Bond boom indicates change in corporate Germany funding model
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.
This article first appeared in IFR online on 12 March 2013.
The contents of this document are indicative and are subject to change without notice. This document is intended for your sole use on the basis that before entering into this, and/or any related transaction, you will ensure that you fully understand the potential risks and return of this, and/or any related transaction and determine it is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances. You should consult with such advisers as you deem necessary to assist you in making these determinations. The Royal Bank of Scotland plc (“RBS”) will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser or owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on RBS for investment advice or recommendations of any sort. RBS makes no representations or warranties with respect to the information and disclaims all liability for any use you or your advisers make of the contents of this document. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not lawfully be disclaimed.
Where the document is connected to Over The Counter (“OTC”) financial instruments you should be aware that OTC derivatives (“OTC Derivatives”) can provide significant benefits but may also involve a variety of significant risks. All OTC Derivatives involve risks which include (inter-alia) the risk of adverse or unanticipated market, financial or political developments, risks relating to the counterparty, liquidity risk and other risks of a complex character. In the event that such risks arise, substantial costs and/or losses may be incurred and operational risks may arise in the event that appropriate internal systems and controls are not in place to manage such risks. Therefore you should also determine whether the OTC transaction is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances.
RBS and its affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding, or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein.
RBS is authorised and regulated in the UK by the Financial Services Authority, in Hong Kong by the Hong Kong Monetary Authority, in Singapore by the Monetary Authority of Singapore, in Japan by the Financial Services Agency of Japan, in Australia by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority ABN 30 101 464 528 (AFS Licence No. 241114) and in the US, by the New York State Banking Department and the Federal Reserve Board. The financial instruments described in this document are made in compliance with an applicable exemption from the registration requirements of the United States Securities Act of 1933, as amended. In the United States, securities activities are undertaken by RBS Securities Inc., which is a FINRA/SIPC (www.sipc.org) member and subsidiary of The Royal Bank of Scotland Group plc. Dubai International Financial Centre: This material has been prepared by The Royal Bank of Scotland plc and is directed at “Professional Clients” as defined by the Dubai Financial Services Authority (DFSA). No other person should act upon it. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Professional Client”. This document has not been reviewed or approved by the DFSA. Qatar Financial Centre: This material has been prepared by The Royal Bank of Scotland N.V. and is directed solely at persons who are not “Retail Customer” as defined by the Qatar Financial Centre Regulatory Authority. The financial products and services to which the material relates will only be made available to customers who satisfy the requirements of a “Business Customer” or “Market Counterparty”.
The Royal Bank of Scotland plc acts in certain jurisdictions as the authorised agent of The Royal Bank of Scotland N.V.
The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB