Bond boom indicates change in corporate Germany funding model

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German companies are raising record amounts of cash in the bond markets as they capitalise on global demand to diversify funding.The long-term result could be a permanent change in corporate Germany’s funding model and a strong base for future growth, says Ingrid Hengster, RBS Country Head, Germany, Switzerland and Austria.

Ingrid Hengster, RBS Country Head, Germany, Switzerland and Austria

In the past 12 months, European corporate debt markets have boomed. Company treasurers across the continent have taken advantage of rock-bottom yields to sell debt to investors seeking better returns than the near-zero rates on the safest government debt. In Germany, this has meant an unprecedented opening up of the corporate debt markets.

In 2012, investment-grade companies in Germany raised the equivalent of EUR70 billion selling bonds, 96 per cent more than in 2011 and 121 per cent more than in 2010. The market continues to be active this year, with more private companies looking to sell bonds and more medium-sized companies wanting to follow suit. Corporates including construction services provider Bilfinger SE and Hochtief sold bonds for the first time, while Volkswagen, Daimler and BMW were among those who did multiple issues. The average interest rate, or coupon, on investment-grade debt denominated in euros tightened to 2.4 per cent from 3.9 per cent in 2011, while the average tenor remained at 6.8 years.

The traditional investor base for German corporate bonds is also changing, with pension funds, insurance companies and institutional funds being joined by private banks and retail investors. These investors are choosing to place cash hoarded during the financial crisis in German corporate debt because of the strong performance of the economy relative to other European states. They are also locking in longer-term yields higher than what they can find on Government debt. For example, 2013chemical company BASF issued a 10-year bond in November 2012 with a re-offer yield of 2.13 per cent, a 71 basis point pick-up for investors versus investing in German government debt.

As more investors buy and demand increases, it is creating even better conditions for sellers. German companies are effectively funding themselves at the same rate that the German government was two years ago. Some German companies are even achieving negative real yield on their debt, which means the yield they are paying to investors is lower than the rate of inflation. Investors are happy to accept this because they are confident their principal will be repaid when the bond matures. With demand at such high levels, now is the time for Germany corporates to consider cementing medium-term funding plans.

While German companies are predominately selling euro or US dollar-denominated debt to European investors, more liquidity in the market means that other groups of investors and other currencies are becoming accessible. Volkswagen is among companies that sold US dollar debt to US investors, known as yankee bonds, in 2012. Companies are also looking at alternative currencies such as Swiss franc and the Chinese renminbi, either to finance business they conduct in those currencies or to take advantage of even better rates.

This diversification makes it clear that while the current boom in European corporate bonds will not last forever, its affect on the German market will be long-lasting.

The most profound change will probably be to corporate Germany’s funding model, which has long been based on using bank loans for the majority of financing needs.

The dominance of loans will subside for two reasons. Firstly, new regulations forcing banks to boost capital and therefore shrink their balance sheets means they are likely to decrease the amount they can lend. Secondly, more corporates will want to use the capital markets to diversify funding sources and reduce concentration risk.

The recent boom has indicated that not only large, highly rated public companies want to tap the capital markets. Some of Germany’s medium-sized companies are showing more interest in selling public debt. Because of their size, these companies often have lower or no credit ratings. But this is an impediment that will probably be increasingly overlooked by investors keen to go down the rating spectrum to secure higher yields.

The overall result will likely be that within two years, German companies will on average fund themselves 50 per cent in the loan market and 50 per cent in the bonds market.

It is unlikely the funding model will shift further than this because of the strong history of bank/corporate relationships in Germany. Corporates will still have a strong desire to use bank loans for working capital and banks will still want to lend to strong, well-established companies at the right price and under the right circumstances.

The other long-term effect of German companies refinancing debt at low rates is that they will have a strong funding base to protect against future headwinds such as redemptions, or for growth strategies such as acquisitions. It will also likely increase focus on the use of less traditional bond or loan structures, such as high-yield debt, bonds backed by assets or to finance projects.

As the economic future of Europe remains uncertain, and the German economy comes under pressure from industrial production and exports, any opportunity for companies to shore up balance sheets should be welcomed. 

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This article first appeared in IFR online on 12 March 2013.

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