem. I also think ‘too important to fail’ is a better ex-pression, because this issue extends beyond financial institutions to other parts of the in-frastructure of financial markets.

In terms of ‘too big’, i.e. in terms of sys-temic relevance, major problems are differ-ences in accounting standards and whether cross-border, in a global financial system, you may end up comparing apples and or-anges. I.e. whether you treat derivatives ex-posure as net or gross is far from being an insignificant issue.

Accounting standards were supposed to be converging, but, frustratingly, they seem to be diverging lately.

In terms of ‘to fail’, i.e. in terms of reso-lution, we are making progress with living wills at a national level but there has not been enough progress internationally. This issue has been on the table since the fail-ure of Lehman Brothers, but we are still far from being comfortably able to resolve a large, complex, international financial insti-tution, which is disappointing. s

The Bundesbank’s executive board: (L-R) Carl-Ludwig Thiele, Andreas Dombret, Jens Weidmann, Sabine Lautenschläger, Joachim Nagel, Rudolf Böhmler


Banking system

Germany’s number two commercial bank may have ended up as a ward of the state, and its most aggressive Landesbank may have been humiliat-ingly liquidated, but overall the coun-try’s banking sector came through the crisis unusually well and with its unique trio of national banking net-works — public, private and co-opera-tive — intact.

“The structure of the German three pillar system has proven to be reliable and stable during the financial mar-ket crisis,” an official at the ministry of Finance, who did not wish to be named, tells EuroWeek.

“It was clearly a stabilising factor,” adds another of the country’s senior regulators.

Of the three, the unlisted pair — numbering over 1,500 co-opera-tives and public institutions includ-ing the savings banks, along with their handful of central wholesalers — look stronger than ever after their unscathed passage through the cri-sis (with the important exception of some of the Landesbanks, the pub-lic pillar’s weak link). This is thanks to their dominance of lending to the country’s export-oriented mittel-stand, the highly successful small and medium-sized enterprise core of Ger-many’s industrial might.

“For a German bank, maintaining close contact with their sme custom-ers is directly linked with their suc-cess,” says Thomas Keidel, director for financial market relations at the association of German savings Banks (Deutscher sparkassen und Girover-band — DsGV).

“The health of the banking system in a country depends very much on the soundness of the local economy. Compared to the UK or the Us, for example, we are living in a little bit of an island paradise that ensures the health of the banks,” one senior regu-lator believes.

at 42%, the savings banks claim

the biggest share of mittelstand lend-ing. The co-operatives come next with some 20%. With these often family-owned smes performing strongly (strikingly, they include almost half of the world’s ‘hidden champions’, 2,500 low-profile companies that lead their global market, according to Deutsche Bank research), it is little wonder that Deutsche recently announced a restructuring of its domestic organi-sation to compete better for mittel-stand business.

Power of threeBefore the financial crisis of 2007-2008 the three pillar system often faced criticism, from the english-speaking world especially, for being an anachronism that created an over-banked market.

German bankers clearly still resent the fact that the ImF and oth-ers said a single bank model would be more efficient and modern.

From a domestic perspective, the crisis has vindicated Germany’s dif-ferent path. “The German public and government have found out that it is helpful in stabilising the econo-my to have credit institutions with a focus on retail customers in all regions, and credit institutions with an international approach. In a way, it safeguards the economy; when the internationally-oriented banks were having problems, the regionally-ori-ented banks were not,” says Keidel at DsGV.

The ministry of Finance highlights this counter-balancing effect. “The system offers a variety of different business models, thus contributing in fact to diversification of risks in the whole financial sector.”

many bankers justify the system by reference to the needs of Ger-man smes, pointing to their disper-sal across the country. “Public and co-operative pillars with widespread networks support smes in an optimal

way, where they are located. This is very important,” says Hinrich Holm, board member at nordLB.

even with the private banks delev-eraging, robust appetite for smaller company risk is evident. “savings and co-operative banks are stepping into the gap,” Keidel says. savings banks grew sme lending 5% last year.

The system’s ‘safeguarding’ effect is also linked to the unlisted pillars’ national coverage (via local presences across the entire country), he argues. “In the end, the close link between a savings bank and its region is extraor-dinarily useful. Compare it to the UK or the Us, where you could see the scale of the crisis on the streets in some areas.”

AppreciationInternational appreciation of the unlisted pillars has risen since the cri-sis. “Interest in and awareness of this different model has really increased since 2008,” says Keidel. “They now recognise that the savings and co-operative banks have been more con-sistent and successful than the listed banks and have a strong position in the German market.”

The system’s longevity also reflects its significant political patronage.

“From my point of view, it is no longer needed. But no German politi-cian is going to tear it down,” says one analyst.

At first glance, German banking is in decent shape. Set within eurozone’s healthiest economy, the country’s three pillar banking system, once condemned as stodgy and old-fashioned, looks a smart way of guaranteeing diversity of lenders and ensuring nationwide coverage. Two pillars (or at least one and a half) are performing strongly, while the third is headed by a genuine national champion. But weak capital, declining margins, higher funding costs, a growing regulatory burden and a hostile political environment cloud an otherwise benign picture, reports Julian Lewis.

Anglo-Saxon banking? Nein, danke!

“To be competitive in capital markets,

profitability needs to improve — the level

of earnings in the UK or Sweden, for

example, is not there in Germany.”

Hinrich Holm, NordLB


Banking SyStem

Breaking up the system appears an even remoter prospect than it was five years ago, judges one equity ana-lyst who covers German banks. “I see no party willing to do this.” For one thing, many mPs from all political parties sit on the boards of savings banks. For another, their private bank competition is in generally weaker shape now, while the european Com-mission has already taken action on the Landesbanks.

Saving graceThe savings banks continue to take on more sme exposure (up 5% last year, as noted). Proximity is key to their management of this.

“Banks really have to be very, very close to their customers for the whole lifetime of a loan. That is easy for sav-ings and co-operative banks as they are in front of the customer even in rural areas. The management know their customers and they therefore get information very quickly if some-thing happens.”

The banks are bound by a long-standing and sometimes mocked ‘regionality principle’ that confines them to their home region. “They cannot open branches somewhere else to cherry-pick,” says Keidel. “If they want to develop the institution they have to see what they can do in the long term to develop their local companies.”

Despite their similarities, the saving sector’s competition with the co-oper-atives is healthy and promotes prod-uct quality and innovation, he says. “We do need strong competition and the co-operative banks are certainly a strong competitor.” It also ensures nationwide provision, and compe-tition throughout Germany, since private banks are absent from some parts of the country — particularly in the former east Germany.

For some observers, savings banks’ greater exposure to more competitive urban locations is a negative versus the co-operatives’ positioning. While they are unlikely to trigger price wars, they also are not always seen as ser-vice-minded, reports the equity ana-lyst.

Hard landingGermany’s Landesbanks also form part of the public bank pillar. most are owned by a mixture of regional authorities and the region’s savings banks. In contrast to their savings bank owners, however, many of the Landesbanks have struggled since the crisis — and, indeed, the loss of their previous state guarantees in 2005 at the eU’s insistence.

Defenders of the Landesbanks point the service provider role they fulfil for the savings banks. These typ-ically small, local entities look to their wholesalers for access to wholesale and international markets and prod-ucts for mittelstand customers.

nonetheless, the collapse of WestLB and other Landesbanks’ struggles has already nearly halved their number in the post-guarantee period. after Landesbank Berlin goes later this year (the institution is being broken up into a new sav-ings bank and a real estate lender), they will number just six — down from 12 in the watershed year of 2005.

This consolidation inspires some debate in Germany. Chancellor merkel has suggested that a sin-

gle Landesbank would be sufficient to perform the service provider role — similar to that fulfilled by DZ Bank and WGZ Bank as ‘apex institutions’ for the co-operative sector.

The savings banks are less aggres-sive. “Local savings banks cannot open a branch in London or do invest-ment banking,” Keidel notes.

all the same, he recognises a need for change within the Landesbanks, citing expansion that leaves savings banks’ €1tr of assets now dwarfed by their service providers’ €1.5tr. “Landesbanken have successfully started to refocus their business mod-els, to reduce assets and to look very closely at the needs of the savings banks as their customers.”

Landesbanks acknowledge their difficulties. “Given the crisis, we have made adjustments at the Landesbank

level. We still see consolidation — WestLB, for example — or reduction of balance sheets or business lines. I can understand why this was consid-ered necessary by the eU,” comments Holm at nordLB.

He sees scope for further Landes-bank consolidation, noting that the co-operatives get by with a single cen-tral institution (or two, if the region-al WGZ is counted). “my take on this is that the homework is under way, though it may be too slow currently.”

“I consider myself a public bank but operate like a commercial bank with respect to customers and the capital market. I have to answer the same questions as Deutsche Bank and Commerzbank,” Holm continues, noting that the public institutions no longer benefit from the price advan-tage over the private banks they once enjoyed. as the co-op banks’ central institution, DZ Bank is in a similar position, he notes.

Lately, some Landesbanks have drawn on their strong political con-nections to bolster their positions. “They have made improvements to their capital bases with injections from their owners,” notes Claudia Vortmueller, senior banks analyst at Commerzbank, citing Landesbank Hessen-Thueringen (Helaba) and nordLB.

Others are struggling to keep their capital ratios above 10%. But the pros-pect of significant job cuts leaves few market observers expecting any con-certed push for further consolidation — particularly with national elections to be held later this year.

regional government owners also appear committed to ensuring that speciality financing, such as shipping finance, remains available locally to support their key industries.

The returns expected by a Landes-bank’s owner are lower than those demanded by a listed bank’s share-holders, Holm acknowledges. “Our owners understand that in cyclical businesses like real estate or shipping you have up and down cycles. They are willing to stay in at both ends of the cycle so long as there are certain levels of return. That is an advantage.”

Coping mutuallymeanwhile, the German co-operative bank sector is in notably good health. “Probably the most stable banking system in Germany, even europe,”

“For a German bank, maintaining close contact with their SME customers is

directly linked with their success”

Thomas Keidel, DSGV

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Banking SyStem

judges one equity analyst covering German banks.

Once dismissed as an anachronism, the focus on low risk and sustainability that characterises the country’s mutu-al Volksbanken and raiffeissenbank-en now looks prescient. not only did the sector not require public money during the financial crisis, it proudly boasts of never having needed support throughout its 170 year history.

“We are among the very few bank-ing groups who have not used tax-payer money in our entire history,” affirms Gerhard Hofmann, board member at the Federal association of German Co-operative Banks (Bundes-verband der Deutschen Volksbank-en und raiffeisenbanken — BVr). “There have been difficult moments, but we never took it. This is some-thing we are really proud of as it reflects our basic values. We don’t want to be dependent on govern-ments or the taxpayer.”

The co-operatives highlight their €7bn in pre-tax profit in 2011/12. “Our banks have managed to sail quite safely and profitably through the cri-sis,” Hofmann argues. “Those earn-ings are a substantial amount in these days and provide a good buffer under-neath us as most were retained.”

The sector claims to have gained competitive ground during the cri-sis. “We don’t like to boast, but our position in the banking market has improved significantly,” Hofmann says, noting that the challenging years 2010-12 rank among the co-operatives’ best ever.

This vindicates the “low risk, prov-en” business model of “1,100 tradi-tional banks collecting deposits from households and lending to smes”, he argues. The co-operatives embody traditional banking virtues, perform-ing the classical maturity transforma-tion of short-term savings into longer-term loans.

Their presence in underbanked rural areas protects them from the fiercer competition in cities, permit-ting them to charge higher prices. moreover, they are the only group in Germany to have succeeded in ban-cassurance, the equity analyst notes, thanks to their “very tight and close” cross-selling model. some 90% of co-op sales are of the group’s own products.

The co-ops also have more stream-lined systems than their savings bank

peers. even so, they still work with two IT providers.

BVr’s Hofmann also stresses the co-operatives’ distance from bank scandals over market-rigging, mis-selling and tax avoidance. This sup-ports their strong brand name — among Germany’s most resonant, according to research — as does their focus on members who now number 17.3m (only one of the country’s auto clubs, with 18m, can boast more). members are more committed to sustainable development than shareholders, he believes. Demu-tualisation is “not envisaged in the next five years or longer”.

AcceptanceIn turn, the sector is benefiting from increasing acceptance of the co-operative model, BVr reports. Hof-mann relates this to co-operatives’ evident distance from other banks’ role in the meltdown. “People ask ‘who has triggered this huge crisis?’ We can say that we are not responsi-ble for it and we have not provided the reasons for the biggest regulatory package ever.” He goes on to char-acterise the co-op model: “due to its granularity it may be less efficient, but it should be more resilient to shocks.”

The co-operatives’ central institu-tion, DZ Bank, still recently reported pre-tax profit of €1.3bn and added €2.1bn to its capital from retained earnings.

as past attempts to merge DZ and its regional peer WGZ Bank — the final step in a long-term consolida-tion of the sector’s central institutions — were unsuccessful, “we don’t exert any pressure, but we hope that it will happen at some point for the benefit of the whole co-op group. However, the main thing is that we are profit-able and sustainable. That is more important than whether we have one or two apex organisations,” Hofmann says.

Underscoring the sector’s democ-racy, the move would require the approval of three-quarters of the co-operatives.

With 75% of their income stemming from interest charges, the co-opera-tives are challenged by the europe-an Central Bank’s zero interest rate policy and what he terms “the unde-sired side effects of the euro rescue programme. “We clearly have nega-

tive real interest rates in financial markets, which can be seen as a form of financial repression hurting solid financial institutions and insurers over time. although the co-operative banks cannot separate themselves from artificially low rates they are most likely among those institutions who will be able to adjust to even a Japanese-style stagnation,” Hofmann warns.

senior regulators acknowledge the point. “It is a burden on the possibil-ity of interest income,” notes one.

Given this pressure on even the strongest pillar, the Bundesbank recently outlined what it regards as big challenges ahead for German banking. “The plethora of new devel-opments occurring simultaneously will put a number of banks’ business models under pressure. It is not just a matter of the costs that the more stringent regulation will bring with it, but also of the stiffer competitive con-ditions which will emerge,” says dep-uty president sabine Lautenschläger.

Capital challengeeven after five banks highlighted by the eBa’s stress tests rectified their €13bn shortfall she identifies rais-ing new capital as a key challenge, along with controlling costs. “Ger-man banks still have a fair way to go before they are able to cover the Basel III capital requirements in 2022, when full implementation will take effect.” she also judges that “the option of consolidation should also remain on the table.”

With Basel III favouring deposit funding, competition is growing par-ticularly intense in the retail sector. new entrants such as rabobank of the netherlands have added to the challenge, attracting billions in new funding within months of establish-ing online presences.

“The option of consolidation

should also remain on the

table”

Sabine Lautenschläger,

Bundesbank

Quality by tradition: Even in troubled times, the Pfandbrief

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investment are valued by investors in Germany and abroad and, thanks in

particular to the stringent German Pfandbrief Act, it will remain the bench-

mark in the covered bond market.

w w w . p f a n d b r i e f . d e


Banking SyStem

This highlights the cut-throat com-petition that critics say results from the duplications ensured by three pil-lars.

“margins are quite massively nega-tive for all of the banks. some real-ise that they can’t continue with this reckless behaviour and try to be more rational, but then some new player comes in and keeps it going. It is no fun for the time being,” says the equi-ty analyst.

nordLB’s Holm agrees, citing Wal-mart’s failure to establish itself in Germany as evidence of the coun-try’s intensity of competition. “If you look at profitability, there we have some homework. It is fair to say that to be competitive in capital markets it needs to improve in the German sys-tem — the level of earnings in the UK or sweden, for example, is by far not there in Germany.”

In this environment, the private banks’ marginal presence (14% of sme lending, less than a quarter of retail deposits) is notable.

Indeed, each of the two biggest pri-vate players has a substantial domes-tic weakness. While Deutsche is now “a big profitable retail bank”, accord-ing to the equity analyst, following its purchases of Postbank and sal Oppenheim, the limitations of its mit-telstand business are evident from the recent reorganisation. moreo-ver, some analysts regard the bank as undercapitalised by comparison with its key peers — switzerland’s Credit suisse and UBs.

End of state supportIn contrast, recent news that Com-merzbank will undertake a €2.5bn capital-raising signals the beginning of the end for its state support. But while it enjoys the strongest private bank sme franchise, it seems to be struggling in retail where the pur-chase of Dresdner Bank gave it a sig-nificant exposure to now-slumping securities volumes.

“These are challenging times for German banks, and they won’t get any easier in the coming months,” says Uwe Burkert, managing director and head of credit research at Landes-bank Baden-Württemberg.

The narrowness and intensity of domestic competition is driving lend-ers down the credit curve in search of earnings, analysts note. But some also highlight new signs that the sec-

tor is starting to look abroad again for growth, though in a more selective way than before the crisis. “That is the good news. It looks more cautious now,” notes Commerz’s Vortmueller.

examples include a new stockholm operation recently announced by Deutsche Pfandbriefbank, the former Hypo real estate Bank.

Wrestling with regulationWith the German government taking a lead on issues such as bail-in, finan-cial transaction taxes and high fre-quency trading while the eU intensi-fies regulatory scrutiny too, the banks face a welter of new restrictions and reporting tasks. Other developments include the imposition of a national surcharge (on top of Basel III) for the largest, most strategically important lenders and the preparation of ‘living wills’.

“regulatory issues will continue to be the main spread driver for Ger-man banks, apart from unforeseen events,” judges Commerz’s Vortmu-eller.

The additional burden is like-ly to have a particularly negative impact on smaller banks, Burkert at LBBW judges. This could accelerate consolidation of co-operatives and savings banks, which already face substantial costs for their branch networks banks.

“There is a lot of work for German banks and they are not equally affect-ed,” Burkert says. The larger the insti-tution and its earnings, the lower the impact is his rule of thumb. smaller banks lack the technology and other resources to deliver the data regula-tors seek at the speed they demand.

The unlisted pillars are seeking to resist. BVr regards the cumulative impact as excessive. “In all regula-tion there should be a high degree of differentiation between local retail business and international business,” DsGV’s Keidel asserts.

This would be in line with German regulators’ ‘principle of proportional-ity’. This reflects the diverse range of entities they supervise, from a global powerhouse to local lenders with bal-ance sheets that can be as modest as €50m.

The merkel administration appears supportive. “In international negotia-tions on financial sector reform, the German government seeks solutions to take the various characteristics

and specific business models of the three pillar system into due account (eg, principle of proportionality),” the ministry of Finance notes.

The unlisted pillars are also hostile to any pan-european banking union that would seek to make them respon-sible for losses sustained by lenders elsewhere in the eU.

“We don’t like an uncontrolled mutualisation of risks across borders. We have really strong concerns that we become liable for other, more risky banks. That would be to our disadvan-tage and a nightmare for conservative banks,” says Hofmann.

Having long lobbied for an exemp-tion from direct supervision by the eCB or other continent-wide enti-ties, BVr is particularly concerned by common european restructuring funds and deposit guarantee funds.

another challenge is the segrega-

tion of risky trading assets and mar-ket-making as part of a ‘Liikanen’-style division of retail and investment banking. after the opposition social Democrats and left-wing parties pro-moted this popular policy, the govern-ment has adopted a lighter version of it. all 12 of Germany’s sIFIs (systemi-cally important financial institutions) would be affected, according to esti-mates.

“We believe the majority of banks will do anything to escape this,” says Vortmueller. analysts calculate that lower-rated trading entities could see their funding costs rise by up to 100bp.

Overall, though, the new regulatory burdens should be positive for inves-tors’ perceptions of German bank risk, she argues. “They should appre-ciate the more stringent calculation of common equity and tier one, and the better capitalised, safer, strong-er, more transparent institutions that result.” s

“These are challenging times

for German banks, and they won’t get

any easier in the coming months”

Uwe Burkert, LBBW


FINANZAGENTUR PROFILE

In november 2011, shortly after a German government bond auc-tion widely described in the press as a “disaster”, at least one news-paper published a photograph of Germany’s chancellor that seemed to be emblematic of the depth of europe’s economic crisis. Dressed in doleful black, her head bowed and a finger apparently dislodg-ing something nasty from her eye, the world’s most powerful woman appears in the photograph to be buckling under the strain.

The truth of the matter, howev-er, was that Angela merkel, photo-graphed listening to a speech in the bundestag, was probably just bored to tears.

merkel has had many things to worry about during her eight years as Germany’s chancellor. How to sell Germany’s debt has not been one of them. nor is it one that is likely to cost her much sleep over the foreseeable future.

Total supply this year is pro-jected to be virtually unchanged from 2012, at €250bn. of this total, €173bn (compared with €175bn the previous year) will be in what the Finanzagentur describes as “capi-tal market” instruments, with two year Schatz notes accounting for 24%, five year bobls for 20.4%, and 10 and 30 year bunds for 21.6% and 3.2% respectively. The remaining

€77bn of issuance in 2013 will be in six and 12 month money market instruments, or bubills.

Investors and analysts expect yields to remain broadly stable for the foreseeable future, with the Ital-ian election result having reminded investors of Germany’s safe haven credentials. “Prior to the Italian election we were seeing German yields gradually rising as a bid came back to eurozone assets,” says mark Dowding, co-head of investment grade at bluebay Asset manage-ment in London. “Since then, we have seen robust outperformance of bunds as fears of systemic risk have crept back into people’s thinking.”

even if — or when — that fear recedes, Dowding says that low eCb rates will ensure that yields at the front end of the curve remain anchored at their cur-rent levels with volatility sup-pressed at the longer end. “The emU break-up premium seems to have disappeared, so we would not expect the 10 year bund yield to fall below 1.2%,” he says. “We expect the bund to trade in a range of between 1.2% and 2% over the next year.”

neither does merkel — nor bund investors — need to worry unduly about Germany’s triple-A rating going the same way as France’s or the UK’s. In an update published late last year, Standard & Poor’s (S&P) observed that even the contingent eFSF and eSm liabili-ties, amounting to about 8% of GDP, did not present much of a threat to the rating. “If called, these guaran-tees could raise Germany’s gross debt ratio but not in such a degree, in our view, that contingent liabili-ties would crystalize enough to place material pressure on the ‘AAA’ rating,” S&P advised.

The so-called “failed” auction of november 2011 was far from being

the first of its kind. but it was one of the most newsworthy. After all, asked some commentators, if rock-solid Germany could only harness demand of €3.9bn for its €6bn 10 year auction, what did it say about the prospects for the rest of the eurozone?

Investors and bankers were con-siderably more phlegmatic. Indeed, paradoxically enough one of the reasons for the auction’s failure may have been because the issu-er was a victim of its own commit-ment to transparency, as Karsten Kopplin, managing director and head of the public sector for Aus-tria and Germany at HSbC Trinkaus points out. “It is inevitable that the results of bund auctions are going to differ depending on market con-ditions at the time,” he says.

“but the strength of the Ger-man system is that the Finanzagen-tur has a fixed auction calendar, which it sticks to, 100%,” says Kop-plin. “It announces its plans for its major issuance months in advance and the quid pro quo for this trans-parency is that it sometimes finds itself issuing at an unfortunate time. but over the long term it is an approach that is appreciated by investors because of the certainty that it creates.”

Volvo qualitiesIf debt management offices were cars, the Finanzagentur would be more volvo estate than bmW con-vertible. methodical and dependa-ble, but seldom exciting, the Finan-zagentur was set up in September 2000. Its mission was to assume responsibility for the debt manage-ment functions previously under-taken by the ministry of Finance, the bundesbank and the Federal Securities Administration.

If you’re looking for swish pres-entations filled with colourful bar

If debt management offices were cars, Germany’s Finanzagentur would be more Volvo estate than BMW convertible. Methodical and dependable, and good in a crash, the finance agency is Europe’s most predictable borrower. Germany would have it no other way — although investment bankers are crying out for more syndicated deals. Philip Moore reports.

Europe’s rock solid sovereign keeps things simple

“The strength of the German

system is that the Finanzagentur has a

fixed auction calendar, which it

sticks to 100%”

Karsten Kopplin, HSBC

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charts and interesting soundbites about the economy, don’t go to the Finanzagentur’s website. The agen-cy’s public and investor relations machine looks functional and dull in comparison to those of many other debt management offices in the eurozone.

but as bankers say, what distin-guishes the Finanzagentur from its counterparts elsewhere in europe is that its debt more or less sells itself. “Weaker credits sometimes need to offer substantial new issue conces-sions,” says michael Krautzberger, head of euro fixed income at black-rock. “Germany isn’t in that posi-tion.”

This position of strength, say bankers, makes it all the more mysterious that the Finanzagen-tur would countenance support-ing the so-called Hückepack idea, whereby the government would line up alongside some or all of the 16 German states (Länder) in issu-ing a joint bond. “This is an old idea that was revived at the start of 2012 when the federal government needed the support of the Länder in pushing through the constitution-al approval for the european fiscal pact,” explains Alois Strasser, ana-lyst at Standard & Poor’s (S&P) in Frankfurt.

It is easy to see what the Länder — especially the weaker ones — would stand to gain from a joint bond guaranteed (if only in part) by an issuer which by some dis-tance is the strongest credit in the eurozone. It is much harder to see what would be gained from such an arrangement by the federal govern-ment itself which, after all, fought tooth and nail against a pan-eU version of the Hückepack idea.

“For the Finanzagentur, it’s a ludicrous idea,” says one of the many bankers who are prepared to offer frank comment on the so-called Deutschland bond initiative strictly off the record. “I just can’t see what incentive the bund can

have for compromising and paying a higher spread than it otherwise would.”

Auctions onlyAs debt capital market bank-ers will testify, the Finanzagen-tur is not well known for paying up for its funding unnecessarily. To DCm heads, one of the clearest and most consistent illustrations of the strength of the Finanzagentur’s position has been its espousal of auctions rather than syndications as the pillar of its funding strategy.

There was no change to this fun-damental philosophy during the tenure of the popular Carl Heinz Daube as managing director of the Finanzagentur. born and educated in Hamburg, Daube spent 16 years at Hamburgische Landesbank/HSH nordbank — latterly as head of funding — before taking up his post at the helm of the Finanzagentur in February 2008.

There have, however, been two notable exceptions to the Finan-zagentur’s opposition to syndicat-ed issuance. The first has been in its issuance in the inflation-linked market, which began in 2006 with the launch of a €5.5bn 10 year bond linked to eurozone inflation. Abn Amro (as was), barclays Capi-tal (as also was), bnP Paribas and Deutsche bank led the debut linker, building a book of €8bn.

The other famed occasions on which the Finanzagentur has syn-dicated its primary issuance has been on its rare excursions into the dollar market. The first of its two recent dollar benchmarks was the $5bn five year deal led in 2005 by Deutsche bank, Goldman Sachs and morgan Stanley, which was re-offered at 12bp over US Treasur-ies and generated demand of about $14bn.

Although the secondary mar-ket performance of its first dollar issue was disappointing, the Finan-zagentur was able to return to the

dollar market in September 2009 with a $4bn three year benchmark via bank of America merrill Lynch, Citi, Deutsche and HSbC. Priced at 16.7bp over the US government curve, this trade generated simi-larly strong orders which reached $11bn.

The Finanzagentur has never made a secret of the fact that it regards its dollar issuance as pure-ly opportunistic, and on that basis both transactions were — by defi-nition — a resounding success for the borrower. The 2005 issue gen-erated an arbitrage advantage for the German government of about 15bp, while the cost saving in the 2009 deal was estimated at some 25bp relative to where a comparably sized euro benchmark would have priced. That meant that each issue saved the German taxpayer between €20m and €25m, which represent-ed a job well done for the Finanza-gentur.

New man but old policybankers say that they see no rea-son why the Finanzagentur should tinker with its attitude towards auc-tions and syndicated transactions under the leadership of Tammo Diemer, who became the agency’s new managing director at the expi-ry of Daube’s five year contract this January.

Diemer, who moved to Finan-zagentur after a spell as treasur-er of Aareal bank in Wiesbaden, is regarded as a very safe pair of hands who will ensure continuity of policy.

“Tammo worked wonders at Aar-eal and, like Carl Heinz, he is a very capable technocrat who is very well suited for the Finanzagentur job,” says one banker. “but I don’t see him introducing any dramatic changes in its funding strategy.”

even if he wanted to, others say that the managing director of the Finanzagentur probably has more limited scope to influence funding strategy than his opposite num-ber at some of europe’s other debt management offices. “If you’re at the Dmo in the UK or the AFT in France, you’re probably going to enjoy a lot more creative freedom than you’ll have at the Finanzagen-tur, where much of the job simply involves executing the instructions

Total Monthly average€bn HY1 2012 2011 2010 2009 HY1 2012 2011 2010 2009Trading Volume 2,720 6,028 5,679 4,609 453 502 473 392

Net Volume 88 157 247 223 14.69 13.08 20.58 18.63

Secondary market volumes of German government securities

Source: Federal Republic of Germany Finance Agency

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01.02.13 Euroweek 210x297.indd 101.02.13 Euroweek 210x297.indd 1 21.01.13 16:0921.01.13 16:09



of the finance ministry,” says one banker.

A number of bankers are hopeful, however, that the Finanzagentur will continue to issue in the dollar market when windows of oppor-tunity open to raise cost-effective funding on after-swap basis.

“obviously the Finanzagen-tur does not need dollars,” says one. “but there would be plenty of demand for another benchmark from US accounts. Another dol-lar deal would also be a good way of giving something back to the banks in the auction bidding group in terms of fees. The whole ration-ale for acting as a primary deal-er in the bund market is basically league table-related. It is a market where banks don’t earn any money, although they may generate some kudos.”

That may be. others say, how-ever, that for investors looking for US dollar exposure to the credit of the Federal republic of Germany, they have a perfectly good and liq-uid option in place, in the form of KfW. Zero-weighted and explicit-ly guaranteed by the government, KfW’s bonds are, as the issuer never wearies of reminding its investors, “just as safe as German government bonds”.

Linker developmentIf German government syndicated dollar benchmarks are likely to remain collectors’ items, perhaps a more forlorn hope is that the Finanzagentur will add to the suite of inflation-linked products it offers investors.

At the end of 2012, there were five inflation-linked bonds in circula-tion — three 10 year bonds and two five year notes — which between them accounted for about 5% of the German government’s debt portfo-lio at the end of last year.

In 2013, the Finanzagentur says it plans to continue to develop the inflation-linked market, issuing on a monthly basis (excluding August and December), raising a total of between €8bn and €12bn and sup-porting secondary market liquidity.

The Finanzagentur does not specify the planned maturities for its issuance in the inflation-linked market, although it does advise that “the issuer’s long-term plan is to

build up a full curve of real-yield German government securities.”

Investors say that they would like to see the Finanzagentur deliver on this longer term pledge in two ways. First, by adding a longer dated inflation-linked benchmark, ideally with a 30 year issue.

Second and more ambitiously, blackrock’s Krautzberger is one of a number of investors who says that a bond linked to German inflation would be a welcome addition to the Finanzagentur’s product repertoire.

“As an investor I would certainly have an interest in a very long-dated issue linked to european inflation, which is an option that the Finanzagentur has been con-sidering for a while,” he says. “I would also welcome an instru-ment linked to German infla-tion, but this is not something I’d expect to see within the next two to three years.”

others agree that while desir-able, a bond linked to German inflation would be hugely con-troversial from a political per-spective, given Germany’s historic horror of inflation. Indeed, the phil-osophical objection associated with marketing inflation-linked securi-ties to the German investor base was spelt out by Gerhard Schleif, Daube’s predecessor at the Finanza-gentur, in 2005.

“The argument in this coun-try has traditionally been, why should we need instruments that protect against inflation when we have been so successful in fighting inflation,” Schleif told EuroWeek shortly before the Finanzagentur broke with tradition to launch its first inflation-linked bond in 2006. It was a fair point: a modest 16% of Germany’s first linker was placed with domestic investors.

Schleif’s comments were made, however, long before monetary policy in the eurozone was forced to respond to the crisis within the two-speed economic bloc with interest rates that are generally rec-ognised as being absurdly low for Germany. The consequence is that although German inflation remains under control today, there is no guarantee that it will stay that way, with low unemployment and high growth likely to fuel inflationary pressures.

“There is a growing acceptance in Frankfurt and berlin that if compe-tiveness is going to be restored in some of the weaker eU countries, prices in Germany will need to be allowed to creep up,” says Dowding at bluebay.

True to its track record of keep-ing a watchful eye on costs, what the Finanzagentur describes as “the principle of economic efficiency” is also the reason it gives for having discontinued the practice of sell-ing government securities direct to retail investors at the start of 2013.

bankers say it is a pity that a sav-ings product that was popular with members of the public has been scrapped. “There has been a semi-public debate about the govern-ment’s decision to end its retail programme,” says Thomas Cohrs, head of syndicate and origination at nordLb. There were no tax or other incentives offered to investors squirrelling as little as Dm50 (later €50) into federal government secu-rities. but as Cohrs says, the pro-gramme was greatly appreciated by savers looking for a risk-free way of saving money with a slightly high-er yield and more flexibility than a savings account could offer.

over the much longer term, bankers say that there is range of alternative funding strategies that the Finanzagentur may start to consider. one of these, thinks Kopplin at HSbC, may be the rmb market. “Will the rmb become the world’s third currency? Yes, I expect it will,” he says. “Is it some-thing all large issuers will start con-sidering? Yes. Will big investors be attracted? Yes. Is it a currency the Finanzagentur will also consider? not yet. but over the longer term it is probably something it will need to look at.” s

“Before the Italian election we were

seeing German yields gradually

rising as a bid came back to

eurozone assets”

Mark Dowding, BlueBay Asset Management

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210b297_RB_PillowGB_0409.indd 1210b297_RB_PillowGB_0409.indd 1 27.04.2009 11:25:44 Uhr27.04.2009 11:25:44 Uhr

36 EuroWeek Germany in the Global Marketplace 2013

German Public Sector Roundtable 2013

EUROWEEK: Where can Germany’s bond deals go from here? Is there any upside now for investors buying German sovereign debt, other than the likeli-hood of being paid back at maturity?

Diemer, German Finance Agency: The German Bund curve is the benchmark rate curve in the eurozone and the federal government is fully aware of this and fulfils this role with a high level of responsibility. German Bunds play many important roles in various money and capital markets. They serve as surrogate for cash, they serve as high quality collateral for secured interbank business, they serve as efficient hedging instruments for interest rates and they are a high quality long term investment.

Investors in German government securities have at their disposal a range of highly liquid securities across the full yield curve. Buy and sell orders can be executed

at fair market prices at any time. In this respect, there are no other fixed income securities in the European capital market whose price quality is comparable to that of German government securities. Given the vivid sec-ondary market and the fact that German Bunds are the underlying of the most important interest rate future contracts, portfolio managers also express opinions on interest rates using Bunds. Hence — to a large extent — Bund yields reflect capital markets’ expectations on the development of central bank rates.

EUROWEEK: Where do the dealers on the panel expect German Bund yields to go from here? Frank?

Scheidig, DZ Bank: It depends on whether you see Ger-many as a safe haven or not. During the eurozone crisis Germany is, as Tammo rightly outlined, the benchmark issuer outside of the dollar.

Participants in the roundtable, which was held in Frankfurt, were:

Patrick Steeg, head of syndicate, LBBW

Tammo Diemer, managing director, German Finance Agency

Frank Czichowski, senior vice president and treasurer, KfW

Matthias Redlich, head of DCM public sector/financial institutions institutional clients — global markets, Ger-many & Austria, HSBC

Frank Scheidig, head of capital markets and international sales, DZ Bank

Thomas Cohrs, head of syndicate and originations, financial institutions/SSA, NordLB

Ralph Sinclair, SSA markets editor, EuroWeek

Bond markets hold no fear for top tier borrowers

If any set of borrowers has an access all areas pass to the capital markets party, it is Germany’s public sector credits.The Bund remains Europe’s de facto benchmark security and, along with the agencies that the federal republic also

guarantees, is enjoying a period of sustained low yields and tight spreads. None of that looks set to change as the number of triple-A ratings around the globe dwindles. But that is not to

say that German public sector funding officials can put their feet up and watch the cash roll in. KfW continues to help develop new markets, such as the offshore renminbi market, while the German Finance Agency has a new head, Tammo Diemer, who is taking over at a time when German finances are at the heart of Europe’s economic health.

Diemer and KfW’s Frank Czichowski, along with senior capital markets bankers, joined EuroWeek in mid-March to discuss the German public sector bond markets.

Germany in the Global Marketplace 2013 EuroWeek 37


It depends what you expect. If you cut out the risk associated with the outcome of the Italian election, and the probability that France and the financial industry in France does not dive deeper into the mess, then there’s a strong likelihood that Bund spreads are not going to per-form further.

If this holds true, plus if there is a yield turnaround in the US this year, then probably you are better off in other alternative sovereign markets.

Nevertheless, Germany is a very stable backbone of Europe. It’s because of our industry — particularly on the export side — that we are the strongest country still in Europe. So I would still highly recommend having a large proportion of your portfolio in German Bunds.

Cohrs, Nord LB: There has been ample talk of a poten-tial bubble in the core sovereign markets and especially, of course, in the Bund in recent months. And if you look at the yields that have been attainable over the last six months or so, sometimes we have been very close or indeed have even dipped into negative yield territory — that does not sound like a very good starting point for a lot of upside performance.

Having said that, there is a very deep structural bid for Bund paper. It’s probably even better for KfW paper in that context, because obviously, they do pay a little bit more in yield than the German sovereign. But it remains the case that the structural bid is not going to disappear, and that bid comes from a growing pool of investable funds, mostly from outside of Europe. And that’s a pool that we all of course try very hard to access.

Redlich, HSBC: We have been in a broad trading range over the last several months. In our view, we will contin-ue to be so. As we have seen, demand has by far exceed-ed the supply in recent months. So we do not expect a massive rise in yields, especially based on the structural demand and regulatory demand that has been mentioned already. Overall we would expect Bunds and KfW bonds to remain stable and in line.

On the other hand, yields are artificially low, especially at the short end driven by the ECB. This can of course change but nevertheless, we think that German public sector debt will continue to play a major role in the asset allocation globally going forward.

Steeg, LBBW: We have some re-coordination challenges in front of us. Thomas and I also represent the Sparkas-sen — or savings bank sector — that sector will be affect-ed by high redemptions in 2015. If you look into the

deep holes of the Sparkassen, there is still a lot of bank paper in there.

Already the Sparkassen are shifting into agency and supranational paper. And with what is now their low-risk appetite, the first move could be into Bunds and KfW.

Yields will remain low for a time depending on the situation in Europe and also of course the Italian election result.

Any shift away from the safe havens is only partial and a big structural bid for German public sector borrowers will remain.

EUROWEEK: Frank, KfW has been a beneficiary dur-ing the crisis by being able to pay a spread over Bunds while offering a full and explicit sovereign guarantee, making it a Bund surrogate in many ways. Is the lowering of Bund yields something of concern to KfW or are you somewhat immune from Bund yield movements?

Czichowski, KfW: You are right. KfW worked and still works intensively to have its securities trading as closely to the Bund as possible. We have closed the gap consider-ably but we have always paid a spread over the Federal Republic of Germany. It would be the ultimate goal to go flat to the Federal Republic, but on the other side the spread of KfW bonds to the Bund makes our bonds inter-esting to investors worldwide.

The low Bund yields are not a concern to us. The busi-ness model of KfW does not depend on the absolute yield at which we issue debt but rather how attractive our loan programmes are in relative terms. We refinance our end customers via the banking system and our abil-ity to do so does not depend on where absolute yields are, but more where relative yields are and in particular, yields for the banking sector overall.

Let me come back to a question that has been raised before, namely the structural elements of demand for highly liquid securities of very high quality. It was already mentioned that we have on the demand side a structural increase overall. We need more collateral in the derivatives business, interbank lending is done more on a collateralised basis, and there’s a whole host of business-es where we need more high quality.

What is sometimes overlooked in the overall context is that on the other side of that equation, the supply of bonds in our asset class is relatively stable, if not fall-ing. Overall issuance of euro member states has fallen as a result of austerity measures — and not by a small amount. And the same is true if you look in the agency sector. The overall supply from the agency sector is down by approximately 10%.

In a world where you need an increased amount of paper for a lot of different functions, you have a some-what decreased supply of paper. That will provide a long-term element of stability for spreads in this sector. Of course, at the end of the day, the shape of the yield curve will be determined by central bank policy, but the stabil-ity of the sector should be supported by what I would call relatively prudent policies by all parts of the sector in their issuance policy.

EUROWEEK: Will public sector borrowers eventually have to issue more to sustain the viability of collat-eral in the market? Or will collateral users just have to go back to being more lenient about what collat-eral they demand in the first place and how much of it they use?

Thomas Cohrs,NordLB



Czichowski, KfW: None of us will have a mandate to issue securities purely for the sake of issuing securities — i.e. to fill in demand for collateral. The businesses that we run and the liquidity that we need determine our issuance.

If in future there’s a shortage of collateral for some purposes, we will probably either move to using cash collateral more than we do today or other types of col-lateral will be used.

I know that in some countries the government purely issues in order to provide a benchmark for, for instance, corporate issuers to reference themselves against. We are not in this position in the eurozone. If we were in this position, then we’d probably talk about using a com-pletely different framework altogether.

Redlich, HSBC: This is what has already happened. In the recent past investors have been looking at other issu-ers to invest in or to use their bonds as collateral. We’ve seen an increased demand for the likes of the German federal states and the smaller German agencies, so the German public sector as a whole has profited from the structural demand we are talking about.

EUROWEEK: Does that increased structural bid encourage more opportunistic borrowing from pub-lic sector German borrowers, would you say? How have German public sector borrowers reacted to the need for greater supply?

Redlich, HSBC: Some of the issuers profited from the situation by doing increased pre-funding, which will lead to less supply in 2013. Again that will run in favour of tighter spreads.

If demand outstrips supply, then some issuers have the flexibility to tap these markets on short notice. So, yes, there is opportunistic behaviour, but it is just satis-fying demand that is around in the market.

Cohrs, Nord LB: I think this is more applicable to the smaller German agencies — at least I don’t get the feel-ing that KfW or the Federal Republic have been acting in an extremely opportunistic way. They seem to be going along a very strategic funding route. A lot of the struc-turally driven investors that we mentioned before appre-ciate that. But another part of that structural demand is to feed banks’ liquidity books and that needs more opportunistic funding to exist. And here there has been a chance for the smaller issuers — some of the more pro-lific German states and agencies would be among them

— to satisfy that demand. But I don’t get the feeling that KfW or the Bund issuer would be up for that and that shows in the difference in pricing.

Diemer, German Finance Agency: The supply in Bunds is steered by the Bund auction calendar only. It is pub-lished at the end of the year for the following year, and we have the commitment to issue in all the maturities from six months up to 30 years. The maturity profile of our new issues in 2013 is very similar to last year’s. Con-tinuity, transparency and reliability is key for the bench-mark issuer in euros.

That’s the role the Bund has to play. Furthermore we will continue our dialogue with institutional investors here in Germany, the eurozone, Europe and the rest of the world.

EUROWEEK: Speaking of the role the Bund plays, when it comes to the eurozone crisis — and it may seem a strange point to make on the day of an Ital-ian election — but is the crisis abating somewhat? What further role will German public sector borrow-ers have to play in fixing the eurozone debt crisis and what is their role in stabilising markets and how do you see that developing?

Czichowski, KfW: At the European level, a number of institutions have been created with a specific mandate to assist countries in crisis and to make sure that the integ-rity of the eurozone remains intact, i.e. the European Financial Stability Facility (EFSF) and then the European Stability Mechanism (ESM).

When the whole situation evolved back in 2009 and 2010 we had a situation where KfW was rendering assistance along with other countries by way of a loan to Greece. Today, of course, the institutional landscape is better formed and has stabilised and so, from my per-spective, there’s no specific role for KfW or other Ger-man promotional banks in the context of the European debt crisis.

The institutions are there, they function well, and they will continue to do so. And we can continue to carry out our business, namely of being a promotional bank.

EUROWEEK: Do you find yourselves though, when you’re meeting investors, almost acting as informal ambassadors for the eurozone? Particularly when you go outside of Europe, do investors look to you for information about the eurozone debt crisis or has that lessened?

Czichowski, KfW: One of the discussion points with our investors is our issuance strategy — the instruments that we use, the strategies that we follow, how we view capi-tal markets.

But clearly in recent times the development in the eurozone has been a point of discussion with investors. The further you went away from the centre of Europe or from the eurozone, the more investors were unsure about what was happening. Today, they are significant-ly more comfortable with the situation, but there were times last year where there were a lot of questions. And in this context, one of the roles that we had was to pro-vide our perspective on developments in the eurozone, which hopefully led to a better understanding on the side of partners.

Steeg, LBBW: It’s is not really the task of the German

Matthias Redlich,HSBC



public sector to solve the European debt crisis. The EFSF and the ESM are already successfully installed to do that.

However, there are two new public sector issu-ers that created a shift from bank funding into agency funding — Erste Abwicklungsanstalt (EAA) and FMS Wertmanagement.

EUROWEEK: And what sort of questions do interna-tional investors ask dealers about Germany’s role in the sovereign debt crisis or those two German insti-tutions, and what’s your response?

Scheidig, DZ Bank: Well, the main question is how long can Germany keep paying for Europe. If you look to the overall ratio of our savings it is not enough to save Europe. Many overseas investors recognise that, particularly in Asia. But on the other hand, they know that it is important to have one solid rock in Europe that they can count on for secondary market liquidity — which we should also highlight here in the discus-sion because there’s not much left of it because most of the banks can’t provide it anymore with their balance sheets — and that is not as volatile as some of the other markets.

From the long-term investors’ perspective, their inter-est to know the political situation — will Chancellor Merkel hold the euro together? She has been seen as the strongest politician among European leaders.

And when they look for alternatives outside the euro-zone, they have the Gilt market in the UK. But only this weekend, the UK was downgraded to Aa1 causing vola-tility. Bunds and KfW bonds, German agencies like Rent-enbank and including the two new kids on the block — EAA and FMS Wertmanagement — are the alternatives to count on which are most likely to have a narrow band of volatility.

Cohrs, Nord LB: I work for an institution that is mostly focused on domestic investors and here the view seems to be that KfW and the Bund are more interesting to a lot of foreign investors than they are to the domestic investor base.

Having said that, the alternative big new issuers that have been introduced into the market — the EFSF and ESM — have not quite convinced all domestic investors, certainly not the more conservative ones in the co-opera-tive bank networks and in the savings bank networks, to give them the same faith in credit as they would give the Federal Republic and its agencies.

So, we have a bit of a trade-off here. On the one hand,

the spreads for the Bund and KfW have become so tight that investors think they want a little bit more and on the other hand, the other agencies that are available here with the more European background that aim to work on solving the European debt crisis are not really trusted yet to the same degree as KfW and the Federal Republic.

Czichowski, KfW: To echo that impression, judging by the numbers that we have seen in our benchmark transactions over the last couple of years, the further spreads move in, the less the participation by banks, at the same time the greater the participation, in relative terms, by central banks, in particular. But it is not a very marked trend. To give you some numbers, in 2011 KfW sold 54% of its issues to banks and in 2012, it was 50%. And in 2013, so far, we have sold 44%, so it’s a slight decrease, but it’s not by a very big change.

EUROWEEK: We’ve talked a little bit already about the cost of capital and the cost of collateral. What effect is that having for dealers around the table? Is it making your business tougher? What can be done to alleviate any burdens that new capital regulations are creating?

Cohrs, Nord LB: I would like to throw in something that is bugging a lot of participants in the market, and that is the matter of Collateralised Swap Agreements (CSAs). There is movement to sign them with some agencies who are wiling to move away from the statutory, one-sided collateral agreements to two-sided ones, which seems to be the fairer way of doing business — at least it is between banks, anyway.

But among the premier issuers in the market, there seems to be the opinion that it is not necessary. It makes it a potentially expensive business for many — if not all — dealers in the group.

EUROWEEK: Frank, hasn’t KfW signed two CSAs with everybody?

Czichowski, KfW: We have acknowledged that the ques-tion of collateral in derivative contracts is an issue for banks, both from an economic as well as from a liquidity perspective and — potentially — a regulatory point of view.As far as the regulatory point of view is concerned, it remains to be seen how international regulations will be implemented. In Europe, sovereigns as well as cer-tain government-guaranteed public sector entities like KfW will very likely be exempted from the own funds requirement for CVA risk under CRD IV. We expect an equal treatment of both sovereign states as well as these public sector entities, which would make it easier for banks to trade on an uncollateralised or asymmetrically collateralised basis with these entities. But we need to see how exactly it’s going to be played out.

On the liquidity side, KfW has signed and is in the process of signing two-way CSA collateral agreements.

However, we post KfW bonds as collateral under these agreements, which enable our partners to use them as collateral in their own dealings with other counterparties.

We think that this is a fair treatment, a fair compro-mise. But we are clearly watching the situation very care-fully and monitoring where this is heading to and how we need to adjust the arrangements that KfW offers to the market. We are still getting sufficiently competitive

Frank Scheidig,DZ Bank



quotes in the market and are able to execute our busi-ness just as well as we have done before.

EUROWEEK: Had you found the quotes were becom-ing less competitive or was this just a preliminary step?

Czichowski, KfW: It’s a difficult question. What we have all probably witnessed is that the pricing of derivatives — particularly the more exotic or cross-currency deriva-tives or those in longer maturities — has become more differentiated between banks. The pricing depends on the funding costs of your counterparty, the derivative portfolio you have already contracted as well as a num-ber of other things.

Some partners already calculate CVA charges, while others wait for the implementation of regulations. As a consequence, there is not one identical swap curve any-more, particularly for longer-dated cross-currency con-tracts. But that’s something that you have to live with and which you have to manoeuvre around.

But equally, in certain situations the positioning of a bank may actually lead to very interesting and aggressive pricing for certain transactions. It goes both ways.

EUROWEEK: Tammo, you’ve only been in the job a few days, but how about 30 year or 50 year syndi-cated Bunds? And how does the Finance Agency feel about signing two CSAs with everybody?

Diemer, German Finance Agency: Thirty year Bunds are part of our auction calendar and we have no plans to enlarge the maturity profile. The Finance Agency will stick to its existing CSAs.

Cohrs, Nord LB: But the auctions are dominated by for-eign banks these days.

Diemer, German Finance Agency: We do not influence the share of participation or where the bidding ends up in our auctions.

Scheidig, DZ Bank: In the end, it’s a free decision of the bidding group to bid on a certain price. It’s up to the discipline of the members.

Redlich, HSBC: In the end it’s a question of distribution capabilities. HSBC maintains a global, full service plat-form and uses primary dealerships to get access to first class bonds. Maintaining the supply pipeline that inves-tors demand through primary dealerships is costly and regulatory pressures mean that maintaining bigger posi-tions on the balance sheet isn’t easy these days.

But this is part of the service we provide to both investors and issuers, and we’ll continue to do so. On the other hand, of course, as mentioned here, it would be nice to get some reward for the effort and the cost involved in maintaining this platform by doing some syndicated business from time to time.

EUROWEEK: But is the pressure that comes from being in the German auction bidding group not driven by investor demand rather than pressure from the borrower? Obviously, in some primary dealerships, it’s much more the borrower that dic-tates terms or complains about certain banks having a lack of league table share. But in Germany that doesn’t seem to be the case — perhaps precisely

because there is not the immediate ancillary busi-ness to strive for in return. Investors are driving your auction losses aren’t they?

Redlich, HSBC: As Tammo already mentioned it’s an open system in Germany and more so than in other jurisdictions. We do not face pressure so much from the German Finance Agency.

Scheidig, DZ Bank: It depends what auction is on. In the short end, you often have orders which are not nec-essarily driven by investor demand. But for banks, even in the current environment, it’s still possible to use the very short end of the curve to attempt to come a little bit higher in the primary dealer rankings for the sake of winning derivatives business.

Doing that in the longer issues — like 10 years — is these days far too costly, and even a global player like HSBC cannot afford that anymore.

Cohrs, Nord LB: Being a primary dealer or being in the auction bidding group, as it’s called in Germany, is con-sidered a seal of approval for competence in the capital markets, especially if you work in the SSA market.

If a dealer wants to pursue that with more fervour than others, then I am sure Tammo will very much wel-come this effort. But it carries its own rewards on other deals. I don’t think that the Bund has to come up with syndicated deals for that to be worthwhile.

KfW does syndicated deals as a mainstay of its busi-ness, and of course, they also look at the league table positions of dealers in the market. In a way you can get your trade-off there and that’s fair enough.

Diemer, German Finance Agency: Let me start by emphasising that the German Auction Bidding Group did an excellent job before and is doing an excellent job today. I would like to point out that we maintain a very liberal collaboration with our participants. We put no pressure on our market partners, neither before the auc-tion nor afterwards. It is completely up to them which strategy they like to follow in our well known multi-price auction system. The group is open to everybody, which gives room for competition. Consequently, there is no ‘primary dealership’ in Bunds. This approach has been proven to be very successful over the years. For instance, last year we had 70 auctions, we had an over-all bid-to-cover ratio of 1.8 and issued a total volume of €264bn. This year has started just as successfully. We appreciate the collaboration from our auction bidding group and we will continue in this way.

EUROWEEK: So you’re not planning any major shifts in strategy and you’re not considering any syndica-tions in the near future?

Diemer, German Finance Agency: For particular and special capital market issues, we clearly have the option to use syndication as an issuance format. The dollar transactions Germany did were examples as was the first inflation-linked bond. These are special occasions where we clearly need to syndicate our transactions, but for the general issuance calendar, we will rely on the auction system.

Czichowski, KfW: In the global context, the number of issuers that can deal and the number of instruments which can be dealt through auctions is very, very limit-



ed. Normally, you need to be the benchmark in a certain market to be able to do your issuance via auctions.

I have been on the issuance side of KfW for nearly 20 years and we have repeatedly considered whether auctions would be something for KfW to look at. We always came to the conclusion that KfW’s debt instru-ments are not the right instruments for an auction. Auctions are really limited to very particular issuers and circumstances.

The syndicated model is the rule whereas auctions are the exception. Whoever is able to get away with it and does not have to pay fees would be badly advised to abandon it. It is a very efficient model and it’s clear that only a very limited number of issuers are able to do this.

EUROWEEK: If the EFSF can auction bonds, could KfW not auction bonds?

Czichowski, KfW: KfW is an issuer which issues about half of its volume in foreign currencies and in many different kinds of structures. With almost every issue we need to have a hedge attached to the issue. We may hedge out the currency and/or the interest rate risk. So we need derivative partners. We need a package that we need to contract at a specific moment. And as a conse-quence of that, there’s much more to it than just selling the security. There’s a whole layer of duration manage-ment attached to it and this kind of issuance is not really fit for an auction.

As I said, if there’s a benchmark issuer who, in prin-ciple, is able to take in the funds at the levels that the market provides it with, and that issuer is the core of that particular market, I think it has all the right ingre-dients to use an auction system. In our case we have limited possibilities. At certain times, we theoretically would have the possibility to do auctions, that is to say in certain times we see such an overwhelming demand, for instance, at the short end, that we would be able to get away with an auction. But then you have to look at the consistency of our programme. Thomas alluded to that earlier.

It is very important to be a stable issuer. Investors and intermediaries need to know what to expect. If you change your strategy every other year and say “Oh this year, I just feel like doing auctions” then probably people will be unsure about what your long-term strat-egy actually is. You will probably end up paying for it in terms of basis points. If people are pretty sure about what to expect from an issuer then they feel more com-fortable, and you benefit from this, at the end of the day, in terms of spreads.

Scheidig, DZ Bank: That’s why I would vote for a mix-ture of methods from an issuer. The Bund issuer is such a big one, with so much volume to do, it can afford to have a system which uses both methods.

Auctions have worked quite well in the past. But it is also important to keep some flexibility for deals that need to be syndicated. That has to be the future for an issuer as big as the Finance Agency.

The question is how big will it be in the future then? And that is another topic that I’d like to raise. What will be the volume that the Bund has to raise in the market in the coming years?

Might it have to change or want to change because of the deferred interest rate environment or if it’s issuance is capped by politicians?

Redlich, HSBC: From an investor perspective, we would wait for more issuance in foreign currencies. KfW has impressively demonstrated how well that works, and we’re convinced that there’s room for both the Bund and KfW. There’s a lot of demand out there for the Ger-man names and issuance in different currencies could well be the instruments that should be syndicated. This would be a way to broaden the investor base and gener-ate more funding over time.

Diemer, German Finance Agency: As the benchmark issuer in euros, we are in the same league as US Treasur-ies are for dollars, Gilts are for sterling and JGBs are for yen. We will always steer our capital market activities around our benchmark status in a way that does not interfere with that status. Inflation linkers are an exam-ple of a capital markets segment away from the fixed rate benchmark curve that we continue to develop. We will improve the liquidity in those instruments and have a broader maturity band there. It is not in our plans to have more currencies involved in our issuance.

EUROWEEK: Going back then to KfW and its range of currencies, you’re present in a vast number of markets. Are there new markets you’re looking to access at all? Are their sources demand as yet untapped?

Czichowski, KfW: Issuance in foreign currencies is not done for the sake of issuing foreign currencies. There are two reasons why we do it.

Firstly, in certain cases we need foreign currencies. KfW has a daughter company, KfW-IPEX Bank, which works in international export and project financing. A good part of that business is run in dollars, and to a very limited extent, in other currencies.

Second, we have in most if not in all currency issu-ance outside the euro a certain funding advantage that we have to balance against the derivative risk that we take. If — at the end of the day — we have a favourable funding cost advantage, then we do the trade. As with the Finance Agency, we will always do this sort of busi-ness around our core product, which is the euro bench-mark programme. There will always be a KfW euro benchmark programme.

But we look at all sizeable capital markets around the world. We have been present in the US and Japan since the 1980s, and started our issuance in Australian dol-lars in the 1990s. We continue to issue in these markets whenever there’s a good opportunity for us overall, and therefore, we look also at new developments in the mar-ket and see what they bring for us.

Frank Czichowski,KfW



We watch the renminbi market with very great inter-est to see what is happening there. Together with HSBC we did two offshore renminbi trades last year. We will continue to look at this market because of the very con-siderable potential.

Other than that, the central bank community has made greater investment in particular currencies which are natural resources-related, namely the Australian dol-lar and the Canadian dollar. KfW’s core investor group is central banks around the world, so we have seen a marked pick-up in the volume of the Australian dollar bonds that we sell.

But the number of really new markets over the last couple of years has been relatively small, the renminbi being probably the most important new one.

Redlich, HSBC: KfW is the biggest agency borrower in offshore renminbi and the perfect name to open new currencies with. It’s an established borrower with a top-quality and longstanding track record and high liquid-ity in the secondary market. It has a proven, constant approach and sustainability. Whenever a new market is ready to be opened up, be it driven by domestic retail demand or by demand from the international investor base, KfW is ready and willing to access that market.

Also, it has shown that it can re-open existing mar-kets that have not been open to international issu-ers for a while. Looking at the Canadian dollar market where very little activity took place in recent years, issuers like KfW re-opened the market for the interna-tional issuer community.

EUROWEEK: Is the renminbi market open to other German agency and public sector borrowers?

Redlich, HSBC: It is. We have done issues for L-Bank as well. For most issuers though it’s an arbitrage currency for the time being. It is mostly corporates that regularly have a natural need for renminbi, but with the pace this market is growing and the development we forecast for this currency, we expect it to be one of the major capital markets in a few years’ time. So it’s definitely one of the markets international borrowers should have an eye on.

Scheidig, DZ Bank: Well, it is definitely an important currency for the future, but the question is when? And what are the new Chinese rulers who are taking over in March going to do with the process?

There are voices among them saying it will take at least another 10 years before it’s a free-floating currency

and fully-fledged part of the international currency com-munity. In that respect, I think it’s just opportunistic for now providing you can do the trade with a limited amount of hedging available.

You’re right, you did L-Bank and three or four other deals but there is not more liquidity. The market does not have volume. I guess there is no secondary market at all in renminbi bonds.

That is the problem with that market. I’m a big fan of the renminbi market. If it is doable then the currency should open up earlier. But we should also be careful of what we wish for. The currency also needs to present the economic power of its country, and we have to see what the new generation of political power in China will do over the next months and years.

Cohrs, Nord LB: I guess that’s always the problem with managed currencies. Any currency that is not completely convertible and freely tradable across the globe is going to have that same type of problem. We had these discus-sions with Turkish lira, with Russian roubles, with South African rand in the past. They were all great economic stories with growth everywhere and the recommenda-tion that everybody should be in there. But in the end they all turned out to be flashes in the pan. Now China is, of course, an economy of a different magnitude, but I fully agree with Frank, that it is going to take a while for the renminbi market to develop, and we’re going to have to see some major improvements in the way the currency is liberated in terms of dealing before we see that market fully developed.

Redlich, HSBC: We are at an exciting point and we have seen quite a fast development already. Looking back many people did not expect such speed of development. The Chinese administration is very supportive of inter-national investors and issuers entering the market. Of course continued progress is dependent on the political environment, but we expect strong support and a very positive development of that market within the next years. I don’t think we have to wait for another decade.

Czichowski, KfW: The longest journey starts with a single step and there has been an incredible number of steps that have already been taken. Not all of that pro-gress has come through concrete transactions, but the discussions that have been held, both in the market as well as with Chinese officials, have been very fruitful. There are discussions about renminbi trading centres, both in London as well as in Frankfurt, where there are measures being undertaken to establish renminbi trad-ing. This is a very positive sign and so one comment I would make, Frank, to you is if currency volume issu-ance is small, that does not mean that it is opportunistic — quite the opposite in fact. I think it can be very stra-tegic. It is strategic in the sense that you are in constant discussion with, in this market, the Street, the under-writers as well as with officials on how you can access and develop it and what kind of instruments should be used. That is far from opportunistic. It’s actually a very strategic move to look at this. Would I expect that KfW’s funding volume in three years’ time will be 30% renmin-bi? No I don’t, but we are really talking about the long-term horizon. As I said, it may be a long way, but it’s definitely worth the walk.

Scheidig, DZ Bank: But you mentioned before you need dollars. Looking at the renmimbi market as a source,

Ralph Sinclair,EuroWeek



which already constantly offers cost efficient funding when swapped into either dollars or euros, I have my doubts. Long term this might be the case, but to me it rather seems to be an early signal to an investor base which will — and here we agree 100% — become crucial for issuers of the size of KfW.

The renmimbi market surely has an immediate stra-tegic relevance for those corporate issuers with onshore treasury activities. It is not surprising that we have seen a number of German corporates funding in renminbi already with no need to swap the proceeds into either dollars or euros.

Redlich, HSBC: What about the need for the cur-rency? As an issuer you can enter this market once on an opportunistic basis, or you can have a long-term approach trying to develop a new investor base and over time grow the funding volume that you can generate in this market, linked with all the positive effects that come out of it.

We are developing the secondary market too. There are retail investors and institutional investors that already invest in other currencies that now are eager to get access to KfW and other names in renminbi. There are a lot of benefits from tapping this market with a long-term horizon. There is huge demand.

Steeg, LBBW: There is probably a mixture of both types of issuance going on. It is a strategic step for issuers. Global diversification makes sense for everyone, and one of the positive side effects is to alleviate the pressure on the euro market.

Cohrs, Nord LB: Patrick has made a very important point. Even though, Frank, you have mentioned before that overall SSA issuance is not growing, among our clients there is a lot of concern about the overall vol-umes in euros going up. The EFSF, ESM and EIB issu-ance volumes are rising, KfW’s has been rising, and in that respect, it is always helpful for us to be able to say to investors that these issuers are not dependent on the euro. They can do a hell of a lot of business in other countries as well.

For us, in terms of trying to sell and trade German public sector paper, I think it’s a very important point that you reduce the pressure on the supplies of SSA bonds in euros.

In this context, it can be acknowledged that the ren-minbi market, as mentioned before, may also offer some opportunistic examples.

EUROWEEK: Have there been any changes in the investor base for German public sector borrowers over the last 12 months? And which new investors are desperate to get into this market?

Diemer, German Finance Agency: There seems to be three investor trends that are most beneficial for Bunds. The euro denominated share in central bank cash reserves increases. Bank regulation asks for higher liquidity buffers and for collateralised inter-bank busi-ness. And regulation for insurers demands high quality long dated fixed or inflation-linked securities.

Scheidig, DZ Bank: With the new regulatory issues, bank treasuries — including savings banks and co-opera-tives — have been facing an ever less attractive finan-cial issuer market, given return, regulatory and financial

crisis-driven disincentivisation, while on the other hand facing the need to fulfil the requirements of the Liquid-ity Coverage Ratio (LCR). Both of these aspects drove enormous amounts of liquidity into the so-called core Europe part of the SSA sector throughout much of 2012, driving yields and spreads significantly down.

With the deadline for fulfilling the LCR having been postponed and with potential signs of a softened crisis since the last quarter of 2012, this trend became less forceful and put an extra challenge to these issuers and syndicate banks alike to identify the proper new issue pricing at the beginning of this year.

Cohrs, Nord LB: I can confirm that for the savings banks that we deal with there has been strong demand for KfW. Unfortunately, for Tammo, I cannot confirm that at all for the Bund. The demand for Bunds among the sav-ings bank sector has been very weak, for the simple rea-son that they have become more and more expensive.

They may have been slow to take up the opportunity as Bund yields fell but they don’t really go and try to turn a quick buck.

Steeg, LBBW: In my view, the Liquidity Coverage Ratio is driving it for banks.

Sparkassen have put a big portion of their portfolios in Landesbank paper and there are massive redemptions ahead in 2015. There is a big challenge to replace it in the very near future, and many are already preparing and buying ahead of it, and they tend to buy 0% risk-rated assets.

They have a conservative approach and start looking domestically. I think we will see another push towards German agencies.

Cohrs, Nord LB: It is spread volatility that is keeping a lot of the more conservative bank treasuries from buying peripheral agencies, despite the potential to make a lot of money if you believe in the future of the euro.

Redlich, HSBC: Apart from the domestic bid that has been highlighted, we observe as well increasing inter-national participation. I guess that matches with your statistics, Frank.

Czichowski, KfW: It does, yes.

Redlich, HSBC: One sector that is buying is the fast money and the hedge fund accounts that, not only in times of turmoil, take advantage of the secondary liquid-

Patrick Steeg, LBBW



ity in both Bunds and KfW. But we’ve also seen new investors, especially from the

countries whose wealth is rooted in natural resources. Whenever a central bank or sovereign wealth fund has money to invest, both the issuers on this panel are on the buy-list. So there’s been a broadening of the investor base in both domestic and international respects.

Czichowski, KfW: Bigger investments have come from Asia into our issuance both — interestingly enough — in euros and dollars. In euros, we have gone from 16% of our securities sold into Asia in 2011 to 35% this year. Admittedly, the year has been short and so there have been only two issues so far, but nevertheless, it’s a trend. In 2012, we sold 30% of our bonds into Asia. And that corresponds to a decline in Europe ex-Germany. Germany has been relatively stable.

In the dollar market, it’s the same thing: an increase in Asian demand, which corresponds to an increased take-up of KfW securities by central banks. So the overall share of central banks’ participation has actually increased.

Scheidig, DZ Bank: It’s no surprise. It’s where the cash-flow is. Unfortunately our partner countries in Europe have less and less money to invest and to spend.

EUROWEEK: What changes has the German Finance Agency seen over the last 12 months or so?

Diemer, German Finance Agency: For us it is important to have continuity and reliability. So there is not much that will actually change. We will elaborate and in a sense, intensify our dialogue to our institutional investors and also to our bank partners. And we would also like to fur-ther develop our inflation linker segment.

EUROWEEK: What are the panel’s concerns for Ger-man public sector debt over the next 12 months?

Scheidig, DZ Bank: If there’s a turnaround in the direction of interest rates in the US and if Italy doesn’t rock the boat too much with its elections and there is continued stability in France elsewhere in Europe and we get back to normal — whatever normal means — then I think there is a high likelihood that the safe haven bid is going to melt away a little bit.

So there is a little bit of spread widening risk but not too much here. But the huge real money funds face a dilemma, which is where do they park their money? For sure they will keep to Bunds or KfW, where they have liquidity, and it is relatively stable and safe.

Czichowski, KfW: I don’t quite share that fear. I think even in a rising rate environment, there would be — and we see this time and again when there’s a little bit of a back-up in yields — increased demand because a good proportion of investors need to hold this type of paper but have been crying out for a little bit more yield. There would be great relief among many accounts.

I’m not so concerned with higher yields, as such. I think we are not in the same environment as we were in 1994, for instance, where it was extremely difficult for a couple of months even to issue because people were so afraid. Central banks are managing a rising yield environment very carefully.

I think the worrying perspective would be the deterio-ration of the general environment and any disturbance to the current, very positive consolidation process in the euro-

zone. A massively rising euro would also be an issue for the economic situation overall in Europe.

But in general, I think for the issuance side, we are — from what I can see — in relatively safe territory.

Cohrs, Nord LB: I think if rates do not move too fast that would be helpful. The name of the game for a lot of inves-tors is low volatility. We have had a long, long spell of fall-ing and very low interest rates, and we see it causing some problems in the pension fund industry and the life insur-ance industries — which, by the way, is also a big buyer of these issuers’ long term bonds.

So in this respect I hope that we actually do see some rising yields, just not too fast so that these guys adjust to it. That would be helpful.

My concern actually would be remaining in this low interest rate environment for too long.

Czichowski, KfW: I completely agree with you.

EUROWEEK: Tammo, rising yields on your watch — is that a worry?

Diemer, German Finance Agency: I’m not worried.

EUROWEEK: Is that because it’s not going to happen or it’s just not a worry for you? What are your concerns, if any, for the next 12 months?

Diemer, German Finance Agency: Bunds and Bund yields are more correlated to the other benchmarks, like US Treas-uries and UK Gilts. They reflect capital market expectations on central banks’ rates. From my perspective, we are in a stable environment for Bunds.

Steeg, LBBW: You can profit from both risk-on and risk-off scenarios. If there’s more stabilisation in the eurozone then of course Bund yields will rise. That will drive a buy-ing reaction among savings banks, cooperative banks, life insurers and pension funds.

Redlich, HSBC: The threat for any borrower would be that he either can’t raise his funding or has too high a borrow-ing cost and I can hardly think of any scenario where this would be the case, even with a massive rise in yields.

The German public sector issuers will still be able to gen-erate the funding needed and I think there’s a limitation to the borrowing cost in terms of interest rates having to be paid. I do not foresee a doomsday scenario or any dark clouds for the German public sector. s

Tammo Diemer,German finance Agency

Länder Finance


Anyone for A Hückepack? To the linguistically uninitiated, Hückepack is a German trade name for various baby-carrying devices and backpacks, but it also means a piggy-back of the kind generally given by adults to small children.

In German capital market parlance, it refers to the idea of the 16 federal states, or Bundesländer, effectively piggy-backing off the credit quality of the government bond market to issue pooled bonds in a highly liquid format.

for the Länder, many of which are under pressure to cut their deficits, the attraction of the idea is obvious enough. “The genuine motivation for the idea was to reduce the financ-ing cost for the Länder,” says rainer Guntermann, interest rate strategist at Commerzbank in frankfurt.

When the government originally announced last summer that it was negotiating the possibility of a joint issue, the implications for the Länder seemed almost too good to be true. As Moody’s commented at the time, “the proposal is credit-positive for the Länder because it would likely lower funding costs. With the central gov-ernment’s participation, we expect the Länder bonds will be placed at tighter

spreads to German central govern-ment debt in the primary market, based on the positive credit effect and the potentially higher liquidity of these debt instruments in the sec-ondary market.”

Moody’s made a simple calcula-tion to quantify the potential cost savings to the Länder, which typi-cally trade at a pick-up to Bunds of between 0.3% and 0.8%. A conserva-tive assumption that 30bp could be shaved off the funding costs of the states, savings on interest expenses could have been as high as €383.1m in the case of north-rhine Westphalia, €184.6m for Berlin and €168.2m for Lower Saxony. These calculations did not factor in the costs that the Länder would have saved by issuing via the finanzagentur’s auctions, rather than through syndicated transactions, although it has since been determined that joint bonds would be syndicated rather than auctioned.

Too good to be true?Things that look too good to be true usually are. Guntermann says that within hours the German finance min-istry had poured cold water over the idea when it cautioned that it would be unwilling and possibly even legally

unable to guar-antee a joint bond.

The idea of a Deutschland Bond is not entirely dead, but it’s look-ing decid-edly unlike-ly. “I’m sure we won’t see a Deutschland bond in the first quarter of this year,” says Tor-ben Skopnik, senior cred-

it analyst at LBBW in Stuttgart. “The main reason is that instead of liabil-ity being on a joint and several basis, it will be apportioned on a pro rata basis.”

The Länder themselves confirm that this is the main sticking point. eckhard Helms, head of treasury at the north-rhine Westphalia Ministry of finance, says that there is no truth in the rumour that nrW has decided against participating in a Hückepack bond. But he says that a host of issues need to be resolved before it can com-mit itself to the concept.

“The goal of the majority of the Länder is that the Bund will be the issuer and the funds will be distribut-ed to the Länder,” he explains. “So for the investor it would be the equiva-lent of a Bund issue. That would mean that we would enjoy the same fund-ing conditions as the Bund without harming them. Until now the Ministry of finance has not agreed to this pro-posal and says that each borrower just has to be responsible for its share of the issue. nevertheless, a possible joint liability for a Bund-Länder issue is still part of political negotiations and we hope we will achieve it.”

even if it comes without an explicit government guarantee, a number of market participants are still expect-ing an inaugural issue to be launched before the summer. While no details have been released, bankers say that if it does materialise, it is likely to be a

In spite of Germany’s well developed support system for the federal states, investors clearly do not believe that the 16 Länder share the same credit quality, meaning that the funding status quo will remain broadly in place, with the weaker states accessing the market through pooled jumbo issues and the stronger borrowers issuing on a standalone basis. Unless of course, the German finance ministry changes its mind and endorses the Deutschland Bond concept. Stranger things have happened — even in Germany. Philip Moore reports.

Some Länder are more equal than others

“The genuine motivation for the

idea was to reduce the financing cost

for the Länder”

Rainer Guntermann, Commerzbank

Rising importance of capital market instrumentsOutstanding debt instruments for German Länder, in €bn

0

50

100

150

200

250

300

1996 1998 2000 2002 2004 2006 2008 2010 2012

Treasury notes/bonds bank loans

loans from non-banks

Source: Commerzbank Research

Rising importance of capital market instruments: outstanding debt instruments for German Länder, €bn

Source: Commerzbank Research

Länder Finance


five or seven year transaction with a minimum size of €1bn.

It is questionable how attrac-tive the pricing of a Deutschland bond will be to some of the Länder. Guntermann says that the Bund component means that the bonds would carry a slight pricing advan-tage over existing joint funding instruments. “But the problem is still that the probability of default will be determined by the weak-est rather than the strongest weak in the chain,” he says. As a result, states like Bavaria — which has recently been trading inside KfW — have reportedly indicated that they would be reluctant to participate in a Deutschland or Hückepack bond.

ratings agencies confirm that this is how they would view the joint funding structure. “our current understand-ing is that it would be based on sev-eral rather than joint liability, so with our methodology a rating would be based on the weakest issuer within the group,” says Alois Strasser, analyst at Standard & Poor’s (S&P) in frankfurt. “Investors would possibly look at a joint bond the same way, which would then be reflected in the pricing.”

The dilemma is that in spite of Ger-many’s well developed support sys-tem for the states, investors clearly do not believe that the 16 Länder share the same credit quality. four states in particular — Saarland, Bremen, Schleswig-Holstein and Berlin — are regarded as being the weak links in the Länder chain.

“If Länder were banks, investors would expect some of them to delever-age their balance sheets”, says Hinrich Holm, member of the managing board at nordLB.

Safety in numbersThis suggests that in the capital mar-ket, the status quo that has been established for a number of years will remain broadly in place, with the weaker states accessing the market through pooled jumbo issues and the stronger borrowers issuing on a stan-dalone basis. After all, with no govern-ment guarantee in place for the pro-posed Hückepack bond, it is hard to see how this would materially differ from the existing joint Länder bonds.

At the last count there had been 42 joint Länder issues, the latest of which was a 10 year €1bn issue, launched in January via Commerzbank, Deutsche

Bank, DZ Bank Landesbank Ber-lin and UniCredit. Länderschat-zanweisung no 42 was a joint issue from Bremen, Hamburg, Mecklen-burg-Western Pomerania, rhineland Palatinate, Saarland, Schleswig-Hol-stein and Thuringia. As with previous joint issues, the powerhouses of the German economic machine such as Bavaria and Baden-Wurttemberg were notable by their absence.

nevertheless, the joint jumbo trans-actions continue to make progress in terms of their international distribu-tion, even though they are rated only by fitch, which applies a uniform AAA rating across the Länder sector. In the case of January’s transaction, an unusually high 30% of the bonds were sold outside Germany, which may have reflected the step-up in the search for yield pick-ups in the SSA sector, given pricing of 11bp over mid-swaps.

Among the stronger, standalone issuers, comfortably the most prolific borrower in the international capital market is nrW, which as Helms says is natural enough, given that it is the biggest of the 16 Länder. In 2013, says

Helms, nrW will have a gross funding requirement of €22bn, and a net tar-get of €3.5bn, down from about €4bn in 2012.

nrW’s most recent benchmark was a €1.5bn five year issue led in novem-ber by Commerzbank, Deutsche Bank, HSBC, nordLB, UniCredit and WGZ Bank. Priced at 7bp over swaps, the nrW trade generated an unusually large book of about €3bn from almost 90 accounts. Almost 30% of the issue was sold outside Germany, with 8% placed in Asia.

That, says Helms, is roughly in line with the geographical distribution of most of nrW’s recent benchmarks. “of course German investors are the drivers of our private placements, but in our benchmark issues we general-ly place 30%-50% with international investors,” he says.

Another of the Länder that recently demonstrated the breadth of the inter-national investor base it has cultivated in recent years is Hessen. In the case of its €1.25bn 10 year trade in January, led by a strikingly international quin-tet of Barclays, Deutsche Bank, Hela-ba, HSBC and JP Morgan, only 64% was placed in Germany.

Among other standalone issuers, in the context of a market segment in which new issues are seldom fully subscribed, another recent highlight in the Länder market was the €1bn seven year benchmark in february from Brandenburg. Led by BayernLB, Deutsche Bank, Helaba, LBBW and WGZ Bank, the Brandenburg issue was reported to have been fully subscribed, with 86% of the bonds sold to domes-tic investors.

“I’m sure we won’t see a Deutschland

bond in the first quarter of this year”

Torben Skopnik, LBBW

Source: German Federal Ministry of Finance, DESTATIS; Moody's calculation of projections based on Ministry of Finance's Tax Estimates, October 2012.

0%

50%

100%

150%

200%

250%

Länder debt / Länder total revenues

Debt trend of Bund and Länder: 1991-2016e

General government debt / General government total revenues

German Constitutional Court’s decision of 2006 with regard to Berlin'sbudget crisis

Creation of Winding up legislation

Debt brakeimplementedin Germanconstitution

De

C

CAGR(1991-2010) : +4,07%

CAGR (1991-2010): +4,85%

Germany:"sick man of Europe"

Debt trend of Bund and Länder: 1991-2016e

Source: German Federal Ministry of Finance, DESTATIS; Moody’s calculation of projections based on Ministry of Finance’s Tax Estimates, October 2012.

Länder Finance


Equalisation mechanismBe it in jumbo pooled format, or in standalone issues, access to the capi-tal market is an important factor in the Länder’s ratings. Guido Bach, sen-ior director at fitch in frankfurt, says that the main reason for the uniform triple-A rating that fitch assigns to the Länder is the strength of the institu-tional framework underpinning them. The key pillars are the financial equali-sation mechanism, under which the stronger Länder subsidise their weaker counterparts, and the solidarity agree-ment whereby states facing “extreme budgetary hardship” are supported by those that are not.

“The states’ access to liquidity and their very good standing in the capital market are also important ratings con-siderations,” says Bach. “even during the crisis they were still able to raise funding at competitive levels.”

Another key determinant of credit quality across the Länder sector is the declining trajectory of the state’s debt, driven by the so-called Schulden-bremse, or debt brake, which requires the federal government to achieve a balanced budget by 2016. The Länder have until 2020 to bring their budg-ets into balance, and S&P’s Strasser says that the progress most are mak-ing towards this objective is encour-aging. “The preliminary results are that seven states were able to repay debt in 2012, while the other nine are still incurring new debt but have clear plans to reduce their deficits,” he says.

Although their debt is falling, ana-lysts say they expect the German states to remain busy borrowers in the capital market, given their high debt levels, with LBBW’s Skopnik saying that their total funding requirement for this year will be around €90bn.

Much of this will be refinanced through the international capital market. As Commerzbank’s Gunter-mann says, the longer term trend is

that the capital market is becoming an increasingly important source of funding for the German Länder. He says that according to Bundes-bank data, in 2002 bond issuance accounted for about a third of total Länder financing. Today, this share has risen to more than 50%.

Schuldschein declineThe evolution of nrW’s funding mix in recent years has mirrored this trend, with domestic and inter-national public markets playing an increasingly prominent role. Helms says that the share of Schuldscheine in nrW’s total funding, for example, fell from 40% 10 years ago to just 6% in 2012. “In the first two months of 2013, the share of Schuldscheine recovered to about 20%, but the general trend is down,” he says. “replacing Schuld-scheine has not been a problem, because over the last 10 years we have increased the range of funding pil-lars we can rely on. foreign currency issues accounted for 12% of our fund-ing last year, and we have increased our use of domestic bonds and struc-tured issuance through our MTn pro-gramme over recent years.”

At DZ Bank, executive director Mike richter says that the decline in nrW’s reliance on the Schuldschein market is mirrored elsewhere in the Länder uni-verse. “Since Lehman, investor demand for liquid bonds has risen,” he says. “That has made it much more difficult for borrowers to sell issues of €250m. Insurance companies still have a strong demand for Länder private placements of Schuldscheine, but more generally investor demand has been declining. Issuance volumes by the Länder have been rising this year but still well below what they were 10 years ago.”

Although the absolute costs of Schuldschein financing is marginally lower than in the public bond mar-ket, increased recourse to the capital market by the Länder in recent years has dovetailed with a decrease in their overall funding costs and a tightening of their spreads versus Bunds.

“We are seeing rising investor demand for Länder bonds,” says Holm at nordLB. “Given the strength of the equalisation structure, it is clear to many investors that the repayment risk is effectively the same as federal government risk, which means they are earning a yield pick-up for trusting the Ausgleich system.”

This will be a welcome trend to Länder, especially given that funding via the capital market is likely to con-tinue to rise.

fixed income investor demand for exposure to the Länder is expected to remain resilient, not least, bank-ers argue, because the structure of the sub-sovereign market in Germany is sound, and in some respects could be used as a template for fiscal discipline across the broader eurozone.

Holm explains that a very clear hierarchy operates across the pub-lic sector, with the Länder sitting in between the federal government and the municipalities. The result, he says, is that fiscal discipline in the form of the debt brake percolates from the federal government via the states to the municipalities. “Increasingly, the Länder are recognising that if they don’t address the deficits that many of the municipalities are running, it will be harder for the states themselves to meet their own deficit-reducing tar-gets in line with the Schuldenbremse,” he says. “Many of the Länder are there-fore setting up programmes where they finance the municipalities, based on strict conditionality in terms of the municipalities costs and expenses.”

Whether or not this fiscal discipline could pave the way for the German municipals to extend the reach of the sub-sovereign market by issuing pub-lic bonds is open to question. “Until now there has been little evidence, but theoretically, this would be possible, but I would be surprised to see more municipals issuing directly into the capital market,” says Holm.

others think that over the long-er term municipal borrowers may emerge as a source of capital mar-ket issuance in Germany. “The cities and communities are going to need to explore alternative funding options as pressures on the banks’ balance sheets grow,” says LBBW’s Skopnik. s

“A possible joint liability for a

Bund-Länder is still part of political

negotiations”

Eckhard Helms, North-Rhine

Westphalia Ministry of Finance

”Insurance companies still have

a strong demand for Länder private

placements of Schuldscheine”

Mike Richter,

DZ Bank

German Public Sector Debt


If a publIc sector funding offi-cial’s performance is to be judged upon how cheaply he or she can borrow money on behalf of the tax-payer, then Tammo Diemer — who took over as chief executive of the German finance agency in early february — has an unenviable task. bund yields are, from an investor’s point of view, depressingly low. You might be forgiven for thinking that he is on a hiding to nothing, since his borrowing costs can surely only rise.

but that neglects not just the full role of the bund in Europe’s bond markets but also the weight of evi-dence that suggests the German tax-payer is not about to have to pay up to keep the state coffers full.

“I’m not worried,” says Diemer. “bunds and bund yields are more correlated to the other benchmarks, like uS Treasuries and uK Gilts. They reflect capital market expecta-tions on central banks’ rates. from my perspective, we are in a stable environment for bunds.”

With growth generally sluggish across the world’s developed econo-mies, it would be a desperate man that bets the ranch on rising interest rates and, therefore, lower bench-mark bond prices any time soon. So big is the bund market in its home currency, that it is as much a vehi-cle for expressing views on rates as it is one for expressing views on the issuer’s credit — although at the moment, under a sustained flight to quality, those two views appear to be synchronous.

“German bunds play many impor-tant roles in various money and cap-ital markets,” says Diemer. “They serve as a surrogate for cash, they serve as high quality collateral for secured interbank business, they serve as efficient hedging instru-ments for interest rates and they are a high quality long term investment.

“Given the vivid secondary market and the fact that Ger-man bunds are the underlying of the most important interest rate future contracts, portfolio manag-ers also express opinions on inter-est rates using bunds. Hence — to a large extent — bund yields reflect capital markets’ expecta-tions on the development of cen-tral bank rates.”

Structural demandbut the second reason for back-ing bund yields to stay low is the evidence of a strong structural bid both within Germany and over-seas for highly liquid securities of the utmost credit quality. for many investors — as much as the french might like to believe otherwise — only the bund will do.

The international drive behind this bid is twofold. The first is of course a continued flight to quality with the European sovereign crisis still far from resolved. The french OaT market may offer something approaching the liquidity of the bund market, the Nordic and Dutch markets something approaching the same credit quality. but neither comes close to both characteristics in euros.

and in Germany’s case, it guaran-tees an agency borrower in KfW that has a programme large enough — at €70bn a year — to benefit from this heightened interest.

“There has been ample talk of a potential bubble in the core sov-ereign markets and especially, of course, in the bund in recent months,” says Thomas cohrs, head of syndicate and DcM at Nordlb. “and if you look at the yields that have been attainable over the last six months or so, sometimes we have been very close or indeed have even dipped into negative yield ter-ritory — that does not sound like a

very good starting point for a lot of upside performance.

“Having said that, there is a very deep structural bid for bund paper. It’s probably even better for KfW paper in that context, because obvi-ously, they do pay a little bit more in yield than the German sovereign. but it remains the case that the structur-al bid is not going to disappear.”

Regulators, since the 2008 bank-ing crisis it turns out, are also big fans of the safety and liquidity that the bund market has to offer. and this is helping to drive the structural bid for bunds.

basel III and the liquidity cov-erage Ratio require institutions to hold not just more capital, but bet-ter quality capital than ever before. Inevitably, that means higher demand for bunds.

banks are loading up on bonds to collateralise their inter-bank busi-nesses and to support their deriva-tives portfolios as well as putting in place higher liquidity buffers.

Meanwhile, insurers are facing up to regulatory demands to hold high quality long-dated fixed or inflation-linked securities. When you add to the mix a trend for cen-tral banks increasing their euro reserves, it is hard to imagine a bund selloff occurring any time soon.

but it is not just investors from the financial industries that are

German public sector borrowers have had a whale of a crisis. Indeed it is hard to find a point along the German sovereign’s curve at which an investor won’t have to pay, in real terms, for the privilege of funding Europe’s biggest economy. Ralph Sinclair discovers why that trend is set to continue.

Unyielding: Europe’s premier debt market can only get stronger

“German Bunds play many

important roles in various money and

capital markets”

Tammo Diemer, German Finance

Agency

German Public Sector Debt


looking to snap up top-rated Ger-man debt.

“One sector that is buying is the fast money and the hedge fund accounts that, not only in times of turmoil, took advantage of the secondary liquidity in both bund and KfW,” says Matthias Redlich, HSbc’s head of public sector and fIG DcM, Germany and austria, in Düsseldorf.

“but we’ve also seen new inves-tors, especially from the countries whose wealth is rooted in natural resources. Whenever a central bank or sovereign wealth fund has money to invest, both KfW and the sover-eign are on the buy-list. So there’s been a broadening of the investor base in both domestic and interna-tional respects.”

Domestic interestWithin Germany, conservative domestic investors such as the country’s savings banks, or Sparkas-sen, are also after sovereign paper. The end of 2015 will mark the final possible maturity of landesbank paper issued under the Gewähr-trägerhaftung and anstaltslast guar-antee mechanisms that the Europe-an commission forced Germany to abolish in 2001.

That leaves that group of bond-holders facing a wall of redemp-tions and a dire need to find a safe place to reinvest the redeemed cash. although a number of better yield-ing bonds may be available in the wider sovereign, supranational and agency sector, it is to the bund that

these buyers will make their first move.

“Sparkassen have put a big por-tion of their portfolios in landes-bank paper and there are massive redemptions ahead in 2015,” says patrick Steeg, landesbank baden-Württemberg’s head of syndicate and MTNs in Stuttgart. “There is a big challenge to replace it in the very near future, and many are already preparing and buying ahead of it, and they tend to buy 0% risk-rated assets.”

It is the very certainty of return — no matter how low — that will drive these buyers into domesti-cally issued paper — and not just that issued by the sovereign but also bonds from the agencies it guaran-tees, such as KfW.

“The alternative big new issu-ers that have been introduced into the market — the EfSf and ESM — have not quite convinced all domes-tic investors, certainly not the more conservative ones in the co-opera-tive bank networks and in the sav-ings bank networks, to give them the

same faith in credit as they would give the federal Republic and its agencies,” says cohrs. “It is spread volatility that is keeping a lot of the more conservative bank treasuries from buying peripheral agencies, despite the potential to make a lot of money if you believe in the future of the euro.”

KfW — agency poster boyKfW has as good a claim as any bor-rower to having had an absolute riot of a crisis. cast in the role of bund surrogate — and therefore paying a spread over the sovereign while car-rying its full and explicit guarantee — it has enjoyed virtually unfettered access across maturities and cur-rencies as investors from across the globe have flocked to buy its bonds.

“KfW worked and still works intensively to have its securities trading as closely to the bund as possible,” says frank czichowski, KfW’s head of financial markets. “We have closed the gap considera-bly but we have always paid a spread over the federal Republic of Germa-ny. It would be the ultimate goal to go flat to the federal Republic, but on the other side the spread of KfW bonds to the bund makes our bonds interesting to investors worldwide.”

but it is not just the buy-side’s appetite for German public sector debt that is keeping prices sky high. as a number of previously top-rated issuers continue to drop down the credit rating ladder, alternative issu-ers simply are not issuing as much paper as they were, forcing investors to find alternatives.

“What is sometimes overlooked in the overall context is that on the other side of that equation, the sup-ply of bonds in our asset class is relatively stable, if not falling,” says czichowski. “Overall issuance of euro member states has fallen as a result of austerity measures — and not by a small amount. and the same is true if you look in the agen-cy sector. The overall supply from the agency sector is down by around 10%.”

Should Germany ever have to, as many commentators and experts claim it eventually must, foot the bill for the European sovereign cri-sis, it appears there will be no short-age of creditors willing to lend it the money to do so. s

“KfW works intensively to

have its securities trading as closely to the

Bund as possible”

Frank Czichowski, KfW

1

1.2

1.4

1.6

1.8

2

2.2

02 Jan 17 Apr 01 Aug 15 Nov 01 Mar

Germany 10 year yield 2012-2013 year to date

Source: Markit

Bank Finance


Germany: export nation, deposit nation, mittelstand nation — eco-nomic bedrock of europe. The coun-try’s strength has endured through-out the financial crisis, leading to an influx of deposits and investments from abroad as customers from the continent’s less stable states seek the solidity offered by a German bank account.

This is great for German lend-ers, of course. But it drives invest-ment bankers crazy. “Look at the Germans,” they say. “Look at their Beamers and their mercs, their nice roads and railways, their swish flats, their modern kitchens with their granite worktops and their Smeg fridges. They’re creaming it. Surely we can get a piece of that?”

They all try, and most fail. a host of investment banks have cut their German coverage teams recently, at the same time as dedicating more manpower to troubled areas like the Iberian peninsula.

Why? Because German banks just don’t need their services. not on a regular basis, anyhow.

Commerzbank’s upcoming capital raising and a smattering of covered bonds aside, the country’s issuers have been noticeably absent from the pages of EuroWeek for the past year or so. Bond issuance has been scant — in the public markets, that is. But behind the scenes, the coun-try is a hive of activity.

“The domestic market in Ger-many is really strong,” says Gerald Podobnik, head of capital solutions at Deutsche Bank. “Only the larg-est banks do capital markets fund-ing because they see a need to be present in the global markets. The majority of the remaining funding comes from local insurance com-panies, local corporates and retail deposits. and a lot of it is done via private placements.”

Private banks like Deutsche Bank

and Commerzbank are still delever-aging after the crisis, and therefore need less funding. Deutsche issued a senior unsecured bond earlier this year, but that was a rare appearance.

The country’s network of Sparkas-sen (public savings banks) bare-ly uses the capital markets, being mostly funded by customer depos-its. Co-operative banks are largely in the same boat. The Sparkassen’s international-facing compatriots, the Landesbanks, do use wholesale funding — but a lot of it is done privately, in small size.

Pfandbrief reliancea portion does make its way on to the public markets, in cov-ered bond format, along with deals from mortgage lenders like Deutsche Hypothekenbank.

alongside that issuer, Deutsche Pfandbriefbank, Berlin Hypo, HSH nordbank, Deutsche Kreditbank and DG Hypo have all brought covered bonds in 2013. Deutsche Pfandbrief-bank also printed a senior trade.

Covered bonds provide extremely cheap financing for German banks. The european debt crisis may have dissipated somewhat follow-ing european Central Bank presi-dent mario Draghi’s pledge to do “whatever it takes” to save the single currency last summer, but flighty investors have continued to chase German assets at any sign of trou-ble in europe’s periphery, grinding spreads tighter and tighter.

The lack of supply exacerbates this tightening, but it also means that German covered bonds have a broad international audience, ready to lap up new deals as soon as they appear.

“The domestic investor base buys Pfandbriefe, but there is glob-al demand as well,” says Podobnik. “People want exposure to German assets — especially if they’re backed

by German real estate, because Ger-man real estate is quite conservative.”

Given the advantages that Pfand-briefe offer of tight pricing, good secondary performance and endur-ing investor demand, it is not sur-prising that issuers that have not traditionally been a part of that mar-ket want a piece of it.

Take Commerzbank, for example,

which has not issued covered bonds before — excluding the Sme loan-backed instrument it printed earlier this year. This year, it is planning a push into the Pfandbrief market, and to split its sub-€10bn funding target into one third senior unse-cured and two thirds covered bonds.

“On the unsecured side we benefit from having a strong deposit base, as well as reduced non-core assets,” says Franz-Josef Kaufmann, head of capital markets funding at Commer-zbank in Frankfurt. “That gives us relief on how much we need to fund in capital markets. and our need for senior will continue to decrease as we print covered bonds.”

Others have established covered bond programmes, which they will continue to rely on heavily in 2013.

Deutsche Pfandbriefbank, for example, needs to raise some €8bn. a quarter of that will be done in senior unsecured — but the bank has already printed a €500m senior benchmark and plans to tap the pri-

Like many others, Germany’s banks made some bad decisions in the lead-up to the credit crisis. But as the country’s economy powers through Europe’s troubles with aplomb, its strong domestic investor base continues to serve the banks well — and international money is there to back them up. Will Caiger-Smith reports.

Domestic bliss — banks bask in core Europe glow

“Our need for senior funding will

decrease as we print covered bonds”

Franz-Josef Kaufmann,

Commerzbank

Bank Finance


vate placement market for the rest. The remaining 75% of the €8bn tar-get will be raised through covered bond issuance.

münchener Hypothekenbank, which doesn’t take deposits, is also looking at a split of three quarters in Pfandbriefe and one quarter senior unsecured.

nordLB, meanwhile, envisages a 50/50 split for 2013. It needs to raise roughly €4bn, in historical terms quite low.

The bank has never issued bench-mark transactions — strong domes-tic demand for its private place-ments gives it more than it needs, at very favourable levels, says Carsten Tegtmeier, the bank’s head of debt capital markets.

Private affairOther banks are more reliant on senior unsecured — but again, the bulk of this issuance never sees the international markets, being mostly completed privately.

LBBW has between €7bn and €9bn of capital markets funding to do in 2013, and is planning to issue two thirds of that in senior unse-cured, with the rest covered bonds. But a lot of that funding will be done through its domestic network, in private deals. It is rare to see LBBW in the benchmark arena.

DZ Bank needs a lot more than LBBW — about €20bn of funding with a maturity of over one year. Like LBBW, it will rely mainly on private placements of senior unse-cured — they will provide around 80% of its funding, with some 15%-20% coming from covered bonds issued out of units such as DG Hypo (which printed a €500m seven year in January).

For the moment, these banks can rely on their strong domestic investor base for this funding, with the added

benefit of international interest in covered bonds. But what happens if the dynamic changes?

“We have seen deposit inflows into German banks,” says Kauf-mann. “When the european cri-sis flares up, some people may argue ‘well if I have my money with a German bank — then I get protected by German legislation’. That obviously moved deposits and funding into Germany. But what will happen to that money looking forward?“There is also a lot of competition

in the retail deposit sector. Foreign banks try to grab deposits via their German entities. They offer attrac-tive levels, and you really need to watch out for that element. all of the institutions have launched some ini-tiatives to generate retail money.”

Deutsche Pfandbriefbank, for example, recently opened up an online retail deposit platform. This is not intended to be a mainstay source of funding, but it does offer some diversification.

However, getting the money in the first place is the easiest bit, says Kaufmann.

“Then you need to ensure that you keep that money,” he explains. “you need to offer further products, and then investors might stay. That is what we are doing.”

another question is what happens when the German banking sector starts to grow again, says Podobnik.

“Will that domestic investor base be there for everyone?” he asks. “also, over the past decade, Ger-man banks have been shrinking. The question, is what happens when they start growing again? This needs to happen at some point, you can’t reduce and deleverage forever. When it does happen, will the domestic investor base be large enough to fill that need?

“This is why sometimes banks continue to issue benchmark capi-tal markets funding even when they don’t need to, because they want to keep their name in front of inves-tors, they want to keep the curve.”

However, that argument doesn’t always fly. according to Kaufmann, there are benefits to staying out of the market when you don’t need the funding — a sort of ‘treat them mean, keep them keen’ for the capi-tal markets.

“you could argue both sides,” he says. “you can argue that you want to be in the market to continue a dialogue with investors, so they stay interested in your name. But you can also say that if you are out of the markets for some time and you eventually decide to return, then they are open to you because you are a rarer name. Investors should be willing to buy paper from the second largest German bank, and they will be quick to open up lines. you can build rarity value.”

SME innovationCommerzbank may also have opened up a new funding platform in the form of Sme-backed covered bonds. Its well-flagged debut trans-action in this format finally hit the market at the start of 2013, to an enthusiastic reception from interna-tional investors looking to get expo-sure to Germany’s strong mittel-stand sector.

For Kaufmann, breaking new ground by launching innovative products like this is all part of the push for funding diversification — and it means that if the dynam-ics of Germany’s domestic investor reliance change, Commerzbank has plenty of options at its disposal.

“even with our limited funding needs, diversification is a big driver of what we do,” he says. “Diversi-fication might motivate us into a public transaction at some point, even if we don’t need the cash, just to get access to different pockets of investors.

“We knew that people were open-minded about the Sme covered bond, and we got a strong bid from outside Germany. around 50% of it was allo-cated to foreign investors, who are very open to German exposure.”

The asset class is still in its infan-cy, and who knows — it might not gain traction. But other banks have asked for Commerzbank’s advice on such deals and it could offer another financing option to many of them.

However, for the moment, it is not a necessity for most lenders. If Ger-many continues on its current eco-nomic trajectory, banks are unlike-ly to be stuck for options when it comes to funding — and interna-tional investment banks looking for a slice of the country’s financial pie will continue to be frustrated. s

“Foreign banks try to grab deposits

via their German entities”

Carsten Tegtmeier, NordLB

52 EuroWeek Germany in the Global Marketplace

Bank Finance Roundtable

EUROWEEK: We’re going to be talking a bit about capital today, and how banks are positioning themselves to comply with Basel III. So let’s start by going around the room. How much capital does your firm need to raise to comply with Basel III and German national capital requirements? Norbert, let’s start with you.

Norbert Dörr, Commerzbank: Considering the announcement on March 13, about Commerzbank’s capital raise to allow final repayment of SoFFin and Allianz Silent Participations, going forward I think we are already quite well positioned towards compliance with Commerzbank’s targeted Basel III fully phased-in common equity tier one ratio. Obviously we need to

Participants in the roundtable were (L to R):

Will Caiger-Smith, moderator, EuroWeek

Andreas Strate, head of financial institutions advisory Germany, Commerzbank

Christian Scharf, director, FIG origination, HSBC

Götz Michl, head of funding, Deutsche Pfandbriefbank

Thomas Kaltwasser, head of group treasury, DZ Bank

Norbert Dörr, director, capital management and planning, Commerzbank

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

Jörg Huber, head of funding and investor relations, LBBW

Ralf Winkelmann, director, financial markets sales and corporate finance, LBBW

Carsten Tegtmeier, head of primary products, NordLB

Rafael Scholz, head of treasury, MünchenerHyp

Frank Scheidig, head of capital markets and international sales, DZ Bank

Broadening funding horizons in a deleveraging market

The German banking system suffered hefty losses in the financial crisis of 2007-2009, and has been shrinking for the past few years. With many banks relying on a strong domestic bid and funding through their retail and savings networks, German issuers are relatively rare in the public benchmark space.

But German bank paper has benefited from the eurozone crisis as investors offload riskier southern European assets and pile into products like Pfandbriefe. Spreads have consistently tightened, not just thanks to this dynamic but also because of the scarcity of new supply.

The country’s economy is one of the strongest in Europe, and savers are still pumping their money into its financial institutions. But new products such as Commerzbank’s SME-backed covered bond and NordLB’s aircraft Pfandbrief are courting a more international audience. EuroWeek met 11 of the country’s top bankers to discuss what the future holds for German lenders.

Germany in the Global Marketplace EuroWeek 53


see the finalisation of CRR/CRD IV, but I think we are well prepared.

Ralf Winkelmann, LBBW: For LBBW, there’s no plan to raise any capital. We comply with Basel III, so we’re fine so far.

Rafael Scholz, MünchenerHyp: I will not mention any figures, but it depends on our new loan commitments. We will raise some capital, but mentioning figures doesn’t makes sense at the moment.

EUROWEEK: Thomas, what about DZ Bank?

Thomas Kaltwasser, DZ Bank: I don’t like to give figures. There is a trend of strengthening core capital. We still have uncertainties about the future acceptance of tier one structures and financial markets might have some problems resulting from these uncertainties. We do have a strong risk weighted asset management approach. We believe banks need to capitalise themselves to a higher level than the official requirements.

Frank Scheidig, DZ Bank: A couple of years ago it was estimated that German banks needed about €60bn. With shrinking balance sheets, and reshaped business models, that is probably now more like €40bn-€50bn.

EUROWEEK: Carsten, what about you, from the NordLB side?

Carsten Tegtmeier, NordLB: We already comply with Basel III. I think what has been mentioned is quite interesting, because balance sheets are shrinking, especially public sector banks, or Landesbanks which have only limited access to the open equity market. They have more or less restructured their equity side.

In the longer term view it will be interesting to see what kind of capitalisation the market or the customers want to see. You can choose to just comply with the minimum rates, but on a longer term view there will be competition and investors will look at the equity of the different banks, and say there are some that are better than others. That’s a big question for the future.

And last but not least, there is the question of whether there might be more stress tests in the future. Most of us were a little bit surprised in 2012 when suddenly the European Banking Authority basically decided that Basel III was already effective by 30th June 2012 for the equity side of the bank.

EUROWEEK: Norbert, perhaps you could just talk us through the timing of the capital raise? Some people in the market have said that it’s come quite soon, before the restructuring programme has really had a chance to properly bear fruit. What’s the thinking behind it — is it partly about preparing for Basel III?

Dörr, Commerzbank: I would like to refer to Commerzbank’s statements along with the announcement of the transaction. The main focus was on further strengthening of the bank’s common equity tier one, by taking out instruments or converting equity instruments that under Basel III, fully loaded, are no longer considered as common equity tier one.

EUROWEEK: How much clarity do the issuers around the table feel that you have around CRD IV, and how confident do you feel about issuing tier one and tier two capital that complies with those new regulations?

Jörg Huber, LBBW: The biggest problem is that even once it is finalised, which will hopefully be soon, the national regulator then has to put it into law, and that will take at least a couple more months. Until that is finalised, you don’t really have absolute certainty around how the documentation has to look in a new transaction. So I guess if banks have time to wait, they will wait until this national law is implemented.

Kaltwasser, DZ Bank: I agree on this, especially for the tier one structures. I think for lower tier two structures it might be a bit different, though. If you believe tier two is going to be grandfathered, you can issue, but it’s not a perfect situation.

Dörr, Commerzbank: Yes, it’s very different for tier two and additional tier one. For tier two, the key question is the famous point of non-viability, and whether CRR requires this to be implemented contractually, or on a statutory basis as part of the EU recovery and resolution directive. It looks like the trialogue will eventually agree on a statutory approach. If that happens, then obviously our well-known subordinated tier two instruments tick all the boxes to be treated as tier two capital under CRR. This is clearly welcomed.

For additional tier one, you have technicalities like permanent or temporary write-down and write-up mechanisms. That is becoming less relevant — the biggest issue in additional tier one is the tax treatment, which is still open for debate.

Andreas Strate, Commerzbank: It is interesting to look at what is happening outside Germany, for

Frank Scheidig,DZ BAnk



example in the Coco market. But Germany hasn’t seen any issues on that side. Because of the different pillars of the German banking system, it’s a bit more difficult to issue equity, or to have instruments that convert to equity. For the public banks it’s a different story, but even there we haven’t seen any issues.

Dörr, Commerzbank: I believe there are two important aspects to look at. Switzerland, obviously, is a country that issued its rules already quite a while ago, with the Swiss Finish. They have clearly defined the purpose of Cocos, and that’s why you have seen Cocos from UBS and Credit Suisse, because they are cheaper than equity.

The UK, even though it is in Europe, has a different approach to Pillar II. They want primary loss absorbing capital (Plac), and so for instance the Barclays Coco had a very specific focus — otherwise the option would have been only to issue shares. Germany so far continues to have a gone concern approach to Pillar II, and you fulfil the capital requirements with subordinated capital in the form of tier two and tier one capital. There is no regulatory need or justification for something like Cocos.

Christian Scharf, HSBC: The requirement to issue contingent capital is something which comes out of Pillar II, and in most of the other jurisdictions in Europe, Pillar II is still an area of regulation that is being finalised. In Pillar I, meanwhile, there is no specific requirement for Cocos.

With regards to structure, no-one mentioned tax deductibilities or the economic efficiency of additional tier one, which is, in my view, very important. Also there is a question as to whether additional tier one constitutes leverage or not. That is the discussion at the moment, because banks are coming out of quite low profitability situations. But in a normalised environment, they’re clearly a leverage instrument.

EUROWEEK: In the general market for subordinated debt, do you think that recent events such as the nationalisation of SNS Reaal in the Netherlands have affected appetite for subordinated debt? Do you think it has perhaps woken people up to the idea that you can actually suffer losses, and that it is called subordinated debt for a reason?

Dörr, Commerzbank: I think the more important event recently is the clarification by regulators in the context of the EU recovery and resolution directive and CRR that they want to respect the capital hierarchy, the capital waterfall. I think that is a very important signal to investors, because then they know the risk inherent in an instrument and they can price a transaction. Nevertheless, the example of SNS Reaal shows that if a bank gets into trouble, regulators and lawmakers can react with unexpected measures.

So what investors will do is go back to the rules, first doing the credit work, and then looking at specific transaction provisions, like write-down mechanisms and distance to trigger. Then they will look at the capital base, among other aspects, and decide whether this is an issuer and instrument they want to invest in. The more clarification we get around CRR and recovery and resolution, the clearer it becomes and the simpler it becomes.

Tegtmeier, NordLB: Conditions in the subordinated market are quite attractive. Interest rates are low, spreads are low and investors are more or less exhausted in terms of coupons and spread. But as Norbert said, it depends on what kind of credit you are. For some names it’s relatively easy, but for many others I think the market is more or less closed. As you say, people are doing more and more credit work on the specific names to find out whether they are willing to accept subordinated debt or not.

Huber, LBBW: It’s true that for the first time, investors are properly discussing bail-in. I thought they were quite scared, a bit like when new ideas for additional tier one instruments came out. Investors all over Europe were saying we can’t invest in that anymore because it doesn’t have a clear kind of payment structure. They have changed their views quite a lot since then, and they now invest in Cocos. But they also do much more credit work now. They’re also very interested in what point of non-viability language will look like in the future.

Kaltwasser, DZ Bank: I think we have a very strange situation, if we compare it with two years ago. A couple of years ago, we had a very coherent waterfall structure — we had equity, we had tier one, we had upper and lower tier two. It was really clear that if a bank or an institution went bankrupt, you knew who was losing what money at what stage. Then we had the first signs of stress, of defaults, and this whole structure was changed. Institutions were bailed out and what happened to investors is not what was predicted to happen. They mixed it up. Now, even if you invest in senior unsecured, you’re talking about bail-ins.We had a clear structure, and it was overruled. And now they’re trying to implement some kind of new structure, and it’s a mess. It was clear, and now it just isn’t.

Strate, Commerzbank: You are absolutely right, although in principle the idea behind it is a good one.

Norbert Dörr,CommerZBAnk



You have capital that works on a going concern basis and a gone concern basis, and if that is actually carried forward, it works pretty well, because everybody knows that if there is trouble in a specific year, you’re going to pay for it. Or you take capital for the worst case, that the institution doesn’t exist anymore, and then you have the bail-in discussion on top of that. If the regulation can be more consistent, it can be pretty clear for everybody.

Kaltwasser, DZ Bank: I think it was. You had the capacity to skip coupons if earnings were down, for example. We had a structure which was clear. It didn’t work out, obviously, but the structure was clear.

Dörr, Commerzbank: The big problem is that if you have a small bank that can go bust, then there is a clear structure, and in that structure, the capital holders would have to bite the bullet and take losses. The real paradigm shift comes with the G-SIFIs and the too-big-to-fail banks in general, that in theory can go bust, but in practice don’t. The main focus of the new regulation is that you don’t want to provide state aid, but have existing investors participating in losses first.

Kaltwasser, DZ Bank: I understand this. But one solution would be to just get lenders to hold, for example, 10% or 15% of lower tier two capital, and then it’s clear again. Then you have a really clear structure. You don’t need anything complicated like bail-in, dictating what happens in a stress scenario. You have clear instruments, you just need to implement them with different ratios.

Dörr, Commerzbank: On that I agree with you. I think the discussions about the varieties of instruments — for example, Cocos that write down at 7% common equity tier one — is too complicated. Keep it less complex and eventually you might end up with a very simple capital structure.

EUROWEEK: Do you think that there’s a danger that regulators are focusing too much on capital, and strangling the supply of credit to the real economy?

Scharf, HSBC: I think senior investors are looking much more at who is below them in a stress scenario. And from that perspective I think regulation is going in the right direction. It’s a little bit confusing, we have the capital instruments, we have common equity tier one, additional tier one, tier two, and then we have, in addition, capital through the crisis management directive. We might get additional requirements for bail-inable debt, which is not part of capital but it serves as a liability which can be written down in a certain crisis situation.

That makes it a little bit confusing, but in the end, all the regulation is going in the right direction. It’s not quite as big a topic for the Landesbanks. But other banks, like specialised banks, private specialised banks in particular, they are already managing their capital to try and reach a certain percentage total.

Götz Michl, Deutsche Pfandbriefbank: I agree with your point. It is widely accepted that banks need to be more stable. That means more capital, and more liquidity. It’s very simple, but it comes at a price. You need to hold more capital, but you also need to have return on equity. So who is going to bear the cost? The next question is who gets a loan and at what margin. Ten years ago, when we were discussing Basel II, one of the concerns was that banks would be forced to hold too much equity, and that this would result in a difficult situation for SMEs in Germany.

Then we saw this true sale initiative for securitisation, which was considered a useful funding tool to provide liquidity to corporates directly.

We are more or less in the same situation again. There is no comparable securitisation market anymore — maybe for good reasons. But banks need even more capital, and the question is what will happen to the supply of loans, and the price of those loans, for the final borrowers.

You cannot have both — you cannot have high equity ratios, high liquidity ratios, and on the other hand a very high supply of loans. Everybody needs to do their calculation — if you have more equity, and you need to produce, say, 10% ROE out of it, the loan margin needs to increase.

Winkelmann, LBBW: I think it’s too early to judge that. And it’s too early to answer whether the capital requirement is fair or unfair. There is no clear model to calculate the right capital requirement for banks going forward, and you will see that while some banks raise capital, most of them are reducing risk weighted assets in order to comply with regulations.

Banks will need a capital buffer, because an economic downturn will eventually come, and then all internal risk models will calculate a different capital requirement. And I think that it’s more a trial and error process at the moment. We will eventually find out what it means for banks giving loans, especially to companies that we see at the low end of the credit curve.

Scharf, HSBC: You’re saying that the model is not yet there. Look at the insurance industry, which has

Götz Michl,DeutsChe PfAnDBriefBAnk



a much more straightforward approach towards how much capital they need, because they’ve been running the same risk models for ages. And in Solvency II, they are actually relying on the loss given default approach. And this is what we’re doing in Pillar II, in the banking industry. Should bank regulation rely more on economic models? Michl, Deutsche Pfandbriefbank: I think the point is the sovereign risk. The regulation is quite nice, with the RWAs and all these things. Then if you look at the risk weighting of the sovereigns, and the favourable treatment of the sovereign bonds in the LCR figures, everyone will need to buy them. Of course you can also buy covered bonds, but sovereign bonds are more favourably treated.

Scheidig, DZ Bank: I think it’s important to note that investors like tier two, they like the fact it has to pay a little bit more than other debt. For the issuers that means they can get the capital they need. But on the other hand we have a shrinking covered bond market. Last year volumes were down 40% in Germany, this year probably another 20%, while elsewhere in the world the covered bond market is expanding.

Scholz, MünchenerHyp: Let me just say something about the idea of shrinking loan supply. Gentlemen, this whole story is more than four years old. Has anything changed? Not at all. Is there a big competition for loans? Of course. We don’t see any increasing margins, because loan supply is shrinking.

Michl, Deutsche Pfandbriefbank: Look at the margins in the commercial real estate market, and compare them with the margins with the past. Five years ago, it was common to have loan to value ratios of 80%-90%, and average margins of approximately 80bp. Now we have LTVs of around 50%, and average margins of more than 2%.

Scholz, MünchenerHyp: Yes, but which types of business are you talking about? Maybe in some specific areas of the US, or the UK — but let’s come back to Hamburg, Munich, Frankfurt. Think about local

clients in the commercial lending business. I don’t see anywhere you can get a senior tranche at 200bp over swaps.

Kaltwasser, DZ Bank: For example, look at residential real estate financing in Germany. We are talking about margins of 30bp-40bp, which is not a sign of a credit crunch. Look at SME business — what I have heard from some colleagues in the markets is that we do not really see a big change in the market with regard to margins.

Winkelmann, LBBW: I think we have to distinguish. If you go down the credit curve, then companies have a real problem getting credit, because if you look at banks’ calculations, the buffer that you need for those credits is very high, and banks are quite reluctant on this asset class.

Kaltwasser, DZ Bank: Let’s put it this way — does everybody need to get credit? I’m talking about private individuals. Do you need the credit, with a loan to value ratio of 110% in real estate financing? You can question it, and say maybe it might be better that this institution or this person is not supplied with credit. That might help avoid some of the mistakes made a couple of years ago in some countries, which resulted in big problems.

Huber, LBBW: We’re not really seeing this credit crunch that everybody is talking about, which might still come, because we have a very low interest rate environment. So even if for credits lower down the curve, when banks need to raise their margins, these companies are able to pay it because it’s still below 5%. Once the interest rate trend turns, and we see higher interest rates, the credit crunch will become more apparent, because they won’t be able to afford it any more.

Scheidig, DZ Bank: But we have to look deeper. You guys just mentioned the commercial real estate side, there’s a big difference between core investments and the more speculative ones. You mentioned the supermarkets here in Germany, or little shopping centres. If you go back to the year 2005, huge funds had been set up, particularly in Ireland and the UK, which bought blindly and invested billions of euros in these assets, particularly in Germany. That was all highly leveraged, at 100% and even above.

And those investments have to be rolled, 2015 and 2017. This is the tension on the horizon, and it’s where we have to pay attention. It’s not currently on the screens, but it will come. And this is around €300bn-€400bn, just in Germany. That scares me a little bit — who will finance that, who will take the leverage?

EUROWEEK: Let’s move on to funding. What are your funding needs for 2013, and how will they be split between senior unsecured, covered bonds, short term paper, and deposits?

Huber, LBBW: For long term funding, we estimate a

Rafael Scholz,münChenerhyP



need of somewhere between €7bn-€9bn. Two thirds in senior format, and one third in covered bond format. A large part of our overall funding is done through our domestic network, but we might still tap the markets for a benchmark transaction.

Franz-Josef Kaufmann, Commerzbank: At Commerzbank we have pretty limited funding needs. Last year we had a target of below €4bn, and for the medium term we expect capital markets funding of below €10bn. The majority should be done in the covered bond format, in which we are new to the market.

The split would be probably around one third in senior unsecured and two thirds in covered. The unsecured side would clearly benefit from the fact that we have a strong asset base, and that we are deleveraging the institution and reducing our non-core assets. All of that gives a relief on the funding side, and as we start to issue more covered bonds, we will reduce the need to raise senior unsecured funding going forward.

Scholz, MünchenerHyp: We didn’t change our business model during the crisis. We are mainly focused on German residential mortgages, and regarding funding needs for this year, it will be around the target we achieved last year, depending on our new loan commitments.

The spread will be similar to last year, so around three quarters in Pfandbriefe and one quarter in senior unsecured. All of the funding is raised through the international capital markets, as we do not take deposits.

Tegtmeier, NordLB: Our funding needs for 2013 are roughly €4bn, which is, in historical terms, relatively low. In terms of products we basically have a 50/50 split. In senior unsecured, we have never issued benchmarks, and we do not plan to do that in the future.

We have a very strong domestic base in private placements, which gives us more than we need, at very favourable levels. But besides that, of course, we are continuing our strategy to issue more alternative assets, like the aircraft Pfandbriefe we sold last year. There

will be another one this year, so these are asset classes which we will use a little bit more in the future to finance the relevant underlying asset business.

Michl, Deutsche Pfandbriefbank: The amount of funding we need really depends on the new business we write. We expect an increase in new business volumes, which would increase our funding needs. We continue to rely mostly on Pfandbriefe, with senior unsecured accounting for around 25%.

We will continue to combine benchmark issues with private placements. After our first successful senior unsecured benchmark it is too early to decide whether or not we will do a second.

We also opened up a retail deposit scheme through an internet platform to expand our funding base. However, this will only complement our existing senior unsecured funding.

Kaltwasser, DZ Bank: We define long term funding as anything longer than one year. We have a need of about €20bn, and out of this we’re going to fund maybe 15%-20%. So €3bn-€4bn, in covered bonds, through the different units we have, such as DG Hypo. The rest is going to be senior unsecured, and we are going to concentrate on private placements.

EUROWEEK: Carsten, you mentioned that private placement levels are very favourable for you. There’s massive international demand in the public market for German bank paper. Does there come a point at which that level of demand is going to push pricing for even public benchmark deals further towards, or even inside, your private placement levels?

Tegtmeier, NordLB: Well, I think we should differentiate between the covered bond market and senior unsecured, because in the unsecured market we can issue at levels that are about half what we would have to pay if we issued a big benchmark deal. So in senior unsecured, it doesn’t make any sense to go to the public market.

The spreads are much narrower between public and private deals in the covered bond market. The

Franz-Josef Kaufmann,CommerZBAnk

Carsten Tegtmeier,norDLB



question is will there be an ongoing compression on spreads in the covered bond market? It’s difficult to say, because for the time being, Pfandbriefe spreads are pretty tight compared to other European countries, so for the moment I don’t see a major chance that spreads will tighten further.

But on the other side, as we have heard, issuance is down and the public sector Pfandbriefe market is dying away, so the question is how strong is demand for German covered bonds, and what kind of supply is available from the issuers? I cannot exclude that spreads might tighten further in the long term, but for the time being, that is obviously not the case.

We have seen a couple of issues in the last few weeks where as soon as you go below flat levels, investors say no, and then they look towards Scandinavian issuers, or French issuers.

Huber, LBBW: It is also a question of timing. Until the end of last year, and even at the beginning of this year, when investors were very risk averse, there was a time when Pfandbriefe could be issued at levels which were very tight, and even through your domestic levels. But once investors have switched into risk-on mode, they have the flexibility of taking on other investments. And on this investment horizon, German Pfandbrief is just too expensive.

Scharf, HSBC: But in terms of international investors, I think people have recognised more and more over the past two or three years that German Pfandbriefe offer quality. The asset class benefited so much from the sovereign crisis — everybody rushed into German paper, and there was a lack of supply, so spreads tightened.

When something negative happens in Spain or Italy, it has an even more positive effect from a German issuer’s perspective. And in currencies like sterling and dollars, there is a lack of supply from those issuers who are just not in the market anymore, for example, UK issuers. So they look at Pfandbriefe much more than before. Also, Scandinavian covered bonds have come very, very close to the issuance terms and conditions of German supply.

Munich Hypo is perhaps an exception, offering

dollars and sterling with a retail pool, which is actually a great story for our German investors.

Scholz, MünchenerHyp: Yes, but we have a huge gap between the levels we pay on euro denominated Pfandbriefe compared to sterling or dollars.

I fully agree with Jörg Huber, on what you mentioned about timing. Yes, timing is a key point. We had several situations last year where the private placement market, which we believe is the tightest market, was actually more expensive for us than a benchmark deal.

We issued four times in benchmark format, and one of those deals was a five year transaction at mid-swaps minus 14bp. So yes, there are these flat areas which look like a floor for pricing, but we have gone below that in the past. However, having seen Stadshypotek’s recent deal, maybe it’s not realistic to price even an excellent credit very tight.

Winkelmann, LBBW: There’s a difference. As long as an issuer can reach the international investor base, like central banks and institutional investors, you can price below private placement levels in benchmark trades. These kinds of investors, they are not dominated by risk-on and risk-off mode. They have a specific investment policy, and they don’t change it very much. But if you don’t reach this kind of investor base, then yes, the timing of your issuance might be more relevant.

EUROWEEK: Can you always rely on the local savings banks in that community of investors to buy Pfandbriefe, or is there a point at which they just stop buying?

Winkelmann, LBBW: Well, we have seen that savings banks are more reluctant to buy Pfandbriefe. They prefer to buy senior unsecured, because they don’t think the risk is that different and they get a little bit of yield pick-up. Yes, they would buy covered bonds, but they prefer senior unsecured.

Strate, Commerzbank: Yes, it’s right. Just look how much volumes have dropped in Pfandbrief euro benchmarks. We have had just €24bn this year so far,

Jörg Huber,LBBW

Andreas Strate,CommerZBAnk



compared to €43bn last year, same period. It’s quite amazing, actually, how much less we have in this market.

On the senior side it’s about €36bn this year so far compared to €49bn last year, again same period. So it’s down as well, but not that much. Because the spread is more interesting, senior unsecured has proven a bit more popular with investors and issuers.

Tegtmeier, NordLB: I think it’s a bit of a fairy tale, that the savings banks will always buy our paper. The truth is that savings banks can buy anything they like. About five years ago, they were more focused on the German Pfandbriefe market, but nowadays they are active across the whole European covered bond space. But if they’re happy with the credit, why shouldn’t they buy senior unsecured if there is a reasonable pick-up between senior unsecured and covered bonds?

Scheidig, DZ Bank: But there’s another point. You obviously allocate a little bit more of your deals to German savings banks instead of foreigners. And given that the market is shrinking, it automatically looks like you favour domestic orders. That is probably not the right message, but obviously you have to be a little bit cautious these days in terms of how you allocate your paper. The syndicates have a very difficult job to do, they have to keep everybody happy.

But it is a given fact that, for example, Münchener Hypothekenbank is an expensive credit so investors will switch into higher paying instruments, if they have similar safety features to that issuer.

Scholz, MünchenerHyp: But that’s good for us, that’s a comfortable situation. So far this year we have issued around €1bn in senior unsecured. Two thirds of that went through the DZ/WGZ network. That’s excellent.

EUROWEEK: Am I correct in thinking that the aircraft Pfandbrief is not CRD compliant? Is that a potential problem?

Tegtmeier, NordLB: Not in the longer term. The question is how big is this market? How many issuers or could come with this kind of a product? The answer is very few. And why the hell is this fantastic asset class only rated single-A, when some far worse asset classes are triple-A?

The reason behind that is very simple. The ratings agencies’ official story is that they need to have a proper model in place to rate the product. My version of the story is that they don’t want to invest money in setting up a model for just one issuer. But this is under negotiation and could change over the next 12 months.

What are the consequences of that? The consequence is that roughly 90% of the bond was bought by typical German Pfandbriefe investors, because they understood that they were buying a covered bond, backed with triple-A underlying assets, at a price which was closer to a single-A instrument.

Scheidig, DZ Bank: We will see other issuers do it, but there are very few who can. If we’re talking about benchmark-sized deals, we will probably only see one

deal per year. That hardly gives you room to build a curve. On the other hand, investors won’t continue to see it as comparable to normal Pfandbriefe, so you will be left with a smaller group of investors. Having said that, it’s not just the Germans looking at it — we know that some huge Anglo-Saxon accounts will want to buy it if it becomes CRD compliant.

EUROWEEK: From one new product to another: let’s talk about Commerzbank’s recent SME covered bond. Franz, do you think the SME covered bond risks cannibalising an issuer’s senior unsecured investor base?

Kaufmann, Commerzbank: No. It’s actually had a positive impact on our senior unsecured curve. There is the question of how much you might take out of the market in terms of volume, but we have tried to position the product in between senior unsecured and Pfandbriefe, give or take a few basis points.

EUROWEEK: What effect do you think these kinds have on the market if you’re labeling them as covered bonds?

Scharf, HSBC: We have several different established jurisdictions which now have covered bond laws, and in each one you’re looking at very different legislative frameworks. So I don’t see why we shouldn’t come up with something new.

Scheidig, DZ Bank: The question is which investor base do you want to target? If you want domestic investors, you would want to sell it as a Pfandbrief, but obviously that wouldn’t be allowed as the law is crystal clear.

On the other hand, given the variety of covered bond laws in the world, you can easily come up with a product that is basically a covered bond in all but name. It’s a product for international investors, and I believe Commerzbank will be not the only one; it will soon be followed by names like IKB and others.

Huber, LBBW: Investors nowadays do much more research, much more due diligence on new products

Christian Scharf,hsBC



in the covered bond space. This is one of the first products without a traditional covered bond asset base. It will be more complicated in the future when lots of different types of covered bonds are invented, but covered bonds are not a protected brand like Pfandbriefe. It’s basically just a certain type of asset-backed bond.

Investors ask for more premium for new products like this, because they need to do much more work to really analyse the risks.

Kaufmann, Commerzbank: Yes, since the crisis investors have learnt that they need to look into the product. More and more, they’re looking into the underlying assets, the business model behind it, to reach their own conclusions. That’s what the investors we spoke to did when we approached them. If you’re going to move away from traditional assets, you need to make sure that you get quality assets in place that investors understand and are willing to buy into.

Scharf, HSBC: When we were on the road meeting US investors for the NordLB covered, we were talking to buyers who traditionally looked at senior unsecured. They were very concerned about asset encumbrance and how leveraged their investment would be. This is a typical question when you are looking at a new issue, but it comes down to looking at the individual product, the individual issuer, and you’re there.

Tegtmeier, NordLB: Investors know what they have been buying. The only difference is that if they buy a typical Pfandbriefe style instrument, they know there is a legal background in terms of what collateral is accepted and the legal procedures.

If I were an investor, I would say the SME deal is basically Commerzbank senior unsecured debt. In the worst case scenario, if Commerzbank goes bust, you have access to the underlying asset, which is an SME. The only difference between that and Pfandbriefe is that one is governed by a rigid set of laws and the other is governed by the individual contract of the deal.

I think that’s fine, and the pricing was exactly where it should have been. Commerzbank is just taking advantage of strong demand for German SMEs in a new format.

EUROWEEK: On that topic of knowing exactly what you’re buying as an investor, let’s talk briefly about transparency. In terms of transparency standards between the VDP and the ECBC’s label initiative, which do you think is better?

Tegtmeier, NordLB: Very early on, we decided to accept the ECBC’s labeling system. On one side, the more conservative guys say Pfandbriefe is the toughest label in the world. That’s correct. But in the longer term, if more and more covered bond legislation frameworks accept the ECBC label, then you cannot stand alone with your Pfandbriefe, even if you believe that is the best label in the world. Also, in terms of costs, it is relatively cheap.

Kaufmann, Commerzbank: As a Pfandbriefe community, we developed a section in our legislation that deals with transparency and it has evolved over time. Obviously, that might not meet all the criteria investors want, especially as the market grows.But I still believe that we provide a very high degree of information to the community with the advantage that you get a comparable template to compare to other markets.

Clearly, there are some aspects that might be improved. You might not meet all the needs of every single investor, and you might not meet each aspect of transparency required in each jurisdiction.

Strate, Commerzbank: One of the things we learnt from the crisis is that you have to look into the specific underlyings of each instrument. You don’t buy it just because there’s a label on it. However, it is a good thing that we have these two labels because it means there can be a level of competition between them.

Huber, LBBW: One of the reasons we created the label was that a couple of years ago, the ECBC tried to define a set of rules for covered bonds, but as it is not a protected name it was quite difficult, and in the end what came out was very weak.

We thought that investors who were familiar with the product should be able to agree on a set of minimum standards to create a label of quality for covered bonds.

Scholz, MünchenerHyp: I don’t like the discussion about the VDP label. There is no VDP label — it’s the law. It’s existed for about eight years now and I don’t believe that comparing it to the ECBC label is fair. We should look at both of them, and we should have regular discussions with investors, which the VDP does. We are always thinking about improving that law — not label — and I think we’re on the right track.

Winkelmann, LBBW: In general I think having a law, or having a label, simply makes investor work easier. There are so many investors with scarce resources for credit analysis. If you have a label or a law that you can analyse, that gives you greater flexibility with regard to your investment portfolio. If you have single deals

Ralf Winkelmann,LBBW



that are hard to understand, with 100-200 pages of documentation, then maybe some of those investors will step aside because they simply don’t have the resources to analyse it.

EUROWEEK: Let’s move onto some broader regulatory topics. Plans to ring-fence investment banks from retail institutions in Germany are quite a lot more lenient than they have been in the UK, for example. Do you think that this will benefit German banks in the international arena?

Kaltwasser, DZ Bank: On the one hand, I think it is a very good idea to save the savings of individuals. But just look back at the banks that have had problems in the past. Were these banks active in all the markets or were they more specialised? Look at IKB in Dusseldorf. Look at Lehman Brothers. Look at Northern Rock. These are all institutions which had problems. But would a ring-fenced structure have avoided all these problems?

Dörr, Commerzbank: There is a lot of political pressure to do something quickly and that’s what drives all these various initiatives. I say let’s cross the bridge when we come to it. You asked what is the practical use of ring-fencing, looking at the bankruptcies or the problems in the past. There are also some practical issues with ring-fencing, especially in Germany.

For example, how is a bank supposed to put a trading operation into a separate legal entity? You have to transfer an entire balance sheet. You are within the German Umwandlungsgesetz (reorganisation act), which has legal implications, like five-year Nachhaftung (run-off ). You might end up with mismatches on capital and on funding — there are a lot of practical and legal issues remaining that would have to be addressed in such a situation.

Huber, LBBW: And for the government, what about market-making? Of course, market-making for Government bonds is not proprietary trading. But if you do that for clients which are not real economy clients then it belongs to the trading setup, so in the end it will mean market-making for Government

bonds will become more expensive, and consequently, issuance will become more expensive for the government.

EUROWEEK: What is the impact of the single supervisory mechanism on German banks? Do you think it could put any of the larger players, for example, at a disadvantage compared to the smaller banks?

Scharf, HSBC: There is a massive number of smaller German banks who do domestic business, so they will stay in deposit insurance schemes under German regulation. When it comes to the international deposit insurance scheme, it’s difficult to assess the impact, because we don’t yet know how that is going to work.

It has to be installed into the market, and it has to build a reputation. That will take some time. I think the idea of the single deposit insurance scheme is essentially of the same quality as the deposit insurance schemes that already protect depositors in individual jurisdictions.

Dörr, Commerzbank: I would raise an issue with the practical implementation of banking union. If you look at all the major political discussion items in the CRR and CRD IV trialogue, they are all around the home-host issue. And now you put a third element into it, which is a pan-European regulator. What will be the main objective of this regulator? It will aim to prevent a situation where a bank goes into recovery and resolution in the first place, so it will raise Pillar II requirements. Further, as soon as a bank goes into a recovery and resolution scenario, you’re getting into insolvency law which is a national matter. There are in my opinion many procedural aspects remaining.

Scheidig, DZ Bank: It is definitely very difficult for Germany. The majority of banks will not be governed by the European regulator. All the small co-operative banks and savings banks, most of them will still be regulated by the domestic regulator, the BaFin. So it’s hard to make a uniform set of rules for all of them, from the bigger banks to the smaller ones. The question is, how fair is that? s

Will Caiger-Smith,euroWeek

Thomas Kaltwasser,DZ BAnk

SecuritiSation


Whether by accident or design, Germany has developed a settled sense of how and why secu-ritisation should be embraced. its vast auto finance industry uses abS to refinance car loan and lease books, and its banks have for more than a decade understood the capital benefit that can be gained through synthetic securitisations, typically of SMe loan portfolios.

the odd deal, such as a recent equipment abS, will break this mould, but by and large the mar-ket is unlikely to venture beyond these two asset classes. the residen-tial mortgage market is efficiently and cheaply refinanced through cov-ered bonds. and German credit cards are not conducive to credit card abS, though many investors would be very happy to take exposure to this asset class.

“abS is part of a much broader toolkit for banks for funding and capi-tal,” says Markus reule, co-head of Fi secured debt at rbS in London. “his-torically the performance of the pro-grammes is strong, and investors look-ing for exposure like the economic indicators. anything with granularity is well received.”

Stefan Ziese, managing director and head of dcM bonds/conduit finance at commerzbank in Frankfurt, reck-ons the make-up of the German secu-ritisation market is unlikely to change soon. “Unless something really radi-cal happens in the banking landscape here, i don’t think this general struc-ture of auto abS and SMe loan secu-ritisations will vary.”

German auto ABS at the top the mainstay of the German securiti-sation market is the auto sector. cap-tive and non-captive loan and lease providers have historically refinanced those loans through a mixture of con-duit financing and term securitisa-tions in the public market.

the strength of the German econ-omy and the quality and granular-ity of the collateral, combined with simple, investor-friendly structures, has helped drive auto abS spreads to very tight levels, making it an attrac-tive source of funding for regular issu-ers and those that hit the market more sporadically.

Sitting at the top of the top tier of German auto abS issuers is Volkswa-gen. the German car market leader issues from VcL, a lease securitisation programme, and driver, its loan secu-ritisation shelf. the latest deals issued from the programmes earlier this year were both priced at 25bp over one month euribor, making them the joint tightest auto deals priced in europe since the crisis.

also in the top tier of captive auto abS issuers in Germany are Ford credit europe bank, which issues using its Globaldrive platform, and bMW, which issues from bavarian Sky.

Whether large or small, all car lease providers are bound by section 108 of the German insolvency code, which requires refinancing of leases within three to four months of origination in order to get a clean, true sale opinion. the law is designed to prevent the risk of clawback in the case of the issuing company’s insolvency.

Most companies cannot therefore afford to wait for leases to accumu-late on their own balance sheet before securitising leases for a deal in the

public market. Many larger companies have warehousing arrangements with banks, whereby the leases are sold on a monthly basis into separate SPVs from which, they can be refinanced directly by banks or conduits.

“if you look at the balance sheet of corporates’ finance captives, there will typically be a fair amount of conduit financing going into the company,” says Lynn Maxwell, managing direc-tor, structured finance at hSbc in London.

VW stands out among its peers because of the size of its leasing book, which is the largest in Germany by some margin. it has a VcL master trust, into which it transfers new leas-es every month. rather than automat-ically refinancing through conduits, the VcL master trust also issues asset-backed notes directly out of the SPV to investors.

“VW wanted something that would reach a wider investor base than just bank conduits,” says Maxwell. “it’s useful to tap into a wider investor base in case conduits disappear or pricing dynamics change over time. depend-ing on which market offers the best pricing, this type of structure allows the best of both worlds.”

Some european banks have ended their conduit financing programmes in the last couple of years and more could follow as the basel committee puts forward new risk weightings for abS, according to Maxwell. “the cur-rent proposed risk weightings on abS positions on bank balance sheets will bring into question whether the con-duit business is efficient anymore.”

German bank conduits are used to refinance an array of assets, including leases and trade finance receivables. if banks begin to reduce their con-duit businesses further, some of those assets may instead be turned towards the public securitisation markets.

this year saw the first publicly syn-dicated sale of a european equip-

German securitisation might be small but it is perfectly formed. Limited to just a couple of asset classes, Germany’s auto and SME ABS are among the most popular and innovative products available. However, as Joe McDevitt reports, new capital regulations and an expansionary covered bond might be about to make life a whole lot of tougher.

Compact ABS market in danger of shrinking even further

“Historically the performance of

ABS is strong, and investors looking for

exposure like the economic indicators”

Markus Reule, Royal Bank of

Scotland

SecuritiSation


ment abS, Société Générale’s red & black Germany 1. the deal was backed by loans to German SMes to pur-chase trucks and other large, move-able machinery. the asset class is well established in the US, where compa-nies such as Volvo and General elec-tric issue regular deals.

Maxwell says: “i see this as an inter-esting trend. as banks become sensi-tive around rWas and their own inter-nal costs of liquidity, the term market should be a better place for execution and over time we should see more conduit transactions coming into the public market for assets we haven’t seen before.”

For european auto abS investors, the transition into equipment should be straightforward. “the market already understands residual value and operating leases, and with all that knowledge there is no reason why equipment deals shouldn’t happen.”

Synthetic SME ABS German banks are among europe’s few practitioners of synthetic securiti-sations for regulatory capital relief. it is a trait that is left over from the years leading up to the 2008 financial crisis, when banks would frequently tranche and transfer the risk on large portfoli-os of SMe loans, enabling them to fur-ther increase their SMe lending.

the prospect of more lending to German SMes won the support of the German state, and KfW in 2000 cre-ated the Promise programme, which became the fulcrum of SMe financing by securitisation. it also started the

Provide programme, which trans-ferred risk on residential mortgage portfolios.

Promise works by KfW assuming the risk on a portfolio from a bank by providing compensation on cer-tain losses. KfW then tranches the risk it has just assumed in an SPV and issues credit-linked notes in the public market as its own hedge on that risk.

“We had a phase before the cri-sis started when there were a lot of Promise transactions — that was a programme that worked well and cre-ated a brand name for German SMes,” says Ziese at commerzbank.

“basel capital rules have created a lot of uncertainty as to where the mar-ket will go. Whether an abS trans-action backed by SMe loans makes sense for the originating bank will also depend on how the final capital rules turn out,” says Ziese.

Some German banks have arranged their own synthetic SMe securitisa-tions to provide some capital relief. commerzbank, for instance, uses its coSMO (commerzbank Small and Medium Obligations) programme. the last deal was priced in January 2012 and sold €160m of equity risk to investors.

Similarly, norddeutsche Landes-bank transferred the second loss risk on a portfolio of infrastructure loans in a deal called blue rock, which was priced in august last year. hin-rich holm, nordLb managing board member with responsibility for the bank’s capital markets business, said

in a statement at the time: “On the one hand we have created an innova-tive investment alternative for institu-tional investors, which, on the other, allows us to reduce our risk-weight-ed assets at the same time, thus free-ing up capital for the granting of new loans.”

Since the introduction of new capi-tal requirements in basel iii, there have only been two Promise transac-tions — one in 2008 and the other in 2012 — and the latter of those was not structured to transfer risk. Promise neo 2012 provided a KfW guarantee for a portfolio of hSh nordbank SMe loans. rather than issuing the credit-linked notes to third parties, hSh nor-dbank bought them back from KfW, removing the capital relief.

the KfW wrap did, however, allow hSh nordbank to put the loans into its public sector covered bond pool. Ordinarily, SMe loans are not allowed to back public sector Pfand-briefe unless they have a state guar-antee. hSh nordbank issued a three year public sector Pfandbriefe in early March, made possible by the added SMe collateral, and many covered bond bankers said at the time that other German banks could follow suit.

in which case, KfW’s Promise pro-gramme would continue to play an important, albeit different, role. Whereas the emphasis was previ-ously on capital, this has now shifted towards funding through covered bonds.

commerzbank’s structured SMe covered bond, issued in February, offers another way of refinancing SMe loans. Some covered bond aficionados felt it should not have been called a covered bond, but the deal still repre-sents a market innovation that brings covered bonds and securitisation clos-er together, and perhaps renders any need for straight SMe abS funding even less necessary. s

0

10

20

30

40

50

60

70

2004

Source: DZ Bank

Total German ABS supply (retained and placed) since 2004

2005 2006 2007 2008 2009 2010 2011 2012

€bn

Total German ABS supply (retained and placed) since 2004

Source: DZ Bank

“Basel capital rules have created a lot of uncertainty as

to where the market will go”

Stefan Ziese, Commerzbank

Blue-Chip Companies


Since the 2008 financial crisis, cor-porate borrowers have settled into the role of the safe havens of the capi-tal markets, with German blue-chips firmly established as the safest pros-pects within that community.

“All investors are looking for corpo-rate assets,” says christoph Zender, head of corporate debt origination at LBBW in Stuttgart. “Many of them have shifted their investment focus from financials or sovereigns into cor-porates, and for them it’s a safe haven. And core european companies, espe-cially German names, have very good sentiment from investors.”

German corporate borrowers pro-vide cautious buyers with a safe, secure investment prospect for their capital, tucked soundly away from the wider volatility that abounds in the european FiG and SSA markets. they have further benefitted from being rare visitors to the european bond markets, emphasising their desirabil-ity to international buyers.

“corporates have remained the sec-tor of choice for the broader investor community, during periods of mar-ket volatility,” says James cunniffe, director of corporate debt syndicate at hSBc in London. “Within the corpo-rate sector itself, the German borrow-ers have remained the most stable and the most sought after.”

Borrowers have shifted their fund-ing strategy to take advantage of their status as the darlings of the capital markets. in 2009, a year after the cri-sis hit, when investors were looking for alternative markets to stow their money into away from the banks and borrowers were looking for alterna-tives to the faltering loan market, Ger-man investment grade bond issu-ance peaked at $186.636bn, the largest annual figure ever recorded.

While corporate bond issuance has yet to hit the same heights as 2009, 2012 saw German blue-chip issuance reach an impressive $140.118bn. Also

impressive was the range of markets tapped by the German blue-chip borrowers — in 2009, $169.142bn (91%) of issuance was done in the euro market, while in 2012 this had fallen to $94.566bn (68%).

Although demand in the eurobond market is deep enough to support more or less all the issuance requirements of German blue-chips, issuers believe the ability to finance in different currencies is crucial.

“Many of these companies are truly global franchises,” says Roland Boehm, global head of DcM loans at commerzbank in Frankfurt. “they have boots on the ground in many countries. they have many years of experience and this isn’t just about opportunistic financing in other cur-rencies, but rather matching the denomination of their financing with their business needs.”

Holistic approach to financingMaintaining access to a variety of cur-rencies allows German corporate bor-rowers to be more holistic in their approach to financing.

“it’s about where the demand is,” says Joachim heppe, deputy head of DcM bonds and head of syndicate at commerzbank in Frankfurt. “the Aussie dollar market has provided a good play for yields, and so some bor-rowers have issued there. it’s just a question of the big treasurers follow-ing the market to see where demand is. in their view, the more diverse their financing is the better.”

By nurturing investors in various currencies around the world, Ger-man borrowers are able to develop the range of financing products in their tool box and maximise the optionality of their funding strategies. this also in turn reassures investors that no mat-ter how volatile certain markets may be, German blue-chips will be able to continue to access financing from at least one pool of liquidity somewhere

in the world. As corporates develop their profile in alternative markets, it also means that buyers are able to sat-isfy their craving for european paper without exposing themselves directly to sovereign risk that exists in the FiG or SSA markets.

“the German blue-chips have prof-ited especially in times of uncertain-ty, when US as well as Asian inves-tors didn’t want to get into european financial or state-connected credit deals,” says heppe at commerzbank. “then the global household names are the classic diversification play.”

Although German blue-chips are, on the whole lightly levered, cash-rich and spoilt for choice as far as euro bonds are concerned, they have sought out new funding sources. early in August 2011, German power com-pany RWe announced its plan to issue hybrid capital bonds to shore up its capital structure and support its rat-ing. the firm completed its €2bn plan after tapping the Swiss franc, dollar and sterling markets last year.

By issuing through a wider range of currencies and products, and by developing relationships with inves-tors across the world, German bor-rowers are creating a menu of fund-ing sources they can rely upon at a later date. Perhaps German borrow-ers know the importance of this more than any other issuer class in europe, as these are the issuers that have expe-rienced the benefit of having a stable

German blue-chip companies enjoy some of the most attractive borrowing terms available in the capital markets. But while luxuriating in global investor demand, their core strength comes from their domestic market, where investors that have supported them through past crises can be relied upon in times of volatility. Nina Flitman reports.

Stable, safe and well-spread: blue-chips revel as safe haven

“The banks that are part of the syndicate

for large German companies are as

international as they’ve always been”

Roland Boehm, Commerzbank

Blue-Chip Companies


funding source to rely upon when vol-atility hits.

in 2008, as the european corpo-rate bond market closed in the wake of the credit crisis, German corporate blue-chips revelled in their ability to fall back on the domestic Schuld-schein market. BMW completed a €1.35bn five year transaction in April 2008, while a month later engineering firm Siemens raised €1.1bn in a four tranche Schuldschein.

Such large deals have not been seen since. Borrowers would have to pay more to issue in Schuldscheine rather than in the corporate bond market, so the sector has returned to providing small amounts of funding to compa-nies looking to take their first steps in the capital markets. however, this niche financing product remains a German stalwart that domestic bor-rowers, no matter how large, know that they can rely upon when all other funding avenues are closed.

“they can always come to the Schuldschein market,” says Bettina Streiter, head of corporate origina-tion and senior vice president of debt capital markets at DZ Bank in Frank-furt. “it’s just a question of pricing compared to other markets, such as the bond markets. Many blue-chips tapped the Schuldschein market in 2008-09 with very large transactions, but at that time the bond market was closed. Once it re-opened, the rele-vance of the Schuldschein market for multinationals faded away slightly, but still some of the large caps come to tap it on an opportunistic basis.”

Although the proven capacity of the Schuldschein market provides some

comfort for German blue-chip bor-rowers as volatility continues to roll on in europe, for the moment they are enjoying their status as the darlings of the european bond markets — push-ing the limits of maturity, size and pricing. in February, Siemens (Aa3/A+) raised €2.25bn in a single day — €1.25bn of eight year paper priced at 35bp over mid-swaps and €1bn of 15 year paper at 70bp over. in the same week, auto firm Daimler (A3/A-/A-) completed €1bn of 3.3 year bonds at 37bp over and €500m of 10 year paper at €72bp over. this was Daimler’s sec-ond foray into the longer end of the bond market, having priced a €750m 10 year issue at 77bp over mid-swaps in September last year.

“in former times it would have been unbelievable for Daimler to have come with a 10 year deal, but now they have the advantage of low interest rates and moderate spreads,” says Zender at LBBW. “We saw Daimler issuing its 10 year paper with a coupon of just 2.375%, which is very tight.”

Unusually longWhile 10 years is an unusually long maturity for car makers, Daimler had followed the example of fellow auto Volkswagen, which had at the end of August had sold €1bn of 10 year paper through A3/A- rated Volkswagen Leas-ing. this transaction raised a book of €2.3bn, with around 35% of the demand coming from domestic inves-tors. Around 31% was sold into France, 12% to the UK, 5% to Switzerland, 5% to Asia and 4% to Benelux.

According to cunniffe at hSBc, this breakdown is typical of the demand

for German blue-chips names.“they benefit from not only a stable

domestic sponsorship, but they also have pan-european and Asian sup-port,” he says. “there is an important retail element to some of the deals, and investor interest is boosted by domestic support, but they’re not reli-ant on it. it’s a healthy platform to build on.”

Similarly, in the syndicated loan market, while German blue-chip cor-porate borrowers have a large amount of domestic support to rely upon, their syndicates are made up of a great vari-ety of lenders from around the world.

“For blue-chips, you see clearly that the domestic market plays a role, but it shouldn’t be over-estimated for German corporates,” says commer-zbank’s Boehm. “the banks that are part of the syndicate for large Ger-man companies are as internation-al as they’ve always been. Borrowers are concerned about getting the mix right and not just looking to include the domestic angle. it’s great that it’s there, certainly, but blue-chips think beyond that. they look to include the banks that they need rather than the ones that are available.”

certainly, most German blue-chips have the luxury of choice. Last year, Siemens launched a €4bn five year revolving credit facility in one of the most volatile market windows ever exploited. Yet even as the eurozone was being rocked by the sovereign crisis, the engineering firm set one of the tightest pricing benchmarks of the year — 30bp over euribor — and attracted orders of more than €7.5bn from lenders around the world.

But as Streiter at DZ bank notes, such success should come as no sur-prise to German blue-chip borrowers, who have spent years cementing their positions as the strongest issuers, cor-porate or otherwise, within the euro-pean capital markets.

“corporates themselves have proved to be the asset class that can survive a crisis, that has a cautious funding profile and that has been able to build up adequate liquidity,” she says. “currently, corporate bonds tend to be less volatility than other bond asset classes, and investors appreci-ate that. investor trust in the corpo-rate asset class, especially in German borrowers, has increased over time, underpinned by a strong domestic economy.” s

German investment grade bond volume by currency

Source: Dealogic

0

20

40

60

80

100

120

140

160

180$bn

2008 2009 2010 2011 2012 2013 YTD

$ Other

German IG DCM volume by currency

Source: Dealogic

LEVERAGED FINANCE AND HIGH YIELD BONDS


The German leveraged finance market is, more than others, a bifur-cated one. as in other european countries, Germany has large lever-aged buy-outs and smaller, mid-cap transactions. The financing for the two kinds of deal is quite different — for reasons that tie in with Germany’s long-established economic and bank-ing structure.

While bank lending is generally held to be retreating across europe, Germany still enjoys plenty of it, especially for small and medium-sized LBOs.

“The very large transactions are international deals and they are mostly done in London and maybe new York,” says Steffen althaus, senior director and head of lever-aged finance at nordLB in hannover. “Smaller and medium-sized transac-tions are usually done in Germany.”

Deal sizes in the €500m area can still be financed domestically, he says, mainly because of Germany’s large array of willing bank lenders.

Germany’s numerous banks, from the commercial banking, credit co-operative and Landesbank sectors, are eager to compete with each other, before institutional investors are even brought to the table. many mid-cap LBO financings are done without any institutional investors.

“These deals are usually syndicat-ed, and as a [private equity] spon-sor wanting to finance a transaction, depending on size, you have around five to 10 banks you can talk to, which are all credible players and would be happy to get involved on the arrang-ing side,” says Frank Schehl, head of acquisition and leveraged finance at DZ Bank in Frankfurt. “The market is very competitive.”

Mid-cap advantageFinancing can be very relationship-driven, he adds, which means that paradoxically, German mid-cap loans

often pay lower margins than inter-nationally syndicated loans for larger borrowers.

“People from outside Germany sometimes wonder how it is possi-ble that a €150m transaction is priced 25bp-50bp lower than a Douglas, for example,” says Schehl. “To a cer-tain extent that’s counter-intui-tive, because most people perceive the risk on a large cap transaction as being lower than on a mid-cap transaction. You would expect the pricing for a mid-cap transaction to include a risk premium.”

Douglas, the German perfume and cosmetics retailer, was one of 2012’s internationally syndicat-ed LBO loans, after advent Inter-national bought the business for €1.5bn.

BayernLB, Commerzbank, Credit Suisse, Goldman Sachs, IKB, JP mor-gan, LBBW, raiffeisen Bank Inter-national and UniCredit were book-runners on the senior loans, which though internationally distributed, still saw German banks take huge tickets — some, like nordLB, in the context of relationship banking.

“We were one of the first lenders to commit to the Douglas loan,” says nordLB’s althaus. “We signed at the same time as the underwriting group, even though we were not part of it. German investors know the company very well and so did the sponsor.”

Douglas’s debt package included a €450m institutional tranche in the form of a seven year term loan ‘B’ priced at 550bp over euribor, as well as a €200m term loan ‘a’ and a €180m revolving credit facility with six year tenors, both paying 500bp. There was also €200m of mezzanine financing.

Larger transactions like this can also call on the high yield bond mar-ket, where German issuers have been the second largest group in europe, after those of the UK, supplying 15% of the deals in the past five years.

Last year, however, there were no German high yield financings for LBOs. The high yield market was vol-atile at times — though strong in the second half of the year — but a bigger factor was the lack of new LBOs.

Some deals took alternative financ-

ing routes, including mezzanine. BSn medical, for example, the medical dressings maker founded by Beiers-dorf of hamburg and the UK’s Smith & nephew in 2001, went this way when eQT, the Swedish private equity group, bought it last year. eQT raised €740m of senior loans and €391.5m of mezzanine debt. “The advantage of the mezzanine is that there was higher certainty of financing and we exactly knew the cost of it because there is no flex, there is just the pric-ing,” says Patrick de muynck, a part-ner at eQT in Stockholm.

High yield leadershipStill, the general shift from loans to bonds is also taking place in Ger-many, says Jo heppe, head of debt capital markets bonds at Commer-zbank in Frankfurt. In 2012, 39% of europe’s €38bn of LBO debt came in the form of bonds, according to Com-merzbank, compared with 29% of the €47bn market in 2011.

“The outlook for the high yield bond market is pretty positive,” says heppe. “That’s simply due to the banks’ capi-tal regulations and one has to see how

German banks are making life sweet for German speculative-grade companies. The competitive domestic lending market allows many issuers to achieve attractive pricing without needing the institutional loan or high yield bond markets. But even for larger, more international deals, pricing for German issuers is very fine, supported by a strong domestic bid, writes Stefanie Linhardt.

Banks retreat from lending? Not in German leveraged finance

“The outlook is very positive, as vendors

are realising that valuations are at

the higher end and financing is certainly

not an issue”

Thorsten Gladiator, Commerzbank

LEVERAGED FINANCE AND HIGH YIELD BONDS


this affects the banks’ appetite to lend. Chances are that the bond market gets a further push, as for corporates it also makes a lot of sense to diversify their investor bases.”

away from fresh LBOs, plenty of German companies entered the high yield market for the first time in 2012 — both conventional companies and private equity-owned businesses.

Standing out among them was Schaeffler, the family-owned ball bearing maker that decided to com-pletely remake its capital structure, after its acquisition of a more than 90% stake in tyre maker Continen-tal in 2008 left it with heavy debts. In 2012, the company sold €8bn of loans and €2bn-equivalent of bonds. It has already become a popular credit with speculative grade investors.

Sponsor-owned companies like Techem, the German provider of energy billing and energy manage-ment services owned by macquarie Infrastructure Fund II, also sold its first high yield bond in September 2012. The €735m of notes were priced tightly at 6.125% and 7.875% coupons, with a 10 times oversubscribed book.

“Investors take a lot of comfort in the solid bid behind many Ger-man issuers in the bond market,” says Douglas Clarisse, managing direc-tor at hSBC’s high yield capital mar-kets team in London. “The German Landesbanken are active buyers of bonds and distribute them through their private banking networks, espe-cially bonds with lower denomina-tions.”

This reliable domestic investor bid, with a distinct retail tinge, is a clear competitive advantage for German companies.

“Obviously the credit needs to be solid,” says Clarisse. “But if it’s a Ger-man credit with good name recog-nition, domestic accounts can help push the yield significantly tighter than for equivalent issuers in other european jurisdictions.”

hornbach, the home improvement retailer rated Ba2/BB+, sold a €250m seven year unsecured bond in Febru-ary at a yield of just 4%, thanks to a €1bn book from 200 investors. German and austrian investors bought 55% of the bonds and Swiss buyers 24%.

This loyal following is one reason why Germany’s high yield market is so diverse.

“The nature of German high yield

issuers is more fragmented than in the rest of europe,” says heppe at Commerzbank. “While there are the typical, fully high yield-documented transactions, Germany also brings a lot of cross-over names, both rated and unrated, to the market.”

ThyssenKrupp, the steel and engi-neering group that is one of Germa-ny’s best known industrial names, raised €1.6bn in two bond transac-tions in February and march this year.

now rated Ba1/BB/BB-, ThyssenK-rupp still issues with pure investment grade covenants — to the annoyance of some high yield fund managers, but underlining the reality: there are plenty of investors to buy its debt without high yield covenants.

LBO pipeline fillsFor true leveraged finance, bank-ers and investors expect activity to accelerate in 2013. Compared with last year, bankers are working on far more pitches to private equity funds, bidding for primary, second-ary and tertiary buy-outs.

“The outlook is very positive, as vendors are realising that valuations are at the higher end and financing is certainly not an issue,” says Thor-sten Gladiator, head of leveraged finance origination at Commerzbank in Frankfurt. “There is demand from the european loan market, US inves-tors coming to europe as well as high yield investors.”

One of the companies likely to bring a large transaction is Ista, the metering business. Charterhouse and CVC want to sell it for some €3bn in cash — an amount which will prob-ably require assistance from the bond market.

“Ista certainly would be a deal in the multi-billion range if it were to come,” says Gladiator.

Bahrain-based Investcorp is auc-tioning armacell, the insulation firm, while 3i and allianz Capital Partners plan to sell Scandlines, the German-Danish ferry operator.

Still, some market participants are worried that 2013’s German LBO pipe-line is showing signs of getting very competitive and highly leveraged.

“The quality of assets in some upcoming auctions is not too great and banks are considering putting higher leverage on the deals,” says one senior leveraged finance banker.

“For one transaction, senior lever-age levels of 4.5 times are being put forward, at a 450bp margin — that’s quite challenging.”

more challenges for loan inves-tors come from the increasing flow of repricings — where companies return to the market seeking to cut the mar-gins they have obtained on existing loans.

Bankers suggest that every per-forming borrower could be a potential candidate for a repricing, including several German names.

New funding sourcesFor the top credits, the Schuldschein or promissory note is another financ-ing option. heidelbergCement, for example, used it in late 2011. rated

Ba1/-/BB+, the building materials group hopes in due course to gain investment grade ratings.

Like other Schuldschein issuers, larger and smaller, heidelbergCement found the product a handy alternative to loan or bond finance. however, it has so far only been used for corpo-rate issuers and not to finance LBOs.

For the latter, however, a new mar-ket is growing — unitranche financ-ing, in which one investor or a small club provides combined senior and subordinated debt.

“Two years ago this development would not have come up in a con-versation about the German lever-aged market, but now there are pri-vate debt providers who are actively offering debt,” says DZ Bank’s Schehl. “When we are pitching for deals we are now hearing more often that there might also be a unitranche provider in the running.”

haymarket and ares Capital are among the direct lenders active in Germany, offering debt priced between typical levels for senior and mezzanine loans. s

“The nature of German high yield

issuers is more fragmented than in the rest of Europe”

Jo Heppe, Commerzbank

FINANCING THE MITTELSTAND


Three or four years ago, a large privately owned German company — from the upper echelons of the Mittelstand — took on a new finance chief.

As a colleague tells the story, the newcomer told the top management: “You’ve got to give financial reports to your banks.”

Management asked why — they had never done so before. “Well, you’ve got a lot of debt,” said the finance executive.

To which the reply came: “But the banks know us!”

This company has been through some interesting times since then, and it has certainly begun producing financial reports for its lenders.

In several ways, it is representative of some quiet changes taking place in the rich soil of Germany’s econo-my — the Mittelstand.

In every country, small and medi-

um-sized companies are called the backbone of the economy, but nowhere is this truer than in Germa-ny. for a variety of reasons, includ-ing historical ones, Germany does not have as many multinational, listed global champions as some other countries. Its main stockmar-ket index is the Dax 30 — a slimmer group than the uK’s fTSe 100.

But in the car industry, high tech machinery and chemicals, Germany has global leaders — and one reason for their success is that they are sur-rounded by a host of smaller, highly specialised manufacturers that sup-ply them, and in some cases are their customers.

roman Schmidt, head of corporate finance at Commerzbank, is proud of the bank’s 110,000 German corporate clients — far more than any other bank, he claims.

“A lot are owner-run, they are

very export-oriented, and they tend to produce something unique,” Schmidt says.

“They also have a very large r&D spending, and in any sort of less pos-itive economic situation, the r&D never dries up — the owners go on investing in it through the cycle to keep the company innovating.”

This is one reason why the Mit-telstand has been able to absorb the shock of the financial crisis, which hit the manufacturing industry hard.

By 2010, says Christian Adrian, deputy head of Mittelstand at DZ Bank, many companies were already beginning to recover.

“for the last three years they have broadened their margins, built up their equity ratios,” he says. “They stick to what they know, and always look for improvements in their core products, or new applications for them.”

Solid owners, solid debtCentral to this deep-rooted indus-trial tradition is the Mittelstand’s financial structure. The archetyp-al Mittelstand company is family-owned and obtains its funding from banks. Capital markets — wheth-er equity or debt — have little to do with it.

of course, that is a simplification. Germany has over 700 listed small and medium-sized companies, and an active corporate bond market (see box).

But whereas in the uK, the uS and many other countries, most sizea-ble businesses are publicly listed, in Germany private ownership remains common.

To Ingo Nolden, head of debt capi-tal markets for Germany and Aus-tria at hSBC Trinkaus & Burkhardt in Düsseldorf, the Mittelstand is defined as much by financing style as by a company’s size.

“Sometimes even big compa-

Germany’s small and medium sized companies — the Mittelstand — are the envy of the industrial world. Yet their financing arrangements are often derided as old-fashioned. That is a mistake, argues Jon Hay. The strength of private, family ownership and the depth of Germany’s relationship-driven banking system are central reasons for the Mittelstand’s success. Now they are exploring a wider range of financial techniques — but at their own pace.

Industrial heart keeps beating calmly as financial world changes

The shape of Germany’s capital markets, compared with those of France and the UK, is to a great extent the product of Mittel-stand traditions — notably, the ability to do without financial markets.

Germany’s economy is at least 30% big-ger than France’s, which is slightly larger than the UK’s.

But far from German capital markets ex-

ceeding those of its neighbours by a sim-ilar factor, they are usually the same size or smaller — and with a more concentrated base of issuers.

Even bank lending is lower in Germany. Ratios of private credit to GDP show that Germany’s corporate and household sec-tors, together, are only 53% as indebted as those in the UK. s

German, French and UK capital markets — the tale of the tape

Germany France UKCorporate bond issuance, 2003-13 €502bn €515bn €520bn

No of corporate issuers 145 126 260

Equity capital markets issuance, 2003-13 €222bn €206bn €351bn

Average IPOs a year, 2003-13 19, worth 21, worth 95, worth €2.9bn €3bn €6.5bn

Total stockmarket capitalisation (Dec 2012) $1.5tr $1.8tr $3.3tr

Domestic banks’ assets €7.8tr €6.7tr €8tr

Ratio of private credit to GDP 108% 112% 203%

Source: Dealogic, World Federation of Exchanges, ECB, World Economic Forum



nies regard themselves as fami-ly-owned, Mittelstand companies because they have certain values and norms which distinguish them from a listed company,” he says.

Such privately-owned compa-nies may be very innovative in their products, but they are often financially conservative. A few have no debt, perhaps apart from an undrawn credit facility. oth-ers, like the supermarket chains Aldi and Lidl, are extremely large but very secretive and partly as a result, have issued loans and Schuld-scheine, but no bonds.

“In the uK, at some stage, growing companies need to go to the stock exchange to increase the size of the business and get the leverage they need,” says Schmidt. “That isn’t the case in Germany. The number of companies that are not private equi-ty-owned that have done IPos in the last 15 years is minuscule.”

Partly, the reluctance is cultural. one German finance executive says: “When they grow a big business, Americans like to show they’ve been successful. Germans, if they get rich, wonder ‘how can we build a higher fence?’”

Efficient capitalBut there are hard-headed finan-cial reasons, too. “German code law and accounting rules have histori-cally been very creditor-protective,”

says Nolden, “whereas the Anglo-Saxon legal and accounting structure is more shareholder-friendly as it is much more driven by the concept of ‘true and fair view’.”

That strong protection makes debt capital cheap in Germany — reduc-ing the need for equity.

“After the war, we had no equity culture at all,” says Nolden. “Germa-ny was rebuilt very much with loans, less via the equity market.”

The large industrial sharehold-ings banks and insurance companies held were dispersed in the 1990s, but the debt-based culture remained. “The Mittelstand always had unused bank loan capacity,” says Nolden, “so equity ratios have been very small compared to other countries. Com-panies carried more debt, but mainly bank debt.”

Alexander von Preysing, head of issuer services at Deutsche Börse in frankfurt, attributes the slow rate

of IPos to the volatility of markets in the past 15 years, which has made investors cautious.

he concedes that entrepreneurs’ reluctance to cede control may not be a function of market conditions, but more permanent — though when demand picks up, they are more like-ly to be tempted.

And he points out that the exchange’s Daxplus family Index, which tracks listed companies that still have a controlling family stake, has performed well. “There is still a lot of potential in Germany of com-panies that are in principle capital markets-ready but do not use [exter-nal] equity as a financing tool,” von Preysing says.

The success of Deutsche Börse’s entry Standard bond platform for issuers with turnovers of about €50m-€300m (see box below) gives him hope: “once these companies get used to the capital markets, they may lose their prejudices against raising equity capital.”

Nevertheless, that remains in the future. Most German business own-ers manage to hold on to their com-panies and even pass them on to their children. If they decide to sell, they can choose between the stock-market and private equity.

Spoilt for choiceone of the most important reasons why much of the Mittelstand has

A noTABlE recent innovation in Germany is its Mittelstandsanleihe or Mittelstand bond market. Four German stock exchanges of-fer listings for small bonds, sometimes only of €10m. These are too small for large in-stitutional investors to bother with, but are big enough for retail investors to buy, and still enjoy some liquidity for small trades. The result is a market perfect for small companies to issue in.

Remarkably, Germany’s retail bond mar-ket is the most diverse, innovative — and probably risky — in Europe.

In the equivalent markets of Belgium and Austria, the issuers are local blue-chips and large midcaps. In the UK, dealers are desperate to avoid yet another mis-selling scandal, so parrot the view that bonds must be suitable for retail investors — from well-established, often listed companies, with a

solid track record.But in Germany, the regime is — logically

— more in line with that for equities. Private investors have long been allowed to buy the shares of any company, however small or risky — so why not its bonds?

one or two of the big German banks are very sniffy about the retail market, saying quality control is lax and fearing defaults will bring disaster.

So far, they haven’t. In March 2012, SIAG Schaaf, a maker of wind turbines, filed for insolvency, less than a year after issuing a bond on the Frankfurt Stock Exchange’s En-try Standard for SME bonds platform.

Far from drying up, investor demand has continued. In February, for example, Rudolf Wöhrl, a fashion and sports retailer, sold a €30m five year bond paying 6.5%. It has al-ready traded up from par to 110.00.

Trading more weakly in Frankfurt, at 93.00, is a €60m bond from December, is-sued by MS “Deutschland” BmbH — which owns a large cruise liner. Worried investors might choose to switch from that to octo-ber’s €50m 6.5% issue by Berentzen, the drinks producer.

“More and more companies are willing to use capital markets for debt financing instead of going to the banks,” says Alex-ander von Preysing, head of issuer ser-vices at Deutsche Börse in Frankfurt. “A bond issue can be a kind of IPo-lite. It also involves transparency rules, you have to communicate with investors, but there is no dilution.”

Much of the Mittelstand may have yet to dip its toes in the capital markets. Yet at the same time, the Mittelstand is also home to Europe’s only genuine SME bond market. s

New bond markets link small firms, tiny investors

“They stick to what they know, and always look for

improvements in their core products, or new applications

for them”

Christian Adrian, DZ Bank



not become listed and consolidated is Germany’s remarkable banking system.

for years it was the object of groans, sighs and chuckles in the City of London, by German invest-ment bankers as much as Anglo-Saxons, who saw it as outdated and unprofitable. Yet it remains in place.

In some ways, the banking sector mirrors the Mittelstand: it is highly granular, and only its largest mem-bers are owned by public equity investors. Germany has 1,700 banks. elsewhere in the eu, only Austria and Poland have more than 200. They are organised in several over-lapping layers, offering both regional coverage and different kinds of bank that cater for different tiers of the Mittelstand.

for the 1,100 local co-operative banks, for example, the Mittelstand means very small companies with turnovers up to €5m. “for compa-nies of this size, the co-operative banks and Sparkassen provide about 30% of the finance,” says Adrian at DZ Bank — which acts as central bank for the co-operatives and gives their clients access to 1,400 corre-spondent banks worldwide.

The 430 savings banks are also small and local. “It’s less a share-holder-driven structure, more a stakeholder-driven one,” says Nold-en. “Their shareholders are the municipalities, so their success fac-tors are not about return on equity. It’s about supporting the local econo-my, and sometimes even more about financing donations to schools and festivals.”

Banks like these are much more accessible and willing to listen to people setting up a small business, Nolden says. on top of that, they are flush with money because “almost everybody has a Sparbuch” (savings book).

Scandals blow up from time to time but because there are so many savings banks, they don’t threaten the system.

The savings banks are linked to the much bigger Landesbanks, where much of the institutional change and consolidation in Ger-many’s banking system has taken place.

“All the Landesbanks’ new busi-ness models centre on corporate loans,” says Schmidt. “They even compete in each other’s regions.”At the top of the pyramid are the

commercial banks like Deutsche Bank, Commerzbank and uniCredit — as well as foreign players that have established themselves in Germany.

hSBC’s target stretch of the Mit-telstand, says Nolden, is compa-nies with a minimum turnover of €250m-€500m. Banks like these compete on breadth of service and global reach — helping clients that export to Asia and Latin America, or even manufacture there.

What all these banks add up to is exceptionally competitive fund-ing for the Mittelstand. “every com-pany will have four to seven banks vying to offer it loans,” says Schmidt. “from the corporate’s point of view, it can pick and choose relationships.”

Loan pricing remains extremely tight. “Banks tried to put rates up a bit, when the banking earth shook a little bit in 2008-9, but they didn’t succeed,” Schmidt says. “Pretty quickly they came back in again, and they’re now as competitive as ever.”

Some banks have not blinked dur-ing the crisis. Adrian says DZ Bank’s Mittelstand loan book has grown every year since 2005, and last year expanded by 15%.

Feeling repercussionsNevertheless, there have been strains — especially for the larger Mittelstand firms, too big to rely on the ultra-stable cooperative and sav-ings banks.

“The listed companies can finance themselves, but the midcaps did find it very difficult at times to get finance or draw on facilities when liquidity was scarce between banks,” says Jürgen Machalett, head of cor-porate customers at NordLB in han-over. “We happily always protect-ed our customers, but at times we were a bit calm and careful about

new customers. our marketing was reduced.”

Now, the threat is not banks run-ning short of liquidity, but capital. Some banks in Germany are feeling their capital bases squeezed by tight-ening regulation and are having to reduce lines — or find other tech-niques to ease the balance sheet (see box on next page).

“A strength of the Mittelstand is that the managers are very protec-tive of their companies,” says Macha-lett. “Their father might have found-ed it. So they took very seriously this wake-up call that you can’t rely on banks, as in the past, because the environment has changed.”

Like their counterparts all across europe, Mittelstand Cfos have begun to explore new sources of funds. Debt capital markets bankers who have been badgering compa-nies to listen to them for years sud-denly find clients more receptive. Borrowers and banks are now often in accord: having all one’s funding in bank loans is not ideal.

Hella’s bond bridgeone large midcap that emphatical-ly converted to the capital markets under pressure was hella hueck. The 100 year old, family-owned company in Lippstadt, near Dort-mund, is a specialist in lights and electronic components for cars.

It had issued some yen notes in 2002, and Schuldscheine, but no mainstream bonds.

early in 2009, Moody’s downgrad-ed it from Baa3 to Ba1 as the crisis deepened and General Motors head-ed for bankruptcy.

hella turned first to the loan mar-ket, where it obtained Germany’s first ever forward start loan to refi-nance ahead of time a €650m revolv-er maturing in August 2010.

Then in october 2009, it sold a €300m five year bond, its debut in euros, with a 7.25% coupon.

early this year, now back to its old rating of Baa2 with a stable outlook, hella returned to the market to sell a €500m seven year bond at just 2.375%, using the proceeds to buy back some of the high yield notes.

Not every Mittelstand company is going to make that transition in such a textbook fashion.

“The theme of companies moving to the capital markets has followed

“The Mittelstand took very seriously

this wake-up call that you can’t rely on banks, as in the past”

Jürgen Machalett, NordLB



me for 27 years in the market,” says Schmidt at Commerzbank, rueful-ly. “It is happening — every quarter there is a little more than the quarter before. But there is never a real revo-lution, like in America.”

What has changed, Schmidt argues, is that a few years ago, com-panies didn’t come to the capital markets because they lacked knowl-edge. “Now, all Cfos know what a bond is, what a hybrid is, a convert-ible bond,” he says. “They are very well educated — it’s just about effi-ciency. They will get funding where it suits them, whether it’s loans, bonds, Schuldscheine.”

Private passionGermany’s Schuldschein market, a hybrid of loan and bond, is treas-ured by its banks, which are anxious lest too many foreign dealers should muscle in. It is a puzzling, uneven market, which can absorb very large deals by Siemens and even foreign issuers like Pirelli — as well as small issues of €50m.

As Machalett explains, one of the market’s many attractions is that it’s an easy way to syndicate risk among multiple banks and institutions — with a deal that’s as private as a loan,

and with a mere 20 pages of docu-mentation.

“Three or four years ago if a com-pany wanted a €200m Schuld-schein, one bank would say ‘it’s mine’, underwrite it, and then look for a partner,” he says. “Now if there’s an €80m Schuldschein, four banks do it together. We arranged €1.6bn of Schuldscheine last year, and we didn’t underwrite a single one. It was all on a best efforts basis — though we always keep part of the deals we do.”

As with syndicating or co-arrang-ing loans — another growing trend — Machalett says this sharing of risk helps banks stick within their credit limits, or keep headroom in them for further loans to the borrower.

hand in hand with companies’ desire to explore capital markets has come a new willingness to open up. “There used to be an issue with transparency in the Mittelstand, but not any more,” says von Preysing. “More and more family-owned busi-nesses have changed to IfrS report-ing in the last five years.”

If it ain’t broke...Gentle shifts towards disintermedia-tion and transparency are altering

the Mittelstand. But the essential, a diverse and supportive banking sys-tem, remains — that favourite Ger-man word — stable.

“At the moment, for clients, the system is very safe, because they have a lot of choice,” says Adrian. “In Germany competition has been very high over the last 50 years, so I don’t think it will go down. It would only happen if either the Sparkas-sen or the co-operative sector began to struggle, because then only one major domestic lender would remain.”

But there seems little risk of such an upheaval, since those sectors are healthy. They suffered minimal losses in the crisis, and not through lending to Mittelstand companies, where defaults, Adrian says, were: “absolutely small”.

The symbiotic relationship between the Mittelstand and Germa-ny’s banking sector has served the country’s economy handsomely. You don’t hear people laughing at the German banking system any more.

Schmidt maintains: “Germany is still overbanked for corporates.” As far as the Mittelstand is concerned, their answer is probably: “Long may it continue.” s

DESPITE GERMAnY’S reputation for finan-cial staidness, the country has produced in-novations that have gone global.

The most famous is the Pfandbrief — the model for the covered bonds backed by mortgages and public sector loans that have been copied by banks the world over.

In February, Commerzbank made what might come to be seen as another such breakthrough. Though it had to eschew the narrowly defined Pfandbrief format, Com-merzbank sold a €500m covered bond backed by loans to small and medium-sized enterprises. Despite lacking the advantages Pfandbriefe enjoy under Ucits, Basel III and European Central Bank rules, the five year bond drew €1bn of orders and paid just 47bp over mid-swaps.

Traditionalist covered bond investors were horrified that this novel collateral should be used — but many saw the deal as a socially useful way to bring finance to SMEs.

Backed by a €600m pool of loans spe-cially selected from Commerzbank’s Mit-

telstand portfolio, the deal offered a new way to finance SME loans cost-efficiently — it was rated Aa2/AA and priced halfway between Commerzbank’s senior unsecured and Pfandbrief funding levels.

Two weeks later, HSH nordbank arguably went one better, using SME loans to back a true Pfandbrief issue. The trick was that KfW, the German development bank, guar-anteed the loans, turning them into public sector assets. The €500m three year bond was priced at 11bp over mid-swaps.

In one sense, these deals are an escape route — from the prison into which capital markets funding of SME loans has been thrown by the financial crisis.

In the years up to 2008, many billions of these assets were financed annually across Europe through securitisation. Ger-many was a leader, both with private sector deals and transactions supported by KfW, through its Promise and Provide schemes.

But these withered in the crisis, as in-vestors fled in panic from synthetic secu-ritisation, lumping together benign SME

deals with aggressive CDo-squareds. Since then, KfW has helped where it can by buy-ing chunks of SME securitisations, but the volume has been small.

Commerzbank and HSH’s deals are throwbacks to this world of SME loan ABS, using many of the same structural tech-niques. But by packaging the transactions as covered bonds, the banks made them marketable to investors who have still not plucked up courage to buy ABS again.

However, in the longer term, securitisa-tion may offer a more flexible set of tools. Covered bonds encumber the issuing bank’s balance sheet and cannot bring it capital re-lief. It is capital, rather than access to fund-ing, that analysts fear will be the constraint on banks’ ability to finance SMEs.

Dire warnings of a €4tr lending gap from bank deleveraging in Europe may be over-blown, but through the Prime Collater-alised Securities initiative to quality-stamp ABS, market participants hope to re-estab-lish securitisation as a financing source for SMEs. s

Mittelstand loans — direct to the capital market


German Corporate Borrowers’ Roundtable

EUROWEEK: Here we are in the safe haven of Europe. It’s hard to believe now, but 10 years ago there were even critical articles about the German economy in the Anglo-Saxon press. That seems very remote now, when everybody wants to know what is the secret that the Germans have got right. So has this safe haven perception given German borrowers an easy ride through the crisis?

Ursula Radeke-Pietsch, Siemens: It’s an advantage for German corporates that Germany is in a healthy economic position, with a strong country rating. But also German corporates have done extremely well during the crisis, and therefore the situation in the capital market is that investors are primarily looking

for well rated corporate credits, which they find in Germany.

Martin Hartmann, NordLB: The fact that companies are in Germany plays a major role in their ability to raise funds. There are quite a few international investors who simply would not buy any other country at the moment.

On the border, for example of northern Italy and Austria, you can have two companies that are based in the same position and have the same financial strengths.

One is on the Italian side of the border and the other on the Austrian side, and the funding costs for the Italian one can be up to 250bp higher.

Participants in the roundtable were (L to R):

Christoph Zender, head of corporate debt origination, LBBW, Stuttgart

Martin Hartmann, head of markets, NordLB, Hanover

Henner Böttcher, group treasurer, HeidelbergCement, Heidelberg

Steffen Diel, head of treasury finance, SAP, Walldorf

David Schmidt, head of corporate bond origination, Commerzbank, Frankfurt

Marcus Hilger, director of corporate finance and treasury, Celesio, Stuttgart

Ursula Radeke-Pietsch, head of capital markets, Siemens, Munich

Kirsten Sänger, head of corporate clients, global markets, HSBC, Düsseldorf

Jon Hay, corporate finance editor, EuroWeek (moderator)

Bettina Streiter, head of corporate origination, DZ Bank, Frankfurt

Companies extend reach into markets as banks ease back

Most German companies have not suffered any funding crisis in recent years – collectively, they are the strongest group of corporate borrowers in Europe. Germany’s banks remain closely supportive of local companies. But still, even strong firms have felt here and there a pushback from their lenders – and the message from the banks is clear: go to the capital markets.

A great variety of options is available, from public bonds, with or without a credit rating, to Germany’s treasured Schuldschein market, to US private placements and convertible bonds.

Funding officials from four leading German companies met with five capital markets bankers in Frankfurt in early March to discuss how best to exploit this increasingly diverse funding environment – and whether it is threatened by heavy-handed regulation.



EUROWEEK: And is that resilient performance in Germany really because of the economic reforms of the Schröder government?

Henner Böttcher, HeidelbergCement: Actually, the German corporates themselves have done an excellent job. When the crisis came up, they were the front runners in cutting costs deeply. But it also helps German corporates that Germany is so well provided with bank financing. A lot of foreign banks are now returning after the crisis and pushing lending spreads down. We as a high yield issuer really had a big benefit from that because we were in the position of paying high yields even in Germany.

EUROWEEK: So has the crisis not worried you at all?

Steffen Diel, SAP: Well, of course it worried us, and it still worries us in some aspects. I think the environment will remain difficult, especially on the banking side. We have to stay alert to political events, which can change the picture. The worst is probably behind us but it’s not over.

David Schmidt, Commerzbank: The impact of the volatility and stress on the primary bond market is interesting.

German companies have achieved some of the best results through one of the worst crises of all time. There’s just a tremendous story that they have to tell to investors.

In the midst of the crisis, everyone was preparing themselves for it to last longer. The bond volumes speak for themselves — €310bn of bond issuance in 2009, the most ever by far, and one third of that came from German corporates.

It showed that German corporates were getting their homework done and preparing for the worst, but with their results showing their best.

EUROWEEK: What adjustments to their financing have German companies made in response to the crisis?

Marcus Hilger, Celesio: In the last couple of years companies have focused themselves more internally — for example on cost-cutting — than externally, such as on acquiring other companies. In financing markets, too, there has been more refinancing and building up huge cash piles to secure their position. That is going to

change, maybe this year, maybe next. Companies will start to look externally again to grow their bottom lines.

Bettina Streiter, DZ Bank: From multinationals down to smaller mid-cap companies, capital markets as another pillar beside traditional bank lending have become more and more important.

The companies sitting round this table get money from all sorts of pockets. It’s key to have a broad toolbox, where you can pick the right tools you need at any point. We see it reflected in issuance volumes in the bond market and also in the Schuldscheindarlehen market.

Christoph Zender, LBBW: I agree, but in Germany we are still at the beginning of the transition from loans to bonds, which could in the end bring us to US conditions.

Many companies are going to the Schuldschein market as a first step. The companies here today are all listed, but a huge number of German corporates are family-owned. In terms of transparency, they still have a lot to do — this is what investors need.

They are willing to do it, but it takes time. If you talk to a Swabian company, they say, “We are a brilliant company, but we don’t want to talk about it.”

Hartmann, NordLB: Yes, in northern Germany, it’s very much the same.

But if you draw one conclusion from the crisis, as a corporate treasurer, you should draw the conclusion that somehow bank lending might disappear in a flash.

That means you have to diversify your funding sources, like banks have to, and that leads to the financial markets. It’s a question of raising your game by being more transparent about your accounts and how you do business. This is crucial for the investor.

EUROWEEK: Are the issuers here afraid that bank lending is going to disappear?

Radeke-Pietsch, Siemens: No. Personally, I don’t think so. I totally agree that it’s extremely important for corporates to diversify their investor base, and look for and identify issuing possibilities in the capital markets, besides classic bank financing.

But bank financing will also remain as an important refinancing source, especially considering the demands of the rating agencies for back-up lines, for example for commercial paper programmes. We need refinancing lines for situations when the capital markets are not available; therefore I think we need both bank lending and the broad investor base from the capital markets.

Streiter, DZ Bank: A certain portion of bank lending will always have to exist, because there are needs we cannot fulfil with a capital market product, like the flexibility you need to draw and repay. If you have a bond, it’s out there and it’s redeemed at maturity. So the proportion will vary but I think there will always be bank lending.

Kirsten Sänger, HSBC: There is always some kind of agreement. Companies give DCM mandates to banks who can make sure that they have a solid credit base, so they can have both kinds of funding.

Steffen Diel,SAP



Nevertheless, though bank lending will always be there, the trend to disintermediation will go further. One reason is regulation — the Basel III capital requirements will lead to that.

In Germany companies are fine at the moment because of the safe haven flows. And, due to the low interest rates, there is demand not just from institutional investors but from retail. With the last Hornbach bond about 40% went to retail investors.

So corporates should take the chance to go to the market and diversify their investor base. That’s why I think it is also important which bank you choose. Maybe sometimes the German market is full, so you have to make sure that there is a bank who can bring you international investors.

Böttcher, HeidelbergCement: It would be very costly not to keep back-up facilities from the banks. As long as you have CP or you want to fulfil the requirements of the rating agencies, you have to keep back-up lines in place. But the question is whether banks continue to do term debt, and I would say they tend not to continue that kind of business. That’s why Heidelberg shifted, between 2008 and 2010, more than €7bn from the bank market into the capital market.

EUROWEEK: Did you feel the banks did not want to lend you that money any more?

Böttcher, HeidelbergCement: The banks were hit by the financial crisis and shifted into a risk avoidance mode. We had a very bad experience in negotiating a refinancing and then we made a very prudent shift. We had €8.7bn in a term syndicated facility and we took it totally out and into the capital market.

Zender, LBBW: But nowadays it has changed because all banks are cash-long and they would highly appreciate to lend to companies, even on a term basis. Böttcher, HeidelbergCement: Not all banks.

Radeke-Pietsch, Siemens: Newly founded companies, for example, are not known to bond investors, so they have to rely on bank financing.

EUROWEEK: In the UK, I don’t necessarily believe it, but the big story in the newspapers is always that the banks are not supporting the real economy. Is

that the case in Germany?

Hilger, Celesio: Banks are more and more restricted from giving lines, bilateral or syndicated. Prices are still OK but I do think banks harm themselves if they give up the business they have done for hundreds of years. If they don’t fulfil that role there will be others coming in to fulfil it because companies cannot work without somebody who gives flexible lending. The capital market cannot do so — at least, there are no instruments at the moment.

EUROWEEK: Do you mean that certain banks have withdrawn altogether from the market or is it that the banks you deal with are saying, ‘we’ll lend you €60m but not €100m’.

Hilger, Celesio: More the second. If their demand isn’t very keen they really want a strong business case for lending to you. But there are banks which are more competitive in asking for business than they were in former times.

Diel, SAP: We see the same trend. We have no ongoing financing needs — only in M&A situations. But in the past we could approach the banks for €100m, €200m to be part of an acquisition term loan syndicate.

Now it’s difficult, even for us, to find bank partners which can lay that much money on the table to support our M&A activities. Fewer banks are now capable of providing these big tickets.

The universe of banks to approach was bigger before the crisis. Some of the foreign banks which contributed to our acquisition term loans are refocusing on their local markets and are not available any more.

Zender, LBBW: I think banks are more focusing on their client relationships. It’s a game of give and take. Banks give money and give capital, but they expect to get something back — cross-selling, ancillary business.

Böttcher, HeidelbergCement: If you now go through the process of getting a new syndicated facility, you have much more in-depth discussions about what the business relationship will be in future for the bank. They are not happy just to take a shortfall on the syndicated facility, and then hope for business to come — it’s more a discussion upfront.

Radeke-Pietsch, Siemens: Potential side business had always been a question, but now the banks have to show their boards in advance that there is definitely potential side business. In the past, they lent money and hoped to get ancillary business.

We don’t give our relationship banks commitments for concrete side business in advance, but we monitor the relationship with our banks closely and try to distribute our banking business fairly around our relationship bank group in our syndicated credit facility.

EUROWEEK: Bankers say that in the corporate-bank relationship, it’s become much more transparent how much money the bank makes out of it, partly because the customer can find out things like derivative pricing on the screens. Do you agree with that?

Christoph Zender,LBBW



Böttcher, HeidelbergCement: When it comes to business visits, we compare our share-of-wallet records with the bank’s record and then we see where we stand.

Zender, LBBW: One of the key issues is wallet management, wallet sizing.

Hartmann, NordLB: You never had it a couple of years ago but now in every business meeting you talk about it, even at the top level.

Diel, SAP: I think there should be a fair communication between corporates and banks, to have clear expectation management. A company should show its total wallet and present some opportunities for the bank. On the other side, the bank has to show in which areas it has proven expertise and in which areas it can’t add much value. Then I think we follow the profit of the bank as far as we can, and if there is more transparency on the bank’s side, that helps us give a fair allocation among the banks.

Sänger, HSBC: Some corporates have even hired advisers on this, to make sure what fee business is there and ensure it is allocated in terms of the credit lines.

Schmidt, Commerzbank: Some of the bigger companies have appointed banking relations individuals who look at the overall wallet. Disintermediation and transparency in client and bank relations are two of the key themes happening now in the European capital markets — transparency in the sense of “what are we earning, what are you doing, what do you want to achieve?” And then “how can we do it together?” From both sides of the table.

Hartmann, NordLB: Banks also have to be aware of the change of capital allocation to business you do with every client. With corporates, particularly, long term derivatives tend to get quite expensive. As bankers we need to be fully aware of this, or someone in your bank will tell you how expensive it’s going to be. So managing relationships is a key point.

Hilger, Celesio: But we find that, in recent months and even years, the banks pitch for capital market business in any form and do not much elaborate on their other qualities. They don’t say “I am good at cash

management in that country” or “I am good at lending in that country.”

They all focus on winning DCM business because it makes sense for them. But from a corporate perspective, we need more. We need banks for transferring our funds, for lending in different countries and so forth.

Sänger, HSBC: We are really trying to get a mixture of business. So it’s important to show the capability, especially in emerging markets, in both financing and cash management. We don’t mind pitching for a cash management mandate but nevertheless we are also looking for bond business. There must be a mixture because you can’t rely on just one income stream. That wouldn’t be our understanding of a relationship.

EUROWEEK: If companies are financing themselves to a greater extent in the bond market, do they have to carry a lot more cash so that they can ride out the bad months when the market is not favourable?

Böttcher, HeidelbergCement: If you rely on the capital markets for term debt, you obviously need sufficient back-up facilities to hold out for a few months when the market is closed – for example, for high yield issues – by drawing on the bank facility. That’s how we do it. We always see to it that we have liquidity to survive for 24 months without tapping the market.

Radeke-Pietsch, Siemens: Same for us. We always hold a fixed amount as a liquidity cushion. This liquidity cushion triggers negative carry costs, as well as counterparty risks with the banks where we deposit our liquidity, but we rank these costs as an insurance premium. We also have backup lines in place for situations when the markets might be closed completely. But even in crisis situations, from my experience, the markets are not closed for longer periods and the periods of market closure are getting shorter and shorter.

EUROWEEK: Some companies now take great care when renewing their syndicates to choose banks that are reliable and have a good credit rating. Is that something you monitor quite carefully?

Hilger, Celesio: We just arranged a new syndicated loan in February and we definitely chose the banks for that reason, as well as because we could work with them — where we see there is business for them and there is a help for us. And a commitment from the bank. Out of about 20 banks we invited, we ended up with 15 because with the other five, we could not really match up that we had a long term relationship with them. There was something not really in common — so in the end, we did not go with them.

Böttcher, HeidelbergCement: For us, stability is a great point, since the syndicated facility is relationship-defining and also these are the banks we are doing derivatives business with, so we want to have very, very low counterparty risk or eliminate it. That is why we also took out some banks from our last syndication.

Martin Hartmann,NorDLB



Radeke-Pietsch, Siemens: Counterparty risk in syndicated facilities is an issue, but a more significant one is the counterparty risk when and where we deposit our liquidity. We monitor counterparty risks very closely. If a lending commitment from a bank falls away, we have a syndicate of 34 banks for potential substitution. Counterparty risk in syndicated facilities is important, but it is even more important for our liquidity management.

Zender, LBBW: When you assess the counterparty risk on your deposits, it is CDS level, rating?

Radeke-Pietsch, Siemens: Exactly. We monitor CDS levels closely and move liquidity when CDS levels exceed certain limits.

Diel, SAP: To find the optimal counterparty risk concept is extremely difficult. You can have an approach based on ratings or CDS, but who tells you which counterparty limit is mapped to which rating? Is it €400m, €500m?

What is also important on the investment side is to broaden your opportunities so you have more standard products to choose from, you can go into money market funds, tri-party repos and things like that. We want to have some yield on our investments, but security is the most important factor at the moment.

EUROWEEK: Let’s talk about some of the different currency markets. Ursula you have focused very much on the major markets in the last few years, as opposed to lesser currencies. What is your attitude to currency diversification?

Radeke-Pietsch, Siemens: We act conservatively, and focus mainly on the currencies we need. We are not a frequent issuer and when we tap the market, normally it is for larger volume currencies like euros, pounds and dollars. Recently, besides euros, we issued sterling and Eurodollars.

Even for diversification of investors, we have not focused on smaller currencies as of today.

Böttcher, HeidelbergCement: Last year we did a Sfr150m bond and swapped it back to euros. After swap it was cheaper than our euro secondary curve. So when ideas make financial sense, we will do them. We have done issues in Swedish kronor and Norwegian

kroner, but it’s small volumes. Usually we issue in euros.

Hilger, Celesio: We are not so diversified in terms of currency but more in terms of instruments. We have done two euro corporate bonds, we have two convertible bonds, we have issued Schuldscheine and we have bilateral and syndicated lines.

About two thirds of our business is in euros, in Europe, and then there is the UK, the Nordics and Brazil. In the UK and Norway we do a little bit of factoring and in Brazil there is local financing from the bank, because it doesn’t make much sense to issue in a different country and take the currency there.

EUROWEEK: If currency swaps are becoming more expensive, should that change corporates’ decisions?

Streiter, DZ Bank: It depends what kind of market cycle you are in. Currently there is huge liquidity in the euro market, the home market for German clients, so it doesn’t really make sense to look into every other potential market and see whether there is demand, and then use up bank lines to swap it back, if your overall funding need is mainly in euros. It’s always a question of cost, obviously, after the swap.

There are other market phases when other currencies make more sense. During the debt crisis, for example, Norwegian kroner and Swedish kronor were safe haven currencies that made sense at certain times, and issuers with debt issuance programmes could tap them to optimise their funding.

Schmidt, Commerzbank: The larger the funding volume an issuer has, or the more frequently it issues, the more inclined it will be to look under every stone for new investors. I’m not talking about €1bn or even €3bn, but if you need €8bn or €10bn, then you’re going to be looking for new currencies and investor bases.

If you’re dealing with the major currencies and your primary source of revenue is in euros, the market has become so deep in euros, it has evolved into more of a US-style market with that depth and breadth of investors.

I remember when if you had 150 investors in an order book, it was considered highly granular. Well, 2009 changed all that — now we’re talking about 300 or 400 investors. Some of the fast money may have left this year, but the serious bond investors and many of the new ones that came into the market in 2009 are still around, which is why we had €250bn-plus of issuance in euros alone last year.

It’s still a very healthy, robust and resilient market. After the Italian elections, everyone was asking how quickly the primary market would reopen again. Within a couple of days it was up and running just fine.

Radeke-Pietsch, Siemens: When issuing in niche currencies and swapping these currencies back, you have to consider swap costs and in addition volatile market values.

Böttcher, HeidelbergCement: And as long as you

Ursula Radeke-Pietsch,SieMeNS



don’t have a finance company in that country you will be mixing operating assets and financing, which means your holdco lenders will be structurally subordinated versus the opco. You don’t want trouble with them.

EUROWEEK: Ursula, I think you’ve issued Eurodollars but not in the US market. Is that right?

Radeke-Pietsch, Siemens: We issued a 144A bond in 2006. A week and a half ago we issued a Eurodollar bond and last year we issued a bond plus warrants in dollars. That was a way to raise a larger amount of dollars outside the US market. But if larger volumes in dollars are needed, it is worth thinking about tapping the local dollar market directly.

EUROWEEK: There is growing interest in privately placed debt of various kinds. Germany has its thriving Schuldschein market. Is it just a stepping-stone for new issuers on the way to the public bond markets?

Zender, LBBW: For smaller companies, it’s the first step into capital market funding, with maturities up to 10 years. But in 2008 Siemens went to the Schuldschein market and issued €1.1bn, so it’s important in different ways.

But it will be, volume-wise, a niche market. Last year there was €12bn to €13bn of issuance compared with €250bn in the corporate bond market. It is a mature market, too. There are repayments, redemptions, and liquidity on the investor side.

There is some trading, although most investors are buy-and-hold accounts, and we still see new investors coming from the institutional side as well as from the banking side.

EUROWEEK: So what is really the purpose of the market if it remains small and if the same companies can use it as can issue in the public market?

Hartmann, NordLB: It’s a fairly straightforward instrument for issuers that are relatively new to the market to use. Secondly, in Europe, particularly in Germany, issuers appreciate private placements.

Investors also like the format because it allows them to do their own accounting with that instrument. A lot of investors book at it as a loan rather than as a security, as it doesn’t have a Cusip code, so they don’t have to mark it to market. That is a very important feature.

EUROWEEK: Does the Schuldschein market have potential to grow, or will it always remain a niche market?

Streiter, DZ Bank: In the last four to five years the market has grown, shrunk, depending on what other markets are doing. As with loans, there will always be a bottom line where there is an investor need and appetite to invest in Schuldscheindarlehen, and there will be some years when there are peaks, or other markets are closed, when there will probably again be volumes over €12bn.

It’s also growing slowly from foreign borrowers.

We’ve seen some more who have interest to issue, but there are regulations that will probably not change so easily.

At the same time, there is a general movement into the corporate asset class. As long as we have an unsolved crisis and issues about what other asset classes will do, there will be a natural demand for corporates.

There are new investors coming into the Schuldschein product. We will see whether this demand lasts, and becomes more and more established, or whether in a couple of years’ time we will just stick with the classic investor base of banks and some institutions like pension funds and insurance companies at the longer end of the market.

So the market will probably expand and contract, between about €10bn and €20bn a year, but it’s not

growing to the size of the bond market.

Sänger, HSBC: I would see it a little bit differently. What we see is that there is more and more internationalisation of the Schuldscheindarlehen. There is a range of Asian investors who are really interested in the product.

We’ve done a couple of international transactions in dollars. We did a couple in sterling for UK companies. Two years ago, my colleagues in the UK didn’t even know how to pronounce Schuldscheindarlehen — now they are fluent. So it really has kicked off. It’s really a product we want to bring to a broader investor base and new issuers, and we believe there is huge potential for that.

Radeke-Pietsch, Siemens: I am not sure if dollar Schuldscheine are already a marketable instrument, at a reasonable size and price. But it’s an interesting idea, especially when you are a company looking for dollars.

Zender, LBBW: I think it’s possible to achieve a dollar Schuldscheindarlehen. In 2005, for example, we did one in sterling for Celesio, but it’s limited volume. You could do $100m or $150m.

This is limited by the international investors, because the dollar liquidity has to come from international banks, for example in Asia.

What we need in general is more access to institutional investors, because they have the liquidity we need. In the US private placement market there

Bettina Streiter,DZ BANk



are only 40 to 50 investors and they put $50bn on the table every year — and we have roughly 80 pension funds in Germany.

EUROWEEK: Eighty active in the Schuldschein market?

Zender, LBBW: Not yet! That would be great, we are working on it… But the market is still over-regulated. You have to have a public rating.

Hartmann, NordLB: That is, if you want to sell to a pension fund the issuer needs a rating – or the pension fund has to replace it with its own analysis. And not many of the 80 pension funds have a strong analytics team that can analyse credits in detail. That’s why we have to think about packaging that risk for them.

If you speak to some investors, not small but medium size ones, as long as they don’t have a statistical model to analyse corporate risk on a lot of tickets, it’s very difficult for them. If you are going into a deal where you are going to provide €10m over five years, can you imagine the amount of work you have to put in as a buyer of that risk?

And Mittelstand credits in particular are very often refinanced, not after five years but after three, because the borrower doesn’t want to sit around waiting for a sizeable cliff of Schuldscheindarlehen to refinance.

We are working very hard to educate investors on the product, but these are just a few obstacles that spring to mind.

Hilger, Celesio: For us it is a very special situation. We used to have about half of our financing in Schuldscheindarlehen and we have reduced that to maybe 30%.

And since we are in a conglomerate with the Haniel group, where all the other companies tend to issue Schuldscheindarlehen, it is more us who are moving to the public capital markets. But still, I do think that as a fourth or fifth source of funds, it is better to have it.

EUROWEEK: Steffen, your issuance has risen strongly in the last few years, and you’ve concentrated on euro public bonds and US private placements.

Diel, SAP: Before 2007 we had no financing needs at all, as we have a huge cash flow which could cover everything, capital expenditure and even smaller acquisitions. But with our bigger acquisitions, we had to tap the debt markets.

For an unrated issuer like us, the private placement markets were interesting from the beginning, especially the US market because you have direct access to dollar funding, and we could not tap the US public bond market.

The PP market is also a very stable market. The biggest 30 investors cover about 90% of the demand. There is big flexibility on maturities and the most special feature, I think, is that you have more transparency in that market on pricing, compared with the bond market. The banks give you tables that show, for the different maturities, how much debt each investor wants to offer you, depending on the spread. So you get an idea on the price sensitivity of your potential investor base.

The market has some peculiar features as well, like the due diligence meeting after the pricing, and the NAIC rating process that takes place even after the finalisation of the transaction. But it’s an interesting market and we have tapped it now three times. Last year, we did the biggest cross-border transaction ever, with $1.4bn, and we now have $2.6bn outstanding, the third biggest number out of all US private placement issuers. It’s certainly a market we would consider again.

Sänger, HSBC: We see the volume increasing in US PPs from Germany, but not to the same extent as in euro bonds.

Schmidt, Commerzbank: One reason is that in Germany we have the Schuldscheindarlehen as a viable alternative.

Many German companies, if they’re not up to doing segment reporting under IFRS 8, or they haven’t the appetite to issue as much as €250m, then they’re not going to do a bond.

The Schuldschein has fewer covenant restrictions than US private placements, depending on your NAIC rating and what foreign investors require of you.

Radeke-Pietsch, Siemens: However, there are documentation issues regarding US PPs. They have a most favoured lenders language. We cannot accept this clause because of our negative pledge clauses in our syndicated credit facility documentation — our bank group wouldn’t approve it. That’s the reason why we haven’t tapped the US PP market.

Böttcher, HeidelbergCement: We wouldn’t do it either, just for that reason.

Diel, SAP: We clarified that topic with our legal advisers, and based on the relevant terms of our documentation, we see no such issues.

Hartmann, NordLB: I speak to PP investors in the US and they would like more supply but when you talk to them about certain names, they are not always receptive if it’s a company they have not heard of, or which hasn’t published accounts for long enough.

EUROWEEK: Since we’ve touched on the issue of ratings, we have two unrated issuers here. Do you

Kirsten Sänger,HSBC



often come under pressure to justify that in your conversations with banks and investors?

Diel SAP: I must admit it’s a frequently asked question from the banks and from some investors. German bond investors are quite relaxed about it, but British investors are more focused on that topic. But overall it’s widely accepted that we issue without a rating. We are very open in our communication, so our creditworthiness can be assessed in a comprehensive way.

The easiest answer to why we haven’t got a rating is that we didn’t need it in the past. We started with no financial debt at all, so a clear ‘no’ that a rating was necessary.

And then, having to finance major acquisitions, we were always able to do it via the Eurobond market without a rating, at very attractive terms and conditions. So as long as we can support our company strategy without a rating, I think it’s fine that we do without it.

Hilger, Celesio: We are perhaps not as well known or well regarded as SAP. But still, we can issue quite well without a rating, and we don’t see only the advantages of it but also some disadvantages.

It’s not only the cost of the rating and the management time it takes. Like SAP we also do roadshows and investor relations, so there is enough information in the market.

But if you want to have an investment grade rating, which is the only one that makes sense for us, the rating agencies make lots of demands about your financing. You need a syndicated loan facility, you need to refinance every piece of debt very early, and you need maybe to pile up cash. All that kind of thing has a cost because you earn no interest on the money.

And then sometimes the rating agencies change their perceptions of things. We have seen it with our mother company, Haniel, and with other companies like ThyssenKrupp. All of that taken together has led to the decision that we are not thinking too much about a rating.

Schmidt, Commerzbank: Investors are well accustomed to unrated credits, and they’ve built up their credit portfolio analysis teams through the crisis. Just as issuers are well advised not to rely only on bank financing, investors are not relying only on the rating agencies. So as long as the business has solid metrics and a solid management team, a strong credit story overall, investors are very happy to invest.

In Germany there are a lot of jewels out there without a rating who have yet to come to the market — it’s a really interesting story to watch over the next three to five years. The unrated segment is here to stay.

EUROWEEK: You mention that investors have built up their credit skills — do others find that they are more keen than in the past to engage with issuers and ask searching questions?

Böttcher, HeidelbergCement: Yes, absolutely. We are not as stable a credit as some other issuers here at the table — we are rising stars, so to speak. So investors

call us a lot and we take care of them as well. It’s not just equity investors we focus on. We spend as much time with debt investors. And they are much more interactive than before.

Streiter, DZ Bank: This is certainly a growing trend in the last couple of years. Issuers are putting much more effort into creditor work and having separate teams to deal with debt investors and establish contacts with credit analysts.

Regular non-deal roadshows have become more and more important. Depending on how frequently you issue, it may be easier to bring a new transaction if you have a continuous dialogue, at least with key investors.

The bigger institutions really value it when they know who to talk to in the company, when figures are published or they have questions to ask, whether it’s the treasury department or an investor relations team.

Zender, LBBW: It’s absolutely right to separate investor communication from the actual deal. All the banks do a lot of work with corporates to provide opportunities, whether at conferences or other events, where they can get together with investors and talk.

Radeke-Pietsch, Siemens: We do a lot to communicate with our equity investors. In addition, we organise a non-deal debt roadshow in Europe on an annual basis. Deal-related roadshows would be necessary for issues outside the regular European Medium Term Notes programme, or on not plain vanilla instruments. In Europe, we are well known, so one non-deal-related debt roadshow a year should be sufficient from our perspective.

Hilger, Celesio: We are going to start to do more activity in this area. We have not been that active in the past. We did deal-related roadshows but not non-deal ones and we are thinking about changing this. I don’t know whether debt investors are as receptive to investor meetings as equity investors are. But definitely we have to offer it and if there is demand we will meet it.

Sänger, HSBC: One sign of the trend is that a couple of years ago, when we asked investors to join our conference, it was like they thought they were doing us a favour. Nowadays it’s just the opposite. They want to see corporates and talk to them.

Marcus Hilger,CeLeSio



EUROWEEK: One product investors are very keen on at the moment is convertible bonds. Do you think we’ll see more of them?

Radeke-Pietsch, Siemens: Last year we issued not a convertible, but a bond plus warrants, where the two instruments — bonds and warrants — are separated.

We did this to raise a significant amount of dollars outside the US, not because of the convertible issue. The convertible is not a product we are thinking about at the moment.

Hybrid capital is also very famous at the moment, but if you don’t need the equity content for your rating a hybrid is expensive debt.

Hilger, Celesio: We have two convertibles outstanding. The first matures next year. For us, and I would say for other companies, it was a good way for an issuer to start off in the capital market, even without a rating — rather than the straight bond market.

Convertibles are a different asset class and the investors can do much more, they are more flexible and they don’t look at things like ratings or whether the company is well known.

It is an interesting market to watch in 2013 because equity prices are quite high. Volatility is trading low, but spreads are tight and the market is hot at the moment.

There are not many issues outstanding, some are maturing in 2013 and 2014 and there are not many new deals coming into the market.

For companies like us, it’s a good diversification of the portfolio because it’s a totally different kind of investor, so it could be interesting.

Schmidt, Commerzbank: We’re finding clients very interested in hybrid capital. This year we’ve had over €5.5bn of hybrid issuance in euros, out of €50bn of corporate bond issuance overall. That is pretty eye-opening.

Hybrid issuers are seeking equity treatment from the rating agencies, if rated, or from an accounting point of view, if unrated, and they can get it at coupons which are pretty attractive, for example 4% to 6%.

The investor base is much the same as for senior debt and they can get a higher yield for the same credit, just with slightly different terms. Yield is the name of the game now, so hybrid is in the midst of a perfect set of conditions.

EUROWEEK: Interest rates have been somewhat volatile this year, and some people think they could be substantially higher by the end of the year. Should companies do as much funding as they can now before rates rise?

Radeke-Pietsch, Siemens: I don’t see interest rates rising a lot until the end of this year, or even the middle of next year. We are issuing what we need at the moment but nothing in addition.

EUROWEEK: Because the crisis will continue to rumble enough to keep rates down?Radeke-Pietsch, Siemens: I think so, yes. Look at Europe. Germany is doing well, but look at all the

other countries around — I don’t see that the crisis is over already.

Hartmann, NordLB: It may not be a crisis, but it’s a recession, and in a recession it is very unlikely that interest rates will go up soon.

The US is doing somewhat better in terms of growth. They’ve taken a different approach to dealing with their debt overhang, by growing nominal GDP rather than just shrinking real GDP.

But at any time, companies have to take a view of the market and decide whether it is a good time for them to issue. I very much doubt that corporate treasurers are in the market to play the curve.

Schmidt, Commerzbank: Also, in Europe, unlike in the US, many issuers manage their debt on a floating rate basis anyway, and swap proceeds to floating.

So with the great shape that so many German corporates are in, there’s no need to jump into the market just because rates are so low.

Among the fixed rate thinkers, some have done prefunding last year. I don’t get the sense that anyone is rushing because they feel like interest rates are going to take off. We saw that 30bp jump at the beginning of the year, but we’ve retraced since then.

Diel, SAP: I think financial repression will keep interest rates at a low level. As long as sovereigns can issue their debt at very low levels, this is fine for them and they will work for it through financial regulation. In Germany we have negative real interest rates, so the real value of government debt will erode. So I don’t see an uptick coming.

EUROWEEK: Let’s say a fairy has given you three wishes. One and two are world peace and an end to hunger, so you have one wish left to spend on the capital markets. What would you wish to see happen to financing markets?

Streiter, DZ Bank: I hope for the improvement of the regulatory environment. Some of the developments make sense but some of them you really feel are inhibiting the free exchange of capital between issuers and investors.

More transparency would help, but also for every

David Schmidt,CoMMerZBANk



investor group to be able to access assets like bonds or other formats of debt.

The German regulator has ideas, which are moving in the right direction, but in practice it is sometimes difficult to get more retail investors into transactions.

There are also groups of institutions which are blocked, for example insurance companies, which have strong regulatory limits on what they can buy.

Sänger, HSBC: I would underline what Bettina said. Regulation will be the key issue for the next years, not only in terms of how to cope with investors but also how to cope with bank capital.

The good news is that this, especially the last point, will keep the debt capital markets busy, as disintermediation will just increase. I also wish we could do more hedging activity, but as everyone agreed, I don’t see rates rising for a while.

Schmidt, Commerzbank: I’d like to see the virtuous circle in the corporate bond market continue. What I mean is we’ve seen an influx of new investors, attracting more new issuers to the market, because the market is deeper. In turn, that makes it possible to have a more diverse portfolio, which brings in yet more investors.

More new issuers and investors coming in is clearly healthy for the market overall.

Diel, SAP: I have pretty much the same view as Bettina. All of us would like to see more stability in the banking landscape. With all the financial regulation still to come, I hope this will facilitate funding and not make it more difficult, which might be how it seems today.

Also politics have to change. I would like to see some more clear and comprehensive political steps against the economic crisis and unemployment.

EUROWEEK: Do you think the changes in bank regulation are not fully priced in yet — that credit conditions could get still tighter?

Diel, SAP: A lot of things are still to be decided, and that creates uncertainty. With Basel III, we have to wait to see how the new regulatory framework looks in three years’ time. Then some certainty will come back to the market and hopefully also stability.

Radeke-Pietsch, Siemens: I totally agree. They moved Basel III some months back, and everybody knows something will happen, but nobody knows exactly how each company will be affected.

Another regulatory difficulty is the derivative discussions. The discussions have lasted for at least two and a half years, and everybody is talking about the cost increase but nobody knows exactly what will happen. This uncertain environment does not support strategic decisions.

EUROWEEK: So corporate investment is likely to accelerate once that’s clearer?

Radeke-Pietsch, Siemens: Yes.

Böttcher, HeidelbergCement: In the volatile

environment we are in, over-regulation doesn’t help. It makes things more unstable than they already are. And the different regulations coming forward, Emir, Basel III, MiFID, Solvency 2, all of them are not harmonised with each other. It ends up on the back of the corporates in the end.

There is also the trade tax on derivatives. I don’t think it will end up on the P&L of the banks.

It may seem quite small but, compared to the volumes which you turn as an in-house bank, if you are domiciled in Europe, it can be rather big.

Hartmann, NordLB: It’s a question of how trading is executed. We’ve done some numbers in the lobby groups and if you apply the financial transaction tax to the way we have done business in the last five years, we would pay out almost 40% of our top line revenues.

EUROWEEK: Would you still be profitable?

Hartmann, NordLB: Well, I am not sure we are making a margin of 40% already, so I would be surprised.

Hilger, Celesio: One thing I wish I could change is that the banks are really not looking too good at the moment, from all perspectives, in terms of regulation, capital adequacy, and especially what is in the public eye at the moment — the payment of bankers themselves.

Here we have an example where the state is really crossing a line. This is private between the employer and the employee, and we shouldn’t care about it. Everybody is talking about what managers should earn. But in terms of banking, I think it’s overdone.

Hartmann, NordLB: It only takes one country not to ratify it for it to be blocked.

Zender, LBBW: From an originator’s perspective, it’s a very interesting time to be working, and world to work in. I hope we will see the trend towards capital market funding continue, and the gap close between the pure bank lending in Germany and the funding patterns in the US or UK, with more capital market funding, be it private placements or public issuance. s

Henner Böttcher,HeiDeLBergCeMeNt

Equity Capital MarkEts


Germany has, by common assent, been the stand-out econom-ic performer in europe over the last few years, with its export-orientated industrial firms to the fore. Those firms, the backbone on the DaX and mDaX indices, have also delivered financially throughout the last three years, helping German markets out-perform others in europe.

but while equity capital mar-kets activity has been stronger than in other regions, it has not been immune to volatility. now the crisis has abated, will Germany continue to lead the way in eCm?

“We’re in a market strongly driven by liquidity, with a lack of alternatives on the fixed income side and search for growth at what are still reasonable equity prices, at overall lower valuation ratios than, for instance, in the Us,” says achim schäcker, head of eCm for Germany at hsbC. “I’m very opti-mistic from an eCm perspective at these index levels. It’s an attractive environment to be a seller either of primary or secondary shares and investor appetite is clearly there.”

German shares remain on a roll — investors might also now be looking at more stories from other europe-an countries, but that doesn’t mean they’re going to leave Germany behind.

“The macro situation plays very much into the German strength — and most DaX and mDaX stocks show very healthy and recep-tive investor demand levels,” said schäcker. “Investors are looking for German ‘growth-engine’ types of investment opportunities at reason-able prices and meaningful dividend yields.”

Indeed, part of the attraction is German corporates’ outward-look-ing focus.

“shares are not as cheap as they were recently but the German cor-

porate universe is at the forefront of investors’ thinking given the bal-ance sheets, products and inter-national exposure — the access to growth markets where high qual-ity ebit and margin expansion are generated is well known,” says ralf michaelis, deputy head of eCm at Commerzbank in Frankfurt. “In gen-eral, German corporates have strong financing structures and credit rat-ings, and resilient cashflow posi-tions which provide decent divi-dend yields. If you want to invest in europe, Germany is at the top of your list.”

The macro backdrop might be as strong as it has been since before the financial crisis, but few deals have come to market from the country so far this year.

With the exception of a €1.16bn IPO of LeG Immobilien, a residen-tial property firm sold by Goldman sachs’ Whitehall Funds and Perry Capital, the new issues market has been bereft in 2013 — in contrast to the UK, for example, which has four mid-cap deals either already priced or on the way. and the only €200m capital raising has also come from the residential sec-tor, a quick-to-market trade from Deutsche Wohnen.

still, the cupboard is not bare — particularly if there’s a pick-up in m&a. “most listed companies are

quite well financed at this point in time — and the bond market pro-vides large and midcap companies in most cases with seemingly end-less demand for low coupon debt paper,” says schäcker. “Few compa-nies have real equity needs, so most primary issuance is growth or m&a driven and most secondary issuance is valuation-driven by the percep-tion that this is a good moment to exit.”

michaelis also says that German corporates are very well financed. “Issuance will more likely come from event-driven opportunities such as m&a financing or sharehold-er disposals, or for the financing of future growth,” he says. “Issuance for restructuring and turnaround stories is likely to be limited.”

IPOs, maybeThere’s a similar story when it comes to new issues. a handful of deals over the last six months have given confidence, but that’s not to be confused with certainty.

“We have not seen many IPOs so far this year, but we have seen a strong underlying equity market performance and a number of other equity deals, which makes me opti-mistic,” says michaelis. “It’s difficult to predict whether the full pipeline of queuing IPOs will all make it to market in 2013, but the equity mar-ket environment is certainly open for all types of transactions.”

Likewise, schäcker is not con-vinced that 2013 will be a big IPO year in Germany. “Despite the envi-ronment being positive from a sec-ondary market level and liquidity perspective, IPOs remain the tough-est deals to be placed. nevertheless, I expect a few selected names in the pipeline to receive a very warm wel-come by investors and be listed by year-end.”

Part of the difficulty of getting

The equity capital markets are wide open for German issuers. If only they needed more equity, writes Nick Jacob.

Good times for Germany — but where are all the deals?

“We have not seen many IPOs this year,

but we have seen a strong

underlying equity market performance

and other equity deals, which makes

me optimistic”

Ralf Michaelis, Commerzbank

Equity Capital MarkEts


new companies to market is the competition from private equity and trade buyers — particularly as refi-nancing costs keep coming down. The German IPO market does boast some great successes — most nota-bly the €747m IPO of brenntag in 2010. That deal was followed up in short order by six more block sales that took the sponsors to total exit in little more than two years and at an average exit price 42% higher than the IPO price.

It was textbook execution. “brenn-tag is a fantastic German private equity IPO role model case and I think the dream of every Pe house for the exit of their own asset,” says schäcker. “but obviously there’s no guarantee that such a multi sell-down down strategy is equally suc-cessful in every other IPO exit.

“There are not many private equi-ty-backed companies that I believe will ultimately go down the IPO route at exit — I expect the major-ity rather to go down the m&a route. This is clearly a function of a well-functioning high yield and leveraged loan market, combined with the much higher certainty of execution at usually superior terms embedded in an m&a process, thus avoiding the remaining uncertainty around the required follow-on placements post an IPO.”

There are other options, however. One of the great on-again, off-again stories of corporate Germany over the last few years has been the sale of speciality chemicals firm evonik. Owned by the raG Foundation, a public body, and CVC, it has tried to IPO several times with a price tag of €10bn-€20bn, but been scup-pered by market conditions. The last attempt, in the sum-mer of 2012, was launched just as equity markets hit a peak before being wiped out by the latest bout of eurozone turbulence.

but it now appears to have found a route to market. In February it announced that raG and CVC had privately placed a small proportion of the capital with a small group of institutional investors, fol-lowing up with another place-ment in march. The two deals together accounted for 12% of the shares and valued the

firm at €14bn.That has opened the way for

a small, technical listing of the shares that will be less prone to market conditions. and once it has the listing, the owners can follow up with quick-to-market deals as and when conditions allow.

It is the culmination of a trend for private deals to catalyse public offers, seen previously in sales of Danish cleaning firm Iss and For-mula One last year. but it’s not for everyone.

“I’m not sure a private placement approach is a role model for lots of transactions,” says schäcker. “Let’s not forget that there is a question of ‘pull factor’ for investors to enter into a private placement and to believe in a later IPO. There won’t be a lot of companies that can go down that route unless they have the right size and name.”

Trailblazing CBsOne element of eCm in which Ger-man issuers have shown greater willingness to be engaged with than in the past is equity-linked. sie-mens blazed the trail here, with a $3bn dual tranche bonds and war-rants deal in early 2012, and has been followed by other blue-chip names such as adidas and Volkswa-gen. but while those kind of names look good in pitch books, they aren’t by themselves going to drag in other companies.

“It is indeed always reassuring for clients that others have set a prec-edent — it gives them the ex-post justification to equally use a spe-cific eCm structure,” says schäck-

er. “but ultimately this is not what drives issuance — the launch of a specific issue concept by one DaX issuer is just one out of several financing considerations for anoth-er DaX issuer. In a way this is simi-lar to the IPO market where we also have the myth of the ‘icebreaker deal’ paving the way for other IPOs but ultimately very few examples proving such a role.”

he says that, for investment grade names in particular, the trou-ble of getting supervisory board approval for a convertible bond makes the straight bond market a better bet. There has to be a bet-ter reason than just coupon sav-ings when swap yields are already so low.

still, the market is undoubted-ly open, even if the conventional bond market is an easier, less cum-bersome route to take. Perhaps the opportunity is with smaller names instead — companies such as air berlin, Deutsche euroshop and Kuka have all sold quite small Cbs in the last few months.

“equity-linked is a market that is open to most issuers — from a size

perspective we have seen deals from companies of var-ying sizes with transactions ranging from tens of mil-lions for small caps to multi-billion euro refinancings for blue chips,” says michaelis.

“There is an opportunity for corporates to refinance at attractive levels given cur-rent interest rates, credit spreads and volatility. addi-tionally, there is an imbal-ance of supply and demand with demand from inves-tors outstripping supply. I expect to see a broad range of convertibles in the next months.” s

“Few firms have real equity needs, so most primary

issuance is growth or M&A driven and

most secondary issuance is valuation-

driven by the idea that this is a good

time to exit”Achim Schäcker,

HSBC

0

5

10

15

20

25

30

35

40$bn

2008 2009 2010 2011 2012 2013 YTD

FO CONV IPO

Germany ECM by Type, 2008-2013 ($m)Source: Dealogic, EuroWeek

Germany ECM by type, 2008 — 2013 YTD

Source: Dealogic, EuroWeek

FINANZPATZ FRANKFURT


FrankFurt’s skyline is very much the image of a modern finan-cial centre: the functional innovation of Foster & Partner’s Commerzbank tower, the stocky Messeturm, the glass twin towers of the Deutsche Bank headquarters. so it looks the part, but does it deliver? Does Frankfurt war-rant mention among the world’s lead-ing financial hubs? and is it fair to call Frankfurt Finanzplatz the key finan-cial centre of the eurozone?

The case forFrankfurt’s first boast is location: locally, the centre of the rhein-Main economic region, and taking a wider view, a logical centre for european finance in particular. “it has been a financial centre for centuries, being at the crossroads of north-south and east-west trade,” lutz raettig, presi-dent and chairman of the board at Frankfurt Main Finance (FMF), tells EuroWeek. “Hence, we did not need to build it.”

according to FMF, Frankfurt hosts 34,000 businesses with a gross domestic product of more than €50bn between them. it has individual wealth, too: a gross domestic product per wage earner of over €84,000, FMF says. and if we accept that Frankfurt is the clear financial centre for Ger-many itself, then the scale of Ger-man exports within the total eurozone clearly speaks to Frankfurt’s impor-tance as a financial hub. German exports were €88.6bn in January 2013, and have been as high as €98.8bn in March 2012, according to the German Federal statistical Office. By compar-ison, France, the next most impor-tant safe haven eurozone economy, had exports of €36.735bn in January 2013, according to trading econom-ics, citing data from the Ministry of the economy.

the chart on the next page com-piled by Markit economic research starkly shows Germany’s domi-

nance. By combining final 2012 num-bers in most markets with estimates in others, it indicates that Germa-ny accounted for 31.4% of euro area exports of goods and services in 2012, totalling €1.36tr.

this is well over twice as much as France, and more than the nether-lands, italy and spain combined. so if Frankfurt is the financial hub for this engine room of europe, then that’s a very sound foundation.

second, the institutions. absolute-ly central to any claim of Frankfurt to be a financial centre is the presence of the european Central Bank, which was established here in 1998. On top of that, there is the Bundesbank, the Committee of european insurance and Occupational Pension supervi-sors, and of course Deutsche Börse Group (whose headquarters in the distinctive Cube building is, strictly speaking, in eschborn, but that’s very much within Frankfurt’s periphery).

these institutions, crucial domes-tically, are worth looking at in greater detail from a regional perspective. the eCB is obviously the single key insti-tution in dealing with the eurozone

crisis. as raettig says, the presence of the eCB in Frankfurt has been “ben-eficial all through. From the human to the cultural all the way to the econom-ic aspects. the population is grow-ing and is drawing talent from all over europe. Frankfurt was always an open city, but thanks to the eCB it became probably the most european of cities.”

almighty Bundesbankas for the Bundesbank, few have better stated its importance than Jacques Delors mischievously did during his presidency of the euro-pean Commission: “not all Germans believe in God, but they all believe in the Bundesbank.”

and Deutsche Börse Group is con-siderably more than a Frankfurt stock market these days. Granted, its planned merger with nyse euronext was nixed by the european Commis-sion in February 2012, ending an alli-ance that would have created one of the world’s greatest global exchange groups, but nevertheless the group has considerable reach.

in June 2011 it became the sole owner of eurex, the group’s clearing

While Frankfurt vies with Paris to be Europe’s financial centre, it remains eclipsed by London. As Chris Wright reports, the only possible way it can usurp London’s position is if the UK were to quit the European Union. And although its political relationship with Europe is fractious, the UK knows it has too much to lose to let that happen.

Europe’s engine room not enough for Frankfurt to challenge London

A European financial centre yes, but Frankfurt is no global financial Mecca



Europe’s engine room not enough for Frankfurt to challenge London house and a derivatives exchange that

boasts participants from 700 locations worldwide and 1.5bn contracts traded per year.

it is the majority owner of trade-gate exchange, the european retail platform for equities, bonds, funds and etFs. it runs the XtF business for exchange-traded funds, in which it is the european market leader. and it owns Clearstream, the settlement and custody arm, which calls itself the leading european supplier of post-trading services, with over 300,000 domestically and internationally trad-ed bonds, equities and investment funds deposited with it, relation-ships with 2,500 customers in over 100 countries, and settlement of more than 250,000 transactions per day.

“We are home to the nuts and bolts of financial centres,” says raettig.

“Payment systems (such as sePa), clearing and settlement systems, and the trading platforms at Deutsche Börse, to name but a few.”

On top of that is “the deep capi-tal pool that makes Frankfurt a lead-ing european market for debt instru-ments, not least for the european stability Mechanism,” he adds.

third, there’s the argument that if leadership of the eurozone through crisis has effectively moved to Germa-ny in the last two years because of the country’s economic strength and sta-bility, then it must follow that Frank-furt is the logical financial centre for the region.

Hubertus Vath, acting managing director of Frankfurt Main Finance, recently spelled out this argument. “the ‘Made in Germany’ hallmark stands for quality workmanship, reli-ability and stability,” he said in an address. “and this applies to the ser-vices of the German financial sec-tor just as much as for machines and cars.”

Frankfurt, he said, hosts 260 banks and around 200 branches of foreign banks (though in written responses to EuroWeek FMF now refers to more than 200 banks, with over 74,000 employees, and 156 out of 206 foreign banks that are active in Germany). “it finances the main driver of the econo-my — exports — as well as the expan-sion and internationalisation of Ger-many’s economy with its mainstay of medium sized companies.”

Never a credit squeeze to Vath, Germany’s resilience in the financial crisis is instrumental to the argument for Frankfurt. “there was never a credit squeeze here, despite all the prophecies of doom. the bed-rock that made Frankfurt strong has proved itself yet again: the close link between the financial and the real

economy.” raettig makes a similar point.

“Frankfurt has been stable through-out the crisis,” he says. “We did not participate in the excesses before, nor did we see the big layoffs. We believe that makes Frankfurt the natural centre for regulation in the post-crisis era.”

Vath’s argument — that in Ger-many, a greater portion of financial market activity is based on assets and activities in the real economy — is a powerful one, if difficult to

prove. One can perhaps link it to the popularity of German treasury bonds as safe havens for investors, which they have consistently been through-out the crisis. as other articles in this guide explain, German funding costs are as low as 1.5% for 10 year bonds, and on two year securities ended up with a negative nominal rate for a spell in 2012.

and for those making the stabil-ity argument, it’s useful to be able to point to the presence of the europe-an systemic risk Board, which exists within the eCB, and the institute of risk Management and regulation, which was set up in Frankfurt in 2009. these days Frankfurt touts itself as a centre of excellence for risk manage-ment, which is a canny thing to try to forge a leadership position in.

“Frankfurt is a synonym for pru-dence,” says raettig. “We have unique experience in risk management and regulation. We are not only home to two central banks but, thanks to the Bundesbank, train more nationali-

ties of central bankers than any other financial centre in the world. “

another theme is the Frankfurt rhine-Main knowledge region, which refers chiefly to the universities in Frankfurt and the consequent num-ber of well trained employees avail-able. another is the technology and infrastructure available in Frankfurt, and this can be compelling: Vath has said that 85% of German data traffic, and 35% of all european data traffic, passes through the Frankfurt internet exchange point, the De-CiX.

The case agaiNsT is Frankfurt even the key centre of Germany, let alone euroland? Certain-ly not by population: it is only the fifth largest city in the country, although it has the highest economic power of them all. Other cities have sought to build financial centres too, such as Finanzplatz Düsseldorf, to which HsBC is committed.

We can probably let that argument go — a city doesn’t need a huge popu-lation to be a financial centre, though most happen to have one — but it is certainly fair to compare Frankfurt to other global hubs and see how it stacks up.

What do the independent adjudi-cators say? the Xinhua-Dow Jones international Financial Centers Devel-opment index ranks Frankfurt sev-enth, behind london (second) and, crucially, Paris (fifth). Within that are a number of underlying rankings: the most relevant is "financial market",

“Frankfurt was always an open

city, but thanks to the ECB it became probably the most European of cities"

Lutz Raettig, Frankfurt Main

Finance

2011 2012Germany 31.4% 31.4%

France* 13.0% 13.1%

Netherlands 12.0% 12.1%

Italy 11.0% 10.9%

Spain* 7.8% 7.8%

Belgium 7.5% 7.3%

Austria 4.2% 4.1%

Ireland* 4.0% 4.1%

Finland 1.9% 1.8%

Luxembourg* 1.8% 1.8%

Slovakia 1.5% 1.6%

Portugal 1.5% 1.5%

Greece** 1.3% 1.2%

Slovenia 0.6% 0.6%

Estonia 0.4% 0.4%

Cyprus 0.2% 0.2%

Malta 0.2% 0.2%

Euro area, exports of goods and services: (% of euro area total)

* 2012 forecast ** 2011, 2012 provisional

Sources: Markit / Eurostat



which includes capital market, forex, banking and insurance. Frankfurt is ranked sixth, again behind london and Paris, with the commentary say-ing it showed weakness in forex and insurance.

the Global Financial Centres index, published twice a year by Z/yen Group, ranked Frankfurt just 13th in its 2012 ranking in september, though it had jumped to 10th in a more recent interim ranking. this approach has london at the top and Paris far fur-ther down.

Digging deeper once again into the underlying calculations, Frankfurt ranked seventh worldwide for bank-ing, sixth for government and regula-tory, and ninth for wealth manage-ment, but was outside the top 10 in asset management, insurance and professional services.

it’s worth noting that the Z-yen sur-vey publishers are a london-based think tank and the report is sponsored from Qatar, but nevertheless, the sep-tember 2012 report does not make appetising reading for the eurozone: “a number of questionnaire respond-ents feel that finance is such a global industry that it is now more essen-tial than ever to have a globally linked trading hub in each main time zone. the opinion is that within the europe-an time zone, london is the only real-istic option as Frankfurt and Paris are not sufficiently competitive.”

increasingly, though, there is a sense that Frankfurt’s future as a financial centre is all about london. admittedly, there is scarcely a credible comparison today between the two as global finan-cial centres.

in the Z/yen Group, london ranked top in every sub-index category bar banking (where it was second to new york), leading the world in asset man-agement, government and regulatory, insurance, professional services and wealth management.

according to the World Federation of exchanges, london ranked fourth in domestic equity capital market capi-talization at the end of 2012 ($3.34tr), with Deutsche Börse ninth ($1.49tr). and stocks are the most favourable comparison between the two: in for-eign exchange, london is commonly thought to handle around one third of worldwide transactions while Frank-furt is nowhere. according to Cityuk, london hosts the largest insurance industry in europe, with net premium

income of £187bn in 2011. it accounts for around half of all european invest-ment banking activity, one third of private equity fundraising, and 85% of hedge fund assets. it hosts an interest rate derivatives market responsible for 46% of global turnover, and leadership european positions from legal services to accounting, maritime services and islamic finance.

it’s not just about the population: Frankfurt just isn’t london.

London callingand yet. ask any economist about Frankfurt’s future as a financial cen-tre, and one of the first things they will mention is london. “the develop-ment in Frankfurt depends mainly on developments in london, in my view,” says stefan Bielmeier, chief economist at DZ Bank. “it’s really dependent on whether the uk stays in the euro area. Frankfurt should develop its current role in the future but i don’t expect large steps.”

Janet Henry, chief european econo-mist at HsBC, adds: “any initiative that diminishes the attraction of lon-don as a financial centre is more likely to increase the attraction of Frankfurt. But it is also possible that some eu policies on the financial sector reduce the attractiveness of all of the eu financial sectors relative to, say, new york or Geneva.”

For its part, FMF treads a care-ful line on commenting on the uk. “according to polls, a rising part of the population in the uk is in favour of leaving the eu,” says raettig. “even though we believe it would be a great loss for both the uk and europe, we have to take the possibility of the uk leaving the eu into account. We see

that many decision makers under-stand that Frankfurt is where the trade and investment flows are and will reconsider decisions on where to be and what to do in favour of Frank-furt. We nevertheless do not want the uk to leave.”

Henry’s point on eu policy is an interesting one: that eu policies on banking integration, and on capi-tal requirements, will impact any european financial centre and curb its opportunity. Gernot Griebling, in macro research at lBBW, says: “Gen-erally i would expect the growth of the financial industry will be curbed and grow much slower due to regulatory developments, especially the capital requirements in the Basel iii liquid-ity rules. the financial industry will not be a growth engine as we were accustomed to from the 1990s and the beginning of the new century.” though, as he notes: “this is valid for other countries, not only for Germany; it is also a subject for the uk.”

another question is just how much Frankfurt wants to be the financial leader of europe. economists in other chapters in this special report have spoken of the discomfort Germans feel at any idea of taking eurozone leadership, and there is a sense that this is perhaps not a national priority in terms of financial markets either.

“Frankfurt has strong banks,” says one economist. “But when it comes to ideas of low taxes and bank-friendly regulation, this is not where German politicians would want to fight at the forefront. this is london’s position, essentially. it’s just not likely that Germany in its current mindset will become the Mecca of the bankers of the world.” s

Annual growth of German goods

exports 2000 to 2007 and 2008 to

2012 by regions

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Total exports Asia ex Japan Middle east America exUSA

USA Europe exRussia

EMU

2000 — 2007 2008 — 2012

Source: LBBW Research, Thomson Financial Reuters

Annual growth of German goods exports 2000 to 2007 and 2008 to 2012 by regions

Source: LBBW Research

Export FinancE


Few indicators are as closely watched by global markets, espe-cially in times of crisis, as Ger-many’s monthly export figures. as one of the world’s two trading giants, the country’s statistics are inevitably viewed — like china’s — as a barometer of global eco-nomic health.

even more crucially, over the past three years, they have been seen as holding the key to recov-ery in europe. an uptick in Ger-man exports both enhances the strength of the eurozone’s core economy and raises hopes that the resulting prosperity might in time trickle out to the recession-hit coun-tries in the west and south of the continent.

export-driven economies in cen-tral and eastern europe (cee), meanwhile, reap an even more direct benefit from the pick-up in demand for products from Germany, their main trading partner. rough-ly a quarter of exports from coun-tries such as Poland and Hungary go to Germany, many of them into the supply chain for its own exports.

so the news that German exports had recovered to €88.6bn in Janu-ary from a two year low of €79bn in december was greeted with pro-found relief by policymakers across the continent. indeed, for much of 2012, the export figures produced by Germany’s Federal statistics office had provided a rare gleam of hope amid the continent-wide gloom. on nine occasions the monthly total topped €90bn, substantially above the pre-crisis average.

Stocking the worldKey to this remarkable resilience has been the diversity and make-up of Germany’s exporting industries. For decades, Germany has been a world leader in many of the high-value products that top the shopping lists

of emerging market buyers, from luxury cars to the specialist machin-ery required for industrial and agri-cultural development.

that strength has ensured the continued health of Germany’s exporters since the financial crisis, as demand from emerging econo-mies in asia, in particular, has more than made up for falling purchasing power in the developed world. the global reputation of brands such as audi, BMw and Porsche have ensured that cars remains Germa-ny’s biggest export, accounting for 18% of the total in 2012.

German firms making other types of machinery have also maintained their global reach, accounting for 15% of total exports last year, while other key export sectors include chemicals, electronics, metals and pharmaceuticals.

Many of these are supplied by the country’s famous Mittelstand, the family-owned “hidden champions” that have driven Germany’s export success since the post-war period.

the thousands of small and medi-um-sized companies that make up this group are for the most part export-focused — for many, indeed, exports account for 70%-90% of their business — and are frequent-ly world leaders in their specialist sectors.

all this trade activity, of course, requires financing — and with long

term funding from other sources drying up in the wake of the finan-cial crisis, the past five years have been busy ones for banks’ export finance divisions.

as Martin Vetter-diez, head of trade, receivable finance and com-modity trade companies at HsBc trinkaus, puts it: “as emerging mar-ket demand has gradually emerged over the past decade — and particu-larly since the financial crisis — as the driver of the German export sec-tor, the need for banks to finance this with higher added value prod-ucts such as letters of credit, ecas [government agency-backed export credit agreements] and supplier schemes has naturally increased.”

ingo albrecht, nordLB’s head of export finance, agrees. “Before the crisis many countries and importers were able to refinance via the capital markets, but since the crisis eca-backed export finance has become increasingly important as other refi-nancing sources have dried up,” he says. “we found clients coming to us more and more asking for financing solutions in the wake of the crisis.”

Banks muscle upthis increased demand has nat-urally prompted many banks to boost their export finance divisions and expand their offerings. HsBc trinkaus, for example, had long been a reliable source of profits for the group since its acquisition in 1992 as part of the takeover of Mid-land Bank.

in 2010, however, the decision was taken to step up its export and trade finance activities to lever-age the bank’s connections with both its German client base and HsBc’s global network. the par-ent bank underwrote a €150m capi-tal increase to its subsidiary, in the wake of which the bank grew its workforce in Germany to 2,500.

Germany’s exporting industries have gone from strength to strength since the financial crisis, boosted by demand from the world’s fastest-growing economies for their high quality products. As Lucy Fitzgeorge-Parker discovers, financing that flow has presented such an attractive prospect to many banks that competition between them has become intense. Perhaps only the threat of Basel III will cool their ardour...

Germany the hot centre of ahot export finance market

“Since the crisis ECA-backed export

finance has become increasingly

important, as other refinancing sources

have dried up”

Ingo Albrecht, NordLB

Export FinancE


as a result of these efforts, HsBc trinkaus aims to move from being a niche to a core player in several areas of trade and export finance. in three years, its receiva-bles finance team has risen from the bottom of the German league tables to number 11, while the past five years have seen a doubling of its commodity trade finance loan book.

today, HsBc trinkaus serves a broad spectrum of exporters in Germany and beyond. “our clients range in size from small Mittel-stand companies making their first step beyond the borders of europe up to multinational giants who are already experts in almost all these markets but need a very bespoke, tailor-made and highly efficient low risk service,” says Vetter-diez.

the appeal of the German market in recent years has not only been the sharp demand from local companies for ecas. at the same time, Germa-ny’s status as one of the few remain-ing triple-a sovereigns has ensured that its guarantee on ecas is more appealing than ever to risk-averse banks.

the resulting focus on the coun-try’s corporate sector by global groups such as HsBc has inevitably made for a highly competitive envi-ronment, squeezing margins on eca funding provided under the Hermes scheme. (Most eca cover in Germa-ny is provided by the local division of euler Hermes, the international credit insurance group, and has the added appeal of being eligible for inclusion in public sector Pfandbrief pools.)

Looking for an edgethe pressure on banks to distin-guish themselves from the compe-tition has therefore been intense. For Vetter-diez, it is HsBc’s global reach that gives it an advantage. as a house with extensive operations in regions such as asia and Latin america, HsBc has been ideally placed to track the shift of focus for Germany’s exports from traditional trading partners in europe towards emerging markets.

“almost everyone now wants to do business with the German corporate sector and one of the distinctions we can make is that we can service our clients both locally and accompany

them abroad, thanks to our global network,” says Vetter-diez.

in this respect, he adds, HsBc trinkaus’s competitive advantage has been enhanced by the effects of the financial crisis on Germany’s domestic banking sector.

“For both regulatory and political reasons, the local banks have had to redefine their global strategies, and have often opted to refocus on their core markets,” he says. “that means we now have less competition with German banks abroad, where we can introduce HsBc to German clients.”

as proof of this trend, he points to the 300 German commercial clients that his division brought in to the HsBc group in 2012, a total that he expects to be matched this year.

Greener pasturesralph Lerch, head of export finance at commerzbank, agrees that the competition in Germany has become intense over the past five years. as many as 10 banks regular-ly pitch to finance deals for Germa-ny’s leading exporters – something that has prompted commerzbank to expand its activities in other euro-pean countries that have fallen out of favour with export finance hous-es, and where margins are conse-quently more attractive.

“all the banks are currently focus-ing on ecas backed by the top-rated sovereigns, because the risk assessment is so much easier to jus-tify,” says Lerch. “However, we also see good business opportunities in markets such as France, Belgium, the netherlands or even the czech republic that have slightly lower ratings and where other banks are perhaps reducing their exposure, so the competition is less intense and margins are better.”

that is not to say, of course, that commerzbank has abandoned its

domestic market — indeed, Lerch is confident that in the long term the export finance business model being pursued by some of his foreign com-petitors will prove unsustainable.

“on a global scale, you can’t sur-vive by only covering the top three or four major markets, with the best ecas and the best sovereign rat-ings,” he says.

albrecht at nordLB, however, is not convinced that the German export finance market is quite so uncomfortably hot. “it is certain-ly competitive but i wouldn’t say it’s more so than before the finan-cial crisis,” he says. “we have seen some new participants coming into the market but we’ve also seen some of our previous competitors pulling back, due to problems with liquidity costs and refinancing.”

Fine rootsof course, local banks such as nor-dLB and commerzbank are still able to leverage their domestic expertise in the sMe section of the market, an area where international banks have been less able to make inroads, due to a lack of local knowledge and an inability to achieve economies of scale.

“we have been able to benefit over the past two to three years from the increase in shorter term Hermes and refinancing business for the sMe sector, which is an area that remains the preserve of German banks,” says Lerch. “the foreign players are primarily active in longer term finance.”

Lerch also points to the recent substantial increase in commerz-bank’s provision of Hermes cov-ered receivables — which last year topped 4,000 in total — as an exam-ple of the bank’s ability to serve the sMe market.

commerzbank can tap into these valuable clients through its coun-try-wide branches, which are well provided with export finance spe-cialists, as are its 21 documentary centres. “we have very strong mar-ket penetration on export-oriented companies in Germany, through our branch network, so if we feel that the eca scheme can benefit them then we have the expertise at a local level to suggest solutions for them,” says Lerch.

as to just how far down the sMe

“I expect ECA will once again be

primarily a tool for supporting exports

to emerging markets where domestic bank funding is not

readily available”

Ralph Lerch, Commerzbank

Export FinancE


scale commerzbank will go, Lerch refuses to put a number on the mini-mum turnover required. “our first question when considering a com-pany as qualified for export finance is not about the size of their turno-ver but whether they are an export-oriented business that is aware of all the issues and requirements involved in Hermes transactions, and whether they are active in mar-kets we cover with our global net-work,” he says.

similarly, albrecht is reluctant to put a minimum size on the transac-tions nordLB will undertake for its core sMe client base. “it depends on the underlying export structure,” he says. “i would say there’s usu-ally a solution for every transaction – if it’s not an eca-covered buyer’s credit to the importer then it could be an eca-covered bank-to-bank-credit, if applicable under a frame-work agreement with a foreign bank, or a trade finance arrangement.”

at HsBc, however, Vetter-diez admits — due to the complex nature of long term eca financing arrange-ments — the bank usually sets a minimum size of around €10m on such transactions. He adds, how-ever: “Mittelstand clients have a need for smaller sized transactions with more medium term financ-ing needs, so we are actively look-ing into ways to help those clients too. this is in particular relevant for those sectors in the German indus-try where we are globally strong, such as machinery.”

indeed, Vetter-diez notes that one of the features that make the Ger-man export market — and conse-

quently the instruments required to finance it — unique is the highly concentrated nature of many Mit-telstand companies’ businesses. “a growing number of Mittelstand cor-porates are increasingly successful in niches to win larger contracts in exports to emerging market coun-tries,” he says.

“some Mittelstand companies have ungranular sales, with often larger individual contracts, and for these they usually have payment terms going with some instalments beyond one year, and which are still executed and secured by way of let-ters of credit. as a result, this instru-ment, which is usually used for short term transactions, is often a more medium term instrument in Germa-ny, compared to other countries.”

Back to emerging?as to what the future holds for export finance in Germany, there is some divergence of opinion among sector participants.

For Lerch at commerzbank, the key trend will probably be a refocus-ing on the sector’s roots. “Long term funding is starting to become avail-able again on a commercial basis, especially in the Bric countries, and as it does, i expect eca will once again be primarily a tool for sup-porting exports to emerging markets where domestic bank funding is not readily available,” he says.

“that in turn will affect the banks involved in the sector, because to support that type of business will require a very extensive global net-work and a strong funding base.”

that, he adds, will play to com-

merzbank’s strengths. at present, the bank has a footprint in 60 coun-tries worldwide and is still expand-ing, having opened offices in Bang-ladesh and angola last year. indeed, Lerch identifies south and southeast asia, along with sub-saharan afri-ca, as the key growth regions for the next few years.

He is also optimistic about Latin america, but admits that — given the dollar-based nature of most transactions on the continent and the higher cost of long term dol-lar funding for a european bank — commerzbank will inevitably play second fiddle there.

albrecht, however, is sceptical about claims that eca activity is likely return to its emerging markets roots in the near future.

“it’s too soon to call the end of the crisis, so i’d expect current lev-els of demand for export finance to be maintained, at least for the next couple of years,” he says. “there might even be additional oppor-tunities for new developments in the sector — in future i’d expect to see more covered export finance in oecd countries and more cases where eca finance is combined with project finance.”

The shadow of Baselthere is also disagreement about one of the most hotly contested top-ics in export finance — the potential for severe disruption to the sector from the implementation of Basel iii regulations.

according to Lerch, the effects of an incautious implementation could be disastrous.

“as they currently stand, the Basel iii provisions are punitive for export finance, and that will likely affect the number of banks that are able or willing to cover the sector,” he says.“the leverage ratio is the big-gest issue in the Basel iii legislation for export finance providers, but the treatment of liquidity coverage will also likely make export finance more expensive for both exporters and investors.

“Governments and the europe-an authorities need to take great care to ensure that, in their rush to regulate, they don’t undermine the positive role that eca finance plays in securing stable worldwide trade flows.” s

German exports by regions

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Jan00

Jan01

Jan02

Jan03

Jan04

Jan05

Jan06

Jan07

Jan08

Jan09

Jan10

Jan11

Jan12

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Asia ex Japan Middle East America ex USA USA EMU Rest

Source: LBBW Research, Thomson Financial Reuters

German exports by regions

Source: LBBW Research

ProPerty StockS


With investors interested in anything German, it comes as lit-tle surprise to find that the coun-try’s listed property sector has been attracting an unusual degree of attention in recent months.

traditionally, the buyer base for this quite small group of compa-nies has been dominated by spe-cialist institutional investors from outside Germany. UK-based buyers have tended to take the lion’s share of new offerings, with a solid rump of demand from elsewhere in europe.

Leads on recent listings, however, report interest from a much broader range of equity buyers — from the Us in particular.

“in the past six months we’ve seen more money coming into the mar-ket from non-specialist investors who are simply looking for yield or to take advantage of a market win-dow,” says Carsten schoenen, head of real estate, equity capital markets at Commerzbank.

“this was reflected in our market-ing activities for LeG immobilien, where we had a lot more educational work with investors.”

LeG, one of Germany’s largest resi-dential property firms with around 91,000 housing units in its portfolio, was listed in Frankfurt in late Janu-ary. the company was brought to market by Goldman sachs’ Whitehall funds and Perry Capital, which had acquired it in 2008 from the state of north-rhine Westphalia.

deutsche Bank and Goldman sachs were global co-ordinators on the issue, with Berenberg Bank, Commerzbank, erste Bank and Kem-pen & Co as co-lead managers. the iPo — of a 57.5% shareholding — raised €1.34bn and was priced in the middle of the €41-€47 range at €44.

LeG’s listing came soon after a €195m accelerated bookbuild by fellow residential property firm deutsche Wohnen in mid-January.

that deal — led by Bank of Amer-ica Merrill Lynch and UBs — also reportedly attracted substantial interest from new investors includ-ing Us mutual funds, resulting in high levels of oversubscription.

For buyside participants, the appeal of German property — par-ticularly residential — is obvi-ous. rents across the country have shown astonishing stabil-ity for nearly 15 years, making for dividend yields and free cashflow yields so stable that shares in the leading residential firms are increas-ingly seen by investors as an alter-native to bonds rather than a pure equity play.

Rent on the upWhat is more, in Germany’s biggest cities those rents are starting to feel upward pressure as citizens of south-ern european countries flock to cen-tres such as Frankfurt and Berlin in search of employment.

“the combination of a shortage on the supply side and strong demand from investors for assets with a sta-ble yield profile has had a very posi-tive impact on the market and is why for the first time we’re seeing stocks trading above their net asset value,” says schoenen.

despite the attractive pricing on offer, however, market participants are not predicting a rash of equi-ty offerings from German property companies in 2013.

indeed, most agree that the long-awaited listing of industry leader deutsche Annington — expected in the third quarter — will be the year’s only other iPo.

the reason for the lack of immedi-ate response to the favourable mar-ket conditions lies in very different levels of preparation required for tak-ing a property firm public compared with selling to an individual inves-tor, who is planning to hand the day-

to-day running of the portfolio to a third party manager, according to schoenen.

“the success of LeG’s iPo was definitely encouraging for a lot of companies and there are a few more on the residential side that have the critical mass to look at listing, but a very time-consuming fact is the right corporate set-up,” he says.

“Companies looking to float have to be able to convince investors that they have a well developed busi-ness model and strong management — the ones that have listed recently spent four to five years setting up the necessary structures to attract equity buyers.”

As to what investors are looking for in terms of key metrics, bankers agree that the focus is on funds from operations (FFo) — a property sector measure of cashflow calculated by adding depreciation and amortisa-tion to earnings — and loan-to-value.

Across europe, Ltv for listed resi-dential property firms is generally expected to be in the region of 50%-60%, although in Germany compa-nies tend more towards the bottom of that range.

the factor that most frequently scuppers potential property iPos, however, is having an insufficient-ly diversified debt structure. GsW, which successfully listed in April 2011, had initially tested the mar-ket a year earlier but was rejected

The impressive stability of German real estate is drawing an expanding equity investor base but the onerous requirements of listing mean supply will likely continue to lag demand. Lucy Fitzgeorge-Parker reports.

Destination Germany: economy fires up listed property sector

“We’ve seen more money coming in

from non-specialist investors who are simply looking for

yield”

Carsten Schoenen, Commerzbank

ProPerty StockS


by investors due to the short tenor — two years — of its restructured CMBs.

similarly, bankers on the deal attribute LeG’s success in listing this year — at the second time of trying — to the substantial improvement in the company’s debt structure.

“investors want to see a very well diversified debt side of the balance sheet, meaning a broad group of lenders and a well developed matu-rity profile — indeed, that was one of the key factors that ensured the success of LeG’s and GsW’s listings,” says one.

similarly, the fate of deutsche Annington’s latest attempt at list-ing — which JP Morgan and Mor-gan stanley have been mandated to manage — is also expected to ride on whether investors approve the company’s recently revamped debt structure.

owned by Guy hands’ terra Firma Capital Partners, Bochum-based deutsche Annington is the largest residential landlord in Germany with more than 185,000 housing units. in 2006, the company agreed one of the biggest ever european CMBs at €5.8bn and last year restructured €3.8bn of the debt to extend the weighted average life and spread the maturities.

As part of the restructuring, terra Firma put in €504m of fresh equity, reducing the Ltv below 60%.

Further issuance from deutsche Annington could be likely, with reports in February suggesting that the firm could look to the CMBs mar-ket to refinance €1bn of debt matur-ing this year.

Whether investors approve deutsche Annington’s restructuring — and whether its listing will run into mar-ket volatility ahead of German elections in september — remains to be seen.

Loan market back in playequity bankers, however, say the fact that the company was this year able to obtain a €657m refinancing loan from Berlin hyp — taken in con-junction with the successful refinancing by fellow resi-dential property firm Gagfah in February of €1.06bn of its Woba portfolio in dresden —

is an encouraging sign that long term debt financing is now readily avail-able for the sector.

“the last few months have dem-onstrated that funds are available in big ticket sizes on the debt side, not only in terms of refinancing pre-iPos but also for refinancing and acquisi-tion financing for companies that are already listed,” says schoenen.

that in turn is likely to encourage more players to explore the possi-bilities of listing — and, if deutsche Annington’s iPo proves as successful as that of LeG and the market tone remains positive, bankers agree that the next two to three years could well see more residential property firms going public.

equity buyers eager for new supply from the sector, however, are unlike-ly to have to wait that long for more primary market activity.

if iPos are particularly challenging for property firms, follow-on offer-ings — at least for well-established names such as deutsche Wohnen and GsW — are quite the opposite and are increasingly seen as the nat-ural option for acquisition financing.

“the group of companies that are already listed are all looking to expand their portfolios and can be very nimble when it comes to capital raising, so i’d definitely expect to see more activity on the follow-on side this year,” says schoenen.

on the commercial side, the pros-pects for investors are less entic-ing. the continued willingness of German consumers to spend has kept the retail and shopping mar-ket buoyant but the listed part of the sector remains dominated by

deutsche euroshop. the hamburg-based company

was last in the market in november, when it raised €167m in a combined offer comprising a share placement and a €100m five year debut convert-ible bond to fund an acquisition and diversify its debt funding.

Market participants say further activity from the firm is unlikely in the short term, however, and that the likelihood of new players looking to list remains low.

Meanwhile, the structure of office-focused companies’ portfolios tends to make them less acceptable to equi-ty buyers than sectors such as resi-dential or retail that can boast much better tenant diversification.

Munich-based Prime office, how-ever, managed to raise €215m via an iPo in testing conditions in June 2011 and bankers say further listings from the sector should not be ruled out.

For commercial companies consid-ering a public offering, the param-eters required by investors in terms of debt structure are said to be simi-lar to those in the residential sector although expectations for Ltv tend to be slightly lower than on the resi-dential side, at 45%-50%.

But if the outlook for the commer-cial sector is not all gloom, there is no question that for the moment it is residential companies that are likely to make the running — and will do for as long as rents remain at a level that makes constructing new hous-ing an unprofitable exercise.

inevitably, if rents continue to rise at the current pace there will come a point when building starts to look

more appealing – but, says schoenen, that time is still a few years off.

“on the residential side, on average rents have been stable for nearly 15 years and aren’t high enough to justify investment in new building activities, which is why inves-tors are convinced that rents have the potential to rise over the coming years,” he says.

“At some point over the next two to three years we will probably reach a point where the rent level is high enough to initiate more new building activity but that is definitely not the case now.” s

0

0.5

1

1.5

2

2.5

3$bn

German Real Estate ECM Issuance, 2008-2013 ($m)Source: Dealogic, EuroWeek

2008 2009 2010 2011 2012 2013 YTD

German real estate ECM Issuance, 2008-2013

Source: Dealogic, EuroWeek

Germany In FIGUreS


Over the following pages EuroWeek provides a snapshot of Germany’s macro-economic, bond market and bank sector data, from a range of official sources, including the Federal Republic of Germany Finance Agency, Moody’s, Standard & Poor’s and Fitch Ratings.

Germany in figures: an economic snapshot

Moody’s: Aaa (negative outlook) • Standard & Poor’s: AAA (stable outlook) • Fitch: AAA (stable outlook)

Federal Ministry oF Finance (BundesMinisteriuM der Finanzen)

Federal Financial supervisory authority (BaFin)

GerMan FinanzaGentur

deutsche BundesBank executive Board

elke königPresident

tammo diemerManaging Director

Felix hufeldInsurance supervision

karl-Burkhard caspariHead of securities supervision/Asset management

raimund röselerBanking supervision

Wolfgang schäubleFederal Minster of Finance

steffen kampeterParliamentary State Secretary

Jens WeidmannPresident

hartmut koschykParliamentary State Secretary

sabine lautenschlägerDeputy President

andreas dombret Financial Stability

Joachim nagel Markets and IT

rudolf BöhmlerControlling, Accounting and Organisation

carl-ludwig thiele Cash Management, Payment and Settlement Systems

selected key oFFicials

Germany In FIGUreS


aaa/stable/a-1+

RationaleThe unsolicited ratings on the Federal Re-public of Germany reflect Standard & Poor’s Ratings Services’ view of Germany’s modern, highly diversified, and competitive economy, and the government’s track record of prudent fiscal policies and expenditure discipline. Fur-thermore, we believe the German economy has demonstrated its ability to absorb large economic and financial shocks, including the reunification of West Germany with East Ger-many in the 1990s and the global recession in 2009.

The German economy has made a relatively solid recovery since 2010, supported mainly by a strong rebound of net exports and gross fixed investments. In our view, the econo-my’s overall resilience to the global down-turn reflects years of corporate restructur-ing, wages restraint, and a high savings rate. These factors have also enabled the country to generate sizable trade and current account surpluses, which have led to the economy’s solid net external creditor position (including non-debt assets and liabilities). In addition, we do not consider Germany’s private- or public-sector balance sheets to be under any mate-rial strain. In contrast to other highly-rated peers, Germany has avoided the need for sig-nificant private-sector deleveraging and fiscal consolidation.

Nevertheless, we expect domestic consump-tion to recover only moderately over the next three years as the government maintains tight fiscal policies to comply with its constitutional fiscal rule, and as the eurozone debt crisis weakens consumer confidence. In addition, some of Germany’s major trading partners are still in the process of reducing debt, which will weaken external demand, in our view. Conse-quently, we predict that real GDP growth will slow to 0.6% in 2012, from 3.0% in 2011, be-fore recovering to 1.2% in 2013. Beyond that, we anticipate GDP trend growth to remain close to 1.5%.

After posting balanced general government budgets before the crisis, Germany’s public finances worsened as a result of the reces-sion. However, we believe the deterioration has been more contained than that of several ‘AAA’ rated peers, whose steep deficit in-creases have been more pronounced and may persist for much longer. We expect Germany’s general government deficit in 2012 to be the lowest since the 2008 crisis at 0.3% of GDP.

We estimate that the deficit will remain below 0.5% of GDP throughout the forecast horizon due to a 2009 constitutional amend-ment. This aims to limit structural federal government net lending to 0.35% of GDP per year by 2016 and requires German states to maintain balanced budgets over the economic cycle. We note that similar statutory fiscal con-straints have had a poor track record in sev-eral other countries. However, in our view, this framework may be more effective in Germany because of long-standing public and political support for fiscal discipline. The constitutional limit should also, in our view, mitigate the consequences of Germany’s federal system not typically lending itself to swift and efficient policy decision-making. Despite the political credibility of the fiscal program, we consider its timely achievement as ambitious in light of the prevailing economic risks.

As a result of small deficits, we expect Ger-many’s general government burden to gradu-ally decline from its current level of 79% of GDP. However, and similar to other eurozone members, contingent liabilities stemming from the various financial support mecha-nisms continue to rise. Germany’s European Financial Stability Facility and European Sta-bility Mechanism liabilities currently amount to €211 billion, or about 8% of GDP. If called, these guarantees could raise Germany’s gross debt ratio but not to such a degree, in our view, that contingent liabilities would crystal-ize enough to place material pressure on the ‘AAA’ rating. Furthermore, we believe Germa-ny can carry a somewhat higher debt burden than many ‘AAA’ peers given its diverse and

resilient economic structure as well as its ac-cess to low-cost capital market funding.

A deepening and prolonged eurozone crisis could hit Germany’s economy in other ways. Direct exports to Italy, Spain, Portugal, Ire-land, and Greece were less than 5% of German GDP in 2011, according to official data. But the exposure of Germany’s financial institutions to strained eurozone economies remains sig-nificant. According to Bank for International Settlements data, German commercial bank claims at the end of June 2012 on the afore-mentioned countries, plus Cyprus, still totaled €390 billion or about 15% of GDP, although these claims have decreased by more than half since the mid-2008 peak (in dollar terms). As a consequence, the substantial financial support made available to the eurozone pe-riphery could significantly reduce the likeli-hood that Germany would need to provide further support to domestic banks, and the likelihood of an exogenous shock to Germany’s economy.

OutlookThe stable outlook on our long-term rating on Germany reflects our expectation that its public finances will continue to withstand potential financial and economic shocks and that consensus in favor of prudent economic policies will remain. We expect these factors to contain the net general government debt ratio and sustain the economy’s net external creditor position.

We could lower the unsolicited long-term sovereign credit rating on Germany if, contrary to our current expectations, the net general government debt ratio increases significantly from its current level of just under 77% of GDP. This could occur, for example, if consis-tently larger-than-anticipated deficits surpass 3% of GDP, which is well above the constitu-tional limit. An unexpected surge in contin-gent liabilities could also create downward pressure on the ratings. We currently do not expect these scenarios to materialize over the outlook horizon (up to 24 months).

SELECTED KEY O

FFICIALS

aaa (negative outlook)

Credit Strengths The credit strengths of Germany include:• Diversified and export-oriented economic base• Track record of social and political stability• Tradition of prudent and flexible macroeco-nomic policies• Ready market access due to safe haven sta-tus

Credit Challenges The credit challenges facing Germany include:• Contingent liabilities due to financial support in the context of the euro area debt crisis • Pension liabilities and rising healthcare ex-

penditure

Rating Rationale On 23 July 2012, the outlook on Germany’s Aaa government bond ratings was changed to neg-ative from stable. The first rating driver under-lying Moody’s decision to change the outlook on Germany’s Aaa bond rating to negative was the level of uncertainty about the outlook for the euro area and the impact that this has on the country’s susceptibility to event risk.

The second and interrelated driver of the change in outlook to negative was the increase in contingent liabilities. The likelihood is el-evated that the strong euro area states will need to commit significant resources in order to deepen banking integration in the euro area

and to protect a wider range of euro area sov-ereigns, including large member states, from market funding stress. As the largest euro area country, Germany bears a significant share of these contingent liabilities. Contin-gent liabilities arise from bilateral loans, the European Financial Stability Facility (EFSF), the European Stability Mechanism (ESM), and the European Central Bank (ECB) via the holdings of peripheral debt and the Target 2 balances.

The third rating driver is based on the Ger-man banking system’s vulnerability. German banks have sizable exposures to stressed euro area countries, particularly to Italy and Spain. The risks emanating from the euro area crisis go beyond the banks’ direct exposures, as they

SELECTED KEY OFFICIALSMoody’s: GovernMent oF GerMany Jan 23, 2013

standard & poor’s: Federal repuBlic oF GerMany nov 27, 2012

Germany In FIGUreS


also include much larger indirect effects on other counterparties, the regional economy and the wider financial system. The German banks’ limited loss-absorption capacity and structurally weak earnings make them vulner-able to a further deepening of the crisis.

Germany remains a Aaa-rated credit as its creditworthiness is underpinned by the coun-try’s advanced and diversified economy and a tradition of stability-oriented macroeco-nomic policies. High productivity growth and strong world demand for German products have allowed the country to establish a broad economic base with ample flexibility, gener-ating high income levels. Germany’s current account surplus supports the resiliency of the economy. Moreover, Germany enjoys high lev-els of investor confidence, which are reflected in very low debt funding costs, leading to very high debt affordability.

Rating Outlook The negative outlook reflects the elevated uncertainty regarding the outcome of the euro area debt crisis given the current policy framework. Moreover, it is underpinned by the elevated contingent liabilities that the German government will assume, which comes on top of a marked deterioration in the country’s own debt levels relative to pre-crisis levels. We also see a vulnerability of the German banking sys-tem to the risk associated with the euro area debt crisis. The German banks’ sizable expo-sures to the stressed euro area countries, par-ticularly to Italy and Spain, together with their limited loss-absorption capacity and structur-ally weak earnings make them vulnerable.

What Could Change the Rating — Down Germany’s Aaa rating could potentially be

downgraded if Moody’s were to observe a prolonged deterioration in the government’s fiscal position and/or the economy’s long-term strength that would take debt metrics outside scores that are commensurate with a Aaa rating. This could happen if (i) the Ger-man government needed to use its balance sheet to support the banking system, leading to a material increase in general government debt levels; (ii) any country were to exit the euro area, as such an event is expected to set off a chain of financial-sector shocks and as-sociated liquidity pressures for sovereigns that would entail very high cost for wealthy coun-tries such as Germany, and cause contingent liabilities from the euro area to increase; (iii) debt-refinancing costs were to rise sharply fol-lowing a loss of safe-haven status.

Recent Developments First official estimates show that German eco-nomic growth was lower in 2012 compared to 2010 and 2011. After registering positive growth in the first three quarters, GDP is es-timated to have contracted by 0.5% qoq in the fourth quarter of 2012, dragging down the annual growth rate for 2012 to 0.7%. Net exports remained a main growth driver, al-though financial woes in other euro area coun-tries were weighing on business confidence in Germany. Signs from domestic demand were mixed: public consumption and private con-sumption - backed by a robust labour market - were contributing to annual GDP growth, whereas investment in machinery, equipment and construction as well as inventories con-tracted on an annual basis as companies held back spending in light of the uncertain global economic outlook. However, improvements in the ifo index and PMI leading indicators in

November and December bode well for the first quarter of 2013. That said, since the dip in GDP in the fourth quarter of 2012 will dampen overall growth for 2013 for statistical reasons, we forecast only subdued real GDP growth of 0.4% for 2013, with the euro area debt crisis remaining a key risk to the economic outlook.

Despite weaker growth, Germany is ex-pected to post a small budget surplus of 0.1% of GDP in 2012, the first surplus since 2007. This was achieved due to low interest rates and low social spending as unemployment reached a historically low level. The consolida-tion was especially evident at the central gov-ernment level where the deficit was reduced considerably, whereas local governments and social security funds continued to register surpluses. As a result Germany complies with its debt brake rule already in the second year after implementation as well as with the fis-cal compact of a structural deficit of no more than 0.5% of GDP. The government intends to achieve a structurally balanced budget in 2014. According to official estimates, the general government debt-to-GDP ratio has slightly increased to 81.7% in 2012 from 80.5% in 2011. Note that the bulk of the jump in the public debt ratio from 74.5% in 2009 to 82.5% in 2010 was a reflection of the take-over of gross bank debt due to the statistical classifi-cation (in the government sector) of the newly established winding-up institutions for banks (“bad banks”), i.e. FMS Wertmanagement for Hypo Real Estate and EAA for West LB.

Source: Moody’s Investors Service, Jan 23, 2013

SELECTED KEY O

FFICIALS

long term issuer default rating: aaa

Stable ‘AAA’ Rating: Germany has a high value-added and open economy with a com-petitive manufacturing sector and effective political and social institutions. Against the background of fragile global recovery and the intensification of the eurozone crisis, Ger-many recorded robust GDP growth and falling unemployment in the last two years, partly as a result of earlier structural reforms in the labour market.

Core of the Eurozone: Germany, as the big-gest member, plays a key role in the eurozone (EZ). Its position, often driven by the rigid interpretation of EU principles, is a significant element in framing the gradualist response to the crisis. Germany is also the main contribu-tor to all existing and potential eurozone bail-outs and firewalls.

Safe-Haven Status: Germany enjoys safe-haven status, reflected in its ultra-low gov-ernment bond yields and net private capital inflows. However, as a large net creditor, the increasing home bias of German banks,

through the deleveraging it causes in weaker EZ members, has widespread adverse conse-quences for the European economy.

Gradual Rebalancing: The stronger cyclical position of the German economy will help the necessary adjustment in other EZ members but the rebalancing is likely to be gradual given the mechanics of the monetary union. In contrast to the last decade, Germany will have higher inflation than the EZ average, likely above 2%, the upper limit of the EZ-wide price stability definition. Monetary conditions, set for the entire eurozone, are unusually loose for Germany, though Fitch Ratings does not expect material risks to crystallise in the short or medium term.

Improving Fiscal Performance: Germany has all the ingredients for a declining debt path: the economy has been growing strongly, the budget deficit is moderate and nominal interest rates are at record lows. Nevertheless the longer track record serves as a warning sign. Despite the fiscal rules of the SGP, the debt/GDP ratio increased from 55% in 1995 to 83% in 2010. During the 13 years of the mon-etary union the German debt ratio declined in

only five years and has been above the 60% reference value since 2003.Significant EFSF/ESM Guarantees: Ger-many’s debt/GDP ratio could increase above 90% due to its contribution to EZ bail-outs. Fitch considers the risk of disbursing all of the EFSF’s €440bn lending capacity to be signifi-cant. Given Germany‟s maximum guarantee of €211bn, this would translate into a 7pp in-crease in the gross debt/GDP ratio. Further-more, the €168bn callable capital to the ESM constitutes a contingent liability of 6.4% of GDP.

What Could Trigger a Rating ActionIntensification of Eurozone Crisis: Germany remains exposed to the systemic component of the crisis. A significantly deeper recession in its large trading partners could push Germany into recession with negative repercussions for the fiscal stance. Any additional sizeable contributions to EZ bail-out funds, on top of the EFSF guarantees, could push German debt above 90% of GDP, close to the upper limit that Fitch considers consistent with a AAA rating.

Source: Fitch Ratings, Sep 6, 2012

SELECTED KEY OFFICIALS

Fitch ratinGs septeMBer 6, 2012

Germany In FIGUreS


Foreign currency

Long-Term IDR AAA

Short-Term IDR F1+

local currency

Long-Term IDR AAA

Country Ceiling AAA

outlooks

Foreign-Currency Long-Term IDR Stable

Local-Currency Long-Term IDR Stable

Source: Fitch Ratings

ratinGs inFo

Gdp 3,573.9

Gdp per head (usd,000) 43.6

population (m) 82

international reserves 248.5

net external debt (% Gdp) -6.8

central government total debt (% Gdp) 53

cG foreign-currency debt 0

cG domestically issued debt (eurbn) 688


Financial data 2011 ($bn)

Q 1 2013 Q 2 2013 Q 3 2013 Q 4 2013

Jan Feb Mar April May June July Aug Sep Oct Nov Dec

Security Share 2013 Annual Volume N A N A N A N A N A N A N A N A N A N A N A N A

Change €bn 2013 €bn

Schatz 2Y 24% 2 60 5 5 5 5 5 5 5 5 5 5 5 5

Bobl 5Y 20,4% 1 51 5 4 4 4 5 4 4 4 5 4 4 4

Bund 10Y 21,6% -2 54 5 5 4 4 5 5 4 4 5 5/4 4

Bund 30Y 3,2% -3 8 2 2 2 2

Cap Market 69,2% -2 173 44 44 20 42

Bubill 6M 17,6% -3 44 4 4 4 4 4 4 4 4 3 3 3 3

Bubill 12M 13,2% 0 33 3 3 3 3 3 3 3 3 3 3 3

Money Mart 30,8% -3 77 21 21 20 15

Year total €bn 250 24 21 20 22 22 21 22 20 21 26 19 12

65 65 63 57

N: new issue / R: reopening / Bund10 / Bund30: federal bonds with maturities of 10 or 30 years / Bobl: five year federal notes / Schatz: two year federal treasury notes / Bubills: treasury discount paper with maturities of 6and 12 months

Source: Federal Republic of Germany Finance Agency

issuance outlook oF the Federal GovernMent 2013 (€ Bn)*

Germany Medians

0102030405060708090

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

2010

2011

2012

f

2013

f

2014

f

General government debt


% of GDP

General GovernMent deBt



0 50 100 150

United Kingdom (AAA)

Germany (AAA)

France (AAA)

United States of…

Median (AA)

Median (AAA)

Netherlands (AAA)

GDP per capita income, 2011e

At market exchange rates, USA=100

Gdp per capita incoMe, 2011e


Germany In FIGUreS


2008 2009 2010 2011 2012f 2013f 2014f

Macroeconomic indicators and policy

Real GDP growth (%) 0.8 -5.1 3.6 3.0 0.9 1.2 1.5 Unemployment (%) 7.5 8.1 7.4 7.0 6.8 6.7 6.5

Consumer prices (annual average % change) 2.8 0.2 1.2 2.5 2.1 1.8 1.8

Short-term interest rate (%)a 3.9 1.3 1.0 1.3 0.8 1.0 1.5

General government balance (% of GDP) -0.1 -3.2 -4.3 -1.0 -1.0 -0.5 -0.5

General government debt (% of GDP) 66.7 74.4 83.2 81.2 82.2 81.2 79.7

EUR per USD (annual average) 0.7 0.7 0.8 0.7 0.8 0.8 0.8

Real effective exchange rate (2000=100) 98.2 101.6 101.0 102.4 104.6 100.0 101.0

external finance

Current account balance (USDbn) 226.3 198.1 200.7 204.3 167.4 164.3 163.8

Current account balance (% of GDP) 6.2 6.0 6.1 5.7 5.0 4.6

Current account balance plus net FDI (% of GDP) 4.4 4.5 4.2 5.3 2.9 2.7 2.6

Net external debt (USDbn) -135.9 -370.3 -342.3 -243.8 -353.9 -420.2 -487.0

Net external debt (% of GDP) -3.7 -11.2 -10.4 -6.8 -10.5 -12.2 -13.8

Net external debt (% of CXR) -6.6 -22.0 -18.8 -11.5 -18.2 -20.9 -22.7

Official international reserves including gold (USDbn) 137.7 180.0 217.3 238.4 250.4 255.7 261.4

Official international reserves (months of CXP cover) 0.9 1.5 1.6 1.5 1.7 1.7 1.6

External interest service (% of CXR) 9.3 7.2 6.5 6.4 11.3 11.2 10.7

Gross external financing requirement (% int. reserves) 294.3 325.7 250.2 199.9 206.3 204.5 206.7

Memo: Global forecast summary

real Gdp growth (%)

US - 0.3 -3.5 3.0 1.7 2.2 2.6 3.0

Japan -1.0 -5.5 4.4 -0.7 1.9 1.5 1.6

Euro area 0.3 -4.2 1.8 1.5 -0.4 0.9 1.5

World 1.5 -2.3 4.0 2.7 2.2 2.8 3.1

Commodities

Oil (USD/barrel) 97.7 61.9 79.6 111.0 107.0 100.0 100.0

a ECB Refinancing Rate (annual average)

Source: Fitch

2011

France ‘AAA’ Germany ‘AAA’ Netherlands ‘AAA’ UK ‘AAA USA ‘AAA ‘AAA’ median ‘AA’ median

Real GDP (5yr average % change) 0.7 1.1 0.9 0.1 0.5 1.1 2.7

Volatility of GDP (10yr rolling SD) 1.5 2.7 2.1 2.5 2.1 2.2 3.2

Consumer prices (5yr average) 1.8 1.8 1.6 3.2 2.2 2.2 3.1

Volatility of CPI (10yr rolling SD) 0.8 0.8 0.9 1.1 1.2 0.9 2.7

Years since double-digit inflation 29.0 - 30.0 30.0 30.0 n.a . n.a.

Unemployment rate 9.7 7.0 4.4 8.0 9.0 7.0 6.2

Type of exchange rate regime EMU EMU EMU Free float Free float n.a. n.a.

Dollarisation ratio 0.0 0.0 22.4 25.0 1.0 25.0 14.4

REER volatility (10yr rolling SD) 2.0 2.4 2.8 5.2 4.8 2.8 3.9

Source: Fitch

Forecast suMMary

coMparative analysis: MacroeconoMic perForMance and policies

Germany In FIGUreS


-6

-4

-2

0

2

4

6

Q20

7

Q20

8

Q20

9

Q21

0

Q21

1

Q21

2

Eurozone Germany France

UK US Japan

Changes in unemployment ratios

Relative to Q12007 level

Source: Eurostat

(%)

chanGes in uneMployMent ratios

Source: Eurostat

ABN AMRO

Banca IMI

Bankhaus Lampe KG

Bank of America Merrill Lynch

Barclays

Bayerische Landesbank

BBVA

BHF-Bank Aktiengesellschaft

BNP Paribas

Citigroup

Commerzbank

Crédit Agricole

Credit Suisse

Danske Bank A/S

Dekabank

Deutsche Bank

DZ Bank

Goldman Sachs

HSBC

ING

Jefferies

J.P. Morgan

Landesbank Baden-Wurttemberg

Landesbank Hessen-Thuringen Girozentrale

Mizuho

Morgan Stanley

Natixis

Nomura

Norddeutsche Landesbank Girozentrale

Nordea

Rabobank

Royal Bank of Canada

Royal Bank of Scotland

Santander

Scotiabank Europe

Société Générale

UBS

Unicredit

West LB

Source: Bundesbank

list oF Bunds issues auction Group

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DZB_Windraeder_210x297_EuroWeek_39L.indd 1DZB_Windraeder_210x297_EuroWeek_39L.indd 1 15.03.13 13:5615.03.13 13:56

Verwendete Distiller Joboptions

Dieser Report wurde mit Hilfe der Adobe Acrobat Distiller Erweiterung "Distiller Secrets v3.0.2" der IMPRESSED GmbH erstellt.Registrierte Kunden können diese Startup-Datei für die Distiller Versionen 7.0.x kostenlos unter http://www.impressed.de/DistillerSecrets herunterladen.ALLGEMEIN ----------------------------------------Beschreibung: Dateioptionen: Kompatibilität: PDF 1.3 Komprimierung auf Objektebene: Aus Seiten automatisch drehen: Aus Bund: Links Auflösung: 1200 dpi Alle Seiten Piktogramme einbetten: Nein Für schnelle Web-Anzeige optimieren: JaPapierformat: Breite: 228.768 Höhe: 315.083 mmKOMPRIMIERUNG ------------------------------------Farbbilder: Neuberechnung: Bikubische Neuberechnung auf 300 ppi (Pixel pro Zoll) für Auflösung über 350 ppi (Pixel pro Zoll) Komprimierung: Automatisch (JPEG) Bildqualität: MaximalGraustufenbilder: Neuberechnung: Bikubische Neuberechnung auf 300 ppi (Pixel pro Zoll) für Auflösung über 350 ppi (Pixel pro Zoll) Komprimierung: Automatisch (JPEG) Bildqualität: MaximalSchwarzweißbilder: Neuberechnung: Bikubische Neuberechnung auf 1200 ppi (Pixel pro Zoll) für Auflösung über 1800 ppi (Pixel pro Zoll) Komprimierung: CCITT Gruppe 4 Mit Graustufen glätten: AusRichtlinien: Richtlinien für Farbbilder Bei Bildauflösung unter: 150 ppi (Pixel pro Zoll) Ignorieren Richtlinien für Graustufenbilder Bei Bildauflösung unter: 150 ppi (Pixel pro Zoll) Ignorieren Richtlinen für monochrome Bilder Bei Bildauflösung unter: 1200 ppi (Pixel pro Zoll) IgnorierenFONTS --------------------------------------------Alle Schriften einbetten: JaUntergruppen aller eingebetteten Schriften: JaUntergruppen, wenn benutzte Zeichen kleiner als: 100 %Wenn Einbetten fehlschlägt: AbbrechenEinbetten: Schrift immer einbetten: [ ] Schrift nie einbetten: [ ]FARBE --------------------------------------------Farbmanagement: Einstellungsdatei: Farbmanagement: Farbe nicht ändern Wiedergabemethode: FotografischGeräteabhängige Daten: Unterfarbreduktion und Schwarzaufbau beibehalten: Ja Transferfunktionen: Entfernen Rastereinstellungen beibehalten: NeinERWEITERT ----------------------------------------Optionen: Überschreiben der Adobe PDF-Einstellungen durch PostScript zulassen: Nein PostScript XObjects zulassen: Ja Farbverläufe in Smooth Shades konvertieren: Ja Geglättene Linien in Kurven konvertieren: Ja (Grenzwert für Glättung: 0.1) Level 2 copypage-Semantik beibehalten: Ja Einstellungen für Überdrucken beibehalten: Ja Überdruckstandard ist nicht Null: Ja Adobe PDF-Einstellungen in PDF-Datei speichern: Nein Ursprüngliche JPEG-Bilder wenn möglich in PDF speichern: Nein Portable Job Ticket in PDF-Datei speichern: Ja Prologue.ps und Epilogue.ps verwenden: Nein JDF-Datei (Job Definition Format) erstellen: Nein(DSC) Document Structuring Conventions: DSC-Kommentare verarbeiten: Ja DSC-Warnungen protokollieren: Nein EPS-Info von DSC beibehalten: Ja OPI-Kommentare beibehalten: Nein Dokumentinfo von DSC beibehalten: Ja Für EPS-Dateien Seitengröße ändern und Grafiken zentrieren: JaPDF/X --------------------------------------------Standards - Berichterstellung und Kompatibilität: Kompatibilitätsstandard: NeinANDERE -------------------------------------------Distiller-Kern Version: 7050ZIP-Komprimierung verwenden: JaASCII-Format: NeinText und Vektorgrafiken komprimieren: JaMinimale Bittiefe für Farbbild Downsampling: 1Minimale Bittiefe für Graustufenbild Downsampling: 2Farbbilder glätten: NeinGraustufenbilder glätten: NeinFarbbilder beschneiden: JaGraustufenbilder beschneiden: JaSchwarzweißbilder beschneiden: JaBilder (< 257 Farben) in indizierten Farbraum konvertieren: JaBildspeicher: 524288 ByteOptimierungen deaktivieren: 0Transparenz zulassen: NeinICC-Profil Kommentare parsen: JasRGB Arbeitsfarbraum: sRGB IEC61966-2.1DSC-Berichtstufe: 0Flatness-Werte beibehalten: JaGrenzwert für künstlichen Halbfettstil: 1.0ENDE DES REPORTS ---------------------------------IMPRESSED GmbHBahrenfelder Chaussee 4922761 Hamburg, GermanyTel. +49 40 897189-0Fax +49 40 897189-71Email: [email protected]: www.impressed.de

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