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Deutsche Industriebank German Market Outlook 2014 Mid Cap Financial Markets in Times of Macro Uncertainty and Tightening Bank Regulations
Deutsche Industriebank German Market Outlook 2014 Mid Cap Financial Markets in Times of Macro Uncertainty and Tightening Bank Regulations
b
n
German Market Outlook 2014
December 12th, 2013 12
have been focused on matching insurance money with long-term mid-cap lending.
IKBs Senior Secured Debt Fund Hidden Champions is a credit vehicle that
combines the investment funding for mid-cap companies with the investment
requirements of insurance companies.
Development of a mid-cap bond market: Mid-cap companies have in the past
shied away from the disclosure requirements of public bond markets, while at the
same time, the minimum issue sizes of 200m+ often exceeded the financing needs
of the Mittelstand. With the introduction of dedicated mid-cap bond market
segments, German SMEs can now cover funding needs through these channels and
over 5bn worth of capital has been raised thus far. While these new market
segments still face numerous issues in terms of documentation, underlying credit
quality and overall liquidity, the emergence of dedicated institutional fund managers,
various initiatives covering issuer quality and the ongoing need for yield will ensure
the further development of this market into the little brother of the high-yield market
for established German corporations. The recent successful and oversubscribed
issues such as Alfmeier (30m) or Hrmann (50m) underpin the fact that investor
appetite for such issues is still high.
Mid-cap mezzanine: With expansion and investment programs predicted for the
German industry for 2014 and beyond often requiring additional risk capital, we also
forecast an increased demand for dedicated mezzanine capital. The Valin
Mezzanine Fund of IKB/Seer Capital is one of these dedicated funds, providing
mezzanine capital to companies having up to 50m turnover and holding further
growth potential.
Outlook 2014: Further
diversification of
funding sources
In summary, we expect a further diversification of funding sources in 2014, utilized by
German corporations away from traditional bank lending given the increased funding
needs and the desire to reduce dependency on banks and against the backdrop of
continuing regulatory scrutiny for the financial industry.
German Market Outlook 2014
December 12th, 2013 13
German Private Equity Market
2013: overall M&A
volume continues to
rise
After a slow start into the year with the total German M&A volume of 5.8bn in Q1 (down
-57% from 13.6bn in Q4 2012 and -52% from 12.0bn in Q1 2012), the pace picked up
with 29.4bn and 23.4bn in Q2 and Q3 respectively. The aggregate YTD volume as of
Q3 is up 32% as compared to Q3 2012 and already slightly above the entire year of
2012 (58.6bn vs. 58.1bn). The number of deals over that period amounts to 482 vs.
692 for the entire year of 2012, implying an increase of 45% in average deal value during
YTD 2013 as compared to last year. The increase is, among others, driven by three
large sponsor-backed transactions in Q2.
Fig. 20: M&A Activity in Germany
20072013 (Value bn)
Fig. 21: M&A Activity in Germany per
Quarter 20112013 (Value bn)
Source: Merger Market, Q3 2013
Source: Merger Market, Q3 2013
Buy-out activity
increased 33% YTD
compared with 2012
driven by three large
deals in Q2
This years total buy-out volume reached 10.1bn until Q3, representing an increase of
33% over the same period last year. On a quarterly basis, the buy-out activity has
followed a similar pattern, although more pronounced, with a total deal volume of 0.4bn
as compared to 3.9bn in Q4 2012. Later, a significant rise of 8.9bn was witnessed in
Q2 2013, accounting for 88% volume in YTD on the back of 26 transactions. Of this
amount, nearly 7.9bn was contributed by only three transactions: CVC/ ista (Apr-13),
Cinven/ CeramTec (Jun-13) and BC Partners/ Springer Science (Jun-13). On that basis,
the buy-out activity as percentage of the total value has slightly decreased to 17.2%.
Fig. 22: Buy-outs in Germany
20072013 (Value bn)
Fig. 23: Buy-outs in Germany
per Quarter 20112013 (Value bn)
Source: Merger Market, Q3 2013
Source: Merger Market, Q3 2013
Most buy-outs in
industrials/chemicals,
while highest value in
TMT driven by a few
large transactions
In terms of industry sectors, Industrials/Chemicals continue to represent the majority of
buy-outs in Germany with 42.0% of all transactions, but with only 35.0% in terms of
value. TMT was the most sought after sector in terms of value with 30.7%, which was
also driven by the large transactions mentioned above.
86.2
65.1
39.8 39.2 38.4
58.1
58.6
695
586
488
557
650
692
482
0
200
400
600
800
2007 2008 2009 2010 2011 2012 2013
YTD
0
20
40
60
80
100
120
Value in bn No. of deals
14.4
14.2
6.2
3.7
12.0
13.5
19.0
13.6
5.8
29.4
23.4
161
170
167
152
183
147
173
189
170
152
160
0
50
100
150
200
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2011 2012 2013
0
10
20
30
40
50
Value in bn No. of deals
23.9
14.0
4.2
3.2
5.6
11.5
10.1
27.8%
21.4%
10.6%
8.0%
14.7%
19.8%
17.2%
0%
5%
10%
15%
20%
25%
30%
2007 2008 2009 2010 2011 2012 2013
YTD
0
5
10
15
20
25
30
35
Value in bn % of total M&A value
0.6
3.3
0.7
1.0
0.9
4.9
1.8
3.9
0.4
8.9
0.8
4.5%
23.1%
11.5%
27.0%
7.6%
36.4%
9.5%
28.6%
7.4%
30.3%
3.2%
0%
10%
20%
30%
40%
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3
2011 2012 2013
0
2
4
6
8
10
Value in bn % of total M&A value
German Market Outlook 2014
December 12th, 2013 14
Fig. 24: Buy-outs in Germany by
Industry (Value, YTD 2013)
Fig. 25: Buy-outs in Germany by
Industry (# of Transactions, YTD 2013)
Source: Merger Market, Q3 2013
Source: Merger Market, Q3 2013
More buy-outs than
exits sponsors
increase German
exposure
The primary buy-out activity in YTD 2013 has declined by around 45% as compared to
the same period last year, while the secondary volume has more than doubled. Exits to
strategics remained flat, resulting in an increase in sponsors net exposure to Germany.
Fig. 26: Average Mid-Cap: Senior Debt/EBITDA
1)
1) European buy-outs of companies with 50m EBITDA or less
Source: Bloomberg
Growing willingness to
invest in leveraged
paper
Willingness of both banks and investors to invest in leveraged paper has continued to
grow. For European issuers with EBITDA of 50m or less, the average senior leverage
has increased by 1.1x to 4.4x senior debt/EBITDA this year as compared to 2012. While
2012 represented a break from the post-crisis trend resulting in increased risk awareness
driven by the European sovereign crisis, leverage in 2013 has resumed the upward trend
towards the 2007 high of 4.9x.
Key trend I: reduced
funding costs
The continued decline in funding costs has added to these increased leverage levels and
has also led to a significant increase in refinancings. In 2013 YTD, almost 50% of all
leveraged loans were issued to recapitalize existing portfolio assets.
35.0%
30.7%
27.6%
3.6%
1.8%
0.9% 0.3%
0.2%
42.0%
17.4%
10.1%
7.2%
7.2%
5.8%
2.9%
2.9%
2.9%
1.4%
TMT Business Servi ces Industrials & Chemicals
Financial Services Pharma, Medical & Biotech Consumer
Energy, Mining & Utilities Construction Leisure
Agricul ture
4.9x
3.9x
3.4x
3.5x
3.8x
3.3x
4.4x
2007 2008 2009 2010 2011 2012 2013
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
6.0x
Europe
German Market Outlook 2014
December 12th, 2013 15
Fig. 27: Weighted Average New Issue
Spreads in Germany
Fig. 28: Sponsored New-Issue
Leveraged Loan Volume 20042013
Source: S&P, Q3 2013
Source: S&P, Q3 2013
Key trend II: continued
availability of funds
Private equity investors continue to raise significant amounts of funds, driven by
investors search for return. According to Preqin, assets under management as a sum of
the unrealized value of existing portfolios and dry powder, continued to increase by 5%
in 2012. This reflects a slight decline of -1% in funds available for investment, which was
overcompensated by the 8% increase in assets (unrealized value).
Fig. 29: Private Equity Assets under Management 20032012
Source: Preqin, 2013
Key trend III: reduced
uncertainty
The funding costs of Europes weaker economies are used as an estimate of the current
market assessment of the Euro sovereign crisis. The figure below illustrates that one
significant contributor to overall market uncertainty has been reduced (or is being ignored
for now). Spains spread for 10-year government bonds has reduced by over 400bps
from the peak of the crisis in summer 2012 to around 200bps currently. This reduced
uncertainty could increase buyers as well as sellers willingness to reach a deal.
Fig. 30: CDS for Spain/Italy 10Y Government Bonds 20072013 (bps)
Source: Bloomberg, November 2013
E+ 150
E+ 200
E+ 250
E+ 300
E+ 350
E+ 400
E+ 450
E+ 500
E+ 550
2007 2008 2009 2010 2011 2012 2013
RC/TLA TLB/TLC
44.4
103.0
115.8
137.7
48.6
4.7
19.4
33.3
23.4
36.2
2
6
.
4
%
3
2
.
2
%
1
8
.
3
%
2
7
.
2
%
0
.
9
%
0.0%
19.7%
31.7%
37.0%
48.8%
0%
10%
20%
30%
40%
50%
60%
04 05 06 07 08 09 10 11 12 13
0
20
40
60
80
100
120
140
160
Leveraged loan volume (bn)
Recap/Refi as % of total loans
405 409
563
806
1,011 1,075 1,067 994 1,007 997
465
554
675
898
1,265 1,204
1,413
1,783
2,028
2,197
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
0
500
1,000
1,500
2,000
2,500
3,000
3,500
Dry powder US$bn Unreali zed value US$bn
0
100
200
300
400
500
600
700
1 Jan 07 19 May 08 5 Oct 09 22 Feb 11 10 Jul 12 27 Nov 13
Italy CDS USD SR 10 Y Spain CDS USD SR 10 Y
German Market Outlook 2014
December 12th, 2013 16
Key trend IV: attractive
valuations
Reduced uncertainty has not only facilitates M&A transactions, but has also led to a
significant appreciation among equity capital markets around the globe. Since the
beginning of this year, DAX and MDAX have gained 21% and 33% respectively after
rising 25% and 31% in 2012. On this basis, valuation levels have increased further. On
an average, EV/EBITDA (1-year forward looking) increased by 0.8x, increasing sellers
willingness to exit non-core assets (strategics) or to consider early exits (sponsors).
Fig. 31: DAX EV/EBITDA
Fig. 32: Performance of DAX and MDAX
20112013
Source: Bloomberg, November 2013
Source: Bloomberg, November 2013
Outlook 2014: more of
the same
It appears as if all the ingredients are available for maintaining the positive M&A
momentum into the next year, releasing some of the pent-up demand for the post-crisis
M&A activity. Reduced uncertainty from the abatement of the economic crisis provides a
more stable environment for both buyers and sellers. In combination with a favorable
funding environment, financial sponsors should continue to take their share in the rising
M&A activity, potentially even increasing their contribution. Rising asset valuations
combined with cheaper funding and higher leverage should increase the likelihood of
corporate sellers and financial buyers coming to terms. However, a reemergence of the
sovereign debt crisis or an economic slowdown would negatively impact the overall trend.
12.6x
6.0x
8.1x
6.8x
6.0x
7.0x
7.8x
2007 2008 2009 2010 2011 2012 2013
0.0x
2.0x
4.0x
6.0x
8.0x
10.0x
12.0x
14.0x
EV/EBITDA 1 Year Forward
60%
80%
100%
120%
140%
160%
180%
Jan-2011 Dec-2011 Dec-2012 Nov-2013
DAX MDAX
German Market Outlook 2014
December 12th, 2013 17
Corporate Market
Fig. 33: Corporate Loans Volume
(Western Europe)
Fig. 34: Pricing
(Western Europe)
Sources: LPC
Sources: LPC
Key Trends 2013 The Western European loan market managed to arrange a loan volume of 268bn as of
September 2013 YTD, which is 18% below the previous year. The loan market was quite
dynamic, reflecting the competition among European banks to maintain their important
role. The major trends in YTD 2013 were:
Refinancing transactions drove the loan market (82%), while use of proceeds for
M&A activity remained at a low level (5%).
Pricing tightened for A and BBB range corporations from 115bps to 44bps and from
185bps to 82bps between January and September 2013 respectively. Within an 18-
month period, margins have been squeezed even more with -143bps and -131bps
for same rating spectrum.
Maturities for large Blue Chips extended from 3 to 5 years toward 5 years with two
1-year extension options.
The Investment Grade volume in Western Europe amounted to more than
US$700bn and was almost equally divided between loans and bonds. Historically,
the average split was at around 80:20 in favor of loans.
In the German small and mid-sized corporate market, we have observed an
increasing number of non-IG corporations were able to convert bilateral baw
commitments in up to 3-year credit lines.
Outlook 2014 The competitive environment among banks will remain intense for large and mid-
sized Investment Grade companies. Particularly on the back of Basel III
implementation, more banks will be active in the German mid-cap market segment,
which would substantially improve funding costs for IG corporations.
With respect to the overall loan vs. bond volume for corporate financing, we expect
the split to shift in favor for loans given the strong loan market dynamics. However,
corporations have learned their lessons to quickly adjust to market changes and
switch horses.
Institutional investors are positioning themselves to play a more important role
through their direct lending activities. However, competitive pricings and longer
maturities offered to IG corporations will slow down the rollout of direct lending
activities.
This competition among lenders has led to tightening margins during 2013 YTD for
larger IG corporations. We would expect this margin pressure to remain in place
until an exogenous factor affects the risk/return profiles of banks. In addition, we
would expect this trend to roll down the rating scale toward crossovers.
However, the refinancing volume will decline since many Blue Chip corporations
have already taken advantage of the favorable market environment in 2013.
Subsequently, we would expect an increasing number of refinancing transactions
0
50
100
150
200
250
3
Q
0
9
1
Q
1
0
3
Q
1
0
1
Q
1
1
3
Q
1
1
1
Q
1
2
3
Q
1
2
1
Q
1
3
3
Q
1
3
0
20
40
60
80
100
120
140
160
C
o
u
n
t
V
o
l
u
m
e
(
b
n
)
DACH Other Deal Count
2009 2010 2011 2012 2013
E+0
E+50
E+100
E+150
E+200
E+250
E+300
S
p
r
e
a
d
A Pricing BBB Pricing
(-131bps)
(-143bps)
213bps
82bps
186bps
44bps
German Market Outlook 2014
December 12th, 2013 18
with a lower average deal size as larger mid-cap companies would try to benefit
from the increasing bank appetite and aggressive terms.
In 2014, the trend for longer maturities will intensify and slowly move down the
scale into the mid-cap space.
On the back of these developments, refinancings will continue to play a dominant
role in corporate land. We would expect more IG mid-cap companies to focus on
early refinancings in order to take advantage of the current favorable market
conditions. Thus, an increasing number of early refinancings should be observable.
Furthermore, we expect the volume of M&A-driven deals to increase, though from a
rather low starting level. Corporations have improved their operational performance
and are now exploring strategic opportunities.
KfW financing programs for capital expenditures will play a more important role for
prosperous small and mid-sized companies. Depending on the economic climate,
volumes are expected to cross the 23bn threshold in 2014 vs. around 20bn in
2013.
For small and mid-sized companies, we see a continuing trend for borrowers to
push for 35 year credit lines based on a standardized documentation, while trying
to avoid the syndicated loan product as financing instrument of choice.
German Market Outlook 2014
December 12th, 2013 19
Corporate Schuldscheindarlehen: Tongue Twister Goes Abroad
Current developments
and outlook
Over the last 10 years, the Corporate Schuldschein market in Germany has
attracted strong demand from investors. With a total issuance volume of
approximately 8.3bn in 2013, the positive long-term trend remains intact.
Around 65 transactions were completed on best efforts basis in the current year
which is similar to 2011. Especially in the last two years, Corporate Schuldschein
transactions with a minimum volume of 5075m were executed with more than one
arranger in order to increase transaction certainty. A considerable number of private
placements below 30.0m (also bilateral transactions) were not included in the
market volume.
While a public rating can be utilized for marketing a Corporate
Schuldscheindarlehen, the majority of issues were marketed on an unrated basis. It
will be interesting to see whether this changes in 2014, on the back of an increasing
footprint of continental European agencies such as Euler Hermes and higher
awareness of the Schuldschein product by insurance companies that often require
ratings.
Many corporations have taken advantage of the Corporate Schuldschein market as
first time issuers sometimes using Schuldschein as a first step toward capital
markets, and thus showing capital market readiness.
We estimate the total volume of outstanding Corporate Schuldschein volume to be
in the range of 6070bn currently, and the corporate Schuldschein market
redemptions to be approximately 5.06.0bn in 2013. A large number of these
redemptions have been replaced by new issues.
Approximately 25% of the Corporate Schuldschein issuers were foreign companies.
Foreign issuers from European countries have frequently tapped the Corporate
Schuldschein market and have successfully executed transactions.
Additionally, besides Euro tranches, the market also saw a couple of transactions
that include US dollar tranches (e.g. Software AG, Biotest AG).
Transaction maturities extended from around 3 to 5 years in 2012 toward 5 to 10
years in 2013, depending on the industry a trend that we expect to continue in
2014.
The investor universe remains broadly unchanged and dominated by banks in the
shorter maturities. However, as an implication of Basel III, we expect institutional
investors such as insurance companies and pension funds to assume increasing
importance. Consequently, issuers will have to continue to broaden and diversify
their investor base.
In 2014, we expect no change regarding investors interest and liquidity, and
estimate the issued volume to be in the range of 8.510.0bn.
Fig. 35: Total Corporate Schuldschein volume 2004 YTD 2013
Source: IKB; Bloomberg
3,000
4,500
5,000
5,500
18,900
7,020
3,725
7,059
11,985
8,346
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
0
4,000
8,000
12,000
16,000
20,000
i
n
m
Total SSD volume
German Market Outlook 2014
December 12th, 2013 20
Fig. 36: Average Schuldschein Volume per Transaction 2009 YTD 2013
Source: IKB, Bloomberg
Fig. 37: Issuance Volume by Rating 2009 YTD 2013
Source: IKB, Bloomberg
111.4
116.4
108.6
131.7
126.8
2009 2010 2011 2012 2013
0
20
40
60
80
100
120
140
i
n
m
0
50
100
150
200
250
2009 2010 2011 2012 2013
0
500
1,000
1,500
2,000
2,500
3,000
3,500
i
n
m
N.R. BBB A AAA/AA iTraxx Main
German Market Outlook 2014
December 12th, 2013 21
Leveraged Market: Borrower Friendly is Back
Leveraged Volume & New-Issue YTM
Fig. 38: Leveraged Loans
Fig. 39: New-Issue Yield to Maturity
Source: Company, IKB analysis
Source: Company, IKB analysis
Key Trends 2013
The European Leverage Market looks back at 2013 as a strong year. Volumes increased
from 65bn in 2012 to a volume of 117bn YTD October (80% increase). Main deal
purposes were refinancings (41%), acquisitions/M&A (24%) and recaps (9%).
However, on the loan side, repayments (14bn) exceeded new institutional issues since
July (12bn) and the forward M&A pipeline is limited.
Deal structures were driven by:
Strong evolution of high-yield financing structures with issue levels of 60bn and a
proportionate share of 51%
A total volume of 6.4bn in the larger deal segment (EBITDA 100m plus) has been
syndicated at least partially cross-border based on strong US investor liquidity as of
October YTD. Cross-border deals are characterized by bullet structures and a
covenant-lite nature
Clubby deal flow continues in the mid-cap space (EBITDA up to 30m). Direct
lending funds are increasing their presence in this segment, competing with bank
financings, but are often more expensive
We observed the revival of the European CLO issuance with around 6bn worth of new
vehicles in YTD (six-year high), which is still a small volume as compared to 2007 levels
(32bn).
Outlook 2014 In light of a stable macro environment, we expect borrower-friendly terms to persist
over the medium term, as long as investors are vying for deals.
It remains to be seen how far borrowers will be able to push the envelope regarding
reduction of margins and fees, loosening covenant sets, headroom and dividend
language and simultaneously stretching leverage.
Loan structures will remain bullet-driven with a strong focus on the institutional
investor class (and therefore a reduced share available for banks).
However, we expect a set-back of market conditions in late Q1 or Q2 2014 since i)
the market is likely to become overheated, and ii) concerns around the European
sovereign debt remain unresolved.
Investment banks share in the leverage space will presumably continue to be strong
based on the open high-yield window with the product having entered the smaller
deal size area of 200m plus.
Mid-cap transactions with a deal size below 150m continue to be clubby, given the
involvement of debt advisors hired to optimize terms (avoiding market flex language
and reducing management time required for syndication).
Question remains whether M&A activity will support the overall positive momentum.
42.3 43.9
27.3
51.0
0.0 0.0
1.4
6.4
44.4
35.7
36.4
60.2
2010 2011 2012 Jan-Oct
13
0
20
40
60
80
100
120
140
V
o
l
u
m
e
(
b
n
)
Loans Cov-Li te Loans
HY Bonds
86.7
79.6
65.0
117.5
4%
5%
6%
7%
8%
9%
10%
11%
1
Q
1
1
2
Q
1
1
3
Q
1
1
4
Q
1
1
1
Q
1
2
2
Q
1
2
3
Q
1
2
4
Q
1
2
1
Q
1
3
2
Q
1
3
3
Q
1
3
3,80
4,00
4,20
4,40
4,60
4,80
5,00
Y
i
e
l
d
L
e
v
e
r
a
g
e
Loan Debt/EBITDA
HY Senior Secured Bonds
TLB Yields
German Market Outlook 2014
December 12th, 2013 22
European High-Yield Market: Coming in Strongly
2013: a record year in
high-yield issuance
European high-yield bonds are the new favorite among investors, attracting higher
inflows as compared to leveraged loans since 2012. Leveraged loans saw their peak
time in 2007.
Driven by low interest rates and an improved economic outlook for Europe, the
European high-yield bond market has seen another record year in terms of new
issuance in 2013, by surpassing the previous high of 2010. Despite slightly weakened
momentum in H2 2013, issuance is on its way to cross the 70bn mark, with a total of
199 issues as of November 30, 2013, and more than 200 expected by the end of this
year.
1
The average bond size is 352m in YTD 2013, which is slightly bigger than the average
size in 2012 (331m), but well below the levels of 2011 (389m) and 2010 (379m). The
higher risk appetite of investors did not only lead to attractive overall financing
conditions, but also to an increase of more aggressive structures including subordinated
bonds (mostly PIK-toggle notes).
The majority of the issuance (54% by number of counts) was used for the refinancing of
bank and other debt, followed by M&A (19%), recap (14%) and general corporate
purposes (14%).
Fig. 40: European High-Yield Bond Volume
1) YTD 30.11.2012
2) YTD 30.11.2013
Source: LCD
Southern Europe:
issuance activity
picking up
In terms of geography, the UK, Germany and France continue to be the top three most
active countries, together accounting for around 50% of the total European high-yield
volume in YTD 2013. We have also observed the increasing share of issuers from
Southern European countries, e.g. Italy (8.7% of total volume), Spain (5.1%), Portugal
(4.6%) and Greece (3.6%). With investors in search of high-yield opportunities, issuers
domiciled in these countries are also taking advantage of the positive market momentum
to raise debt and diversify away from contracting bank lending markets. Recently, bonds
from first-time Italian issuers such as Astaldi, Teamsystems and Marcolin (IKB acted as
joint-bookrunner) came to the market.
Both sponsored and
non-sponsored
companies increased
issuance activities in
2013
After the booming years of LBO transactions in 2007, bond issuance activities of PE-
sponsored companies dropped in 2008 and 2009, but recovered in 2010. In the past four
years (2010YTD 2013), non-sponsored issuers were responsible for around 6070% of
the total European high-yield bond volume each year. In 2013, the bond issuance
volume from both PE-sponsored and non-sponsored companies, in particular traditional
family-owned businesses diversifying their funding sources, increased substantially. This
clearly shows that high-yield bonds are becoming the favored financing product for
corporations to raise money.
1
LCD European High-Yield Weekly Review, November 29, 2013, by S&P Capital IQ
2.4 3.8
10.0
18.8
16.4 16.7
14.2
30.4
17.4
17.6
2.6
14.5
25.2
19.3
18.4
18.0
32.1
2.9
2.7
0.4
1.3
1.6
5.1
0
50
100
150
200
250
2006 2007 2008 2009 2010 2011 2012 2012 2013
0
10
20
30
40
50
60
70
b
n
Secured Unsecured Subordi nated # of Bonds
22.7
24.2
2.6
24.5
44.4
35.7
67.6
33.1
36.4
1)
2)
German Market Outlook 2014
December 12th, 2013 23
Of the 149 issuers we counted in YTD 2013, 49 (or 33% by count) were public
companies, while 100 issuers (or 67% by count) were in private ownership.
Fig. 41: Share of Total
High Yield Volume
Fig. 42: Bond Volume
by Ownership
1) Southern Europe includes Italy, Spain, Portugal and Greece.
2) YTD as of November 30
th
.
Source: LCD European High-Yield Weekly Review, November 29, 2013
We note the following trends regarding the European high-yield bond issuance:
High-yield corporate bonds are becoming a favored financing instrument for both
issuers and investors due to their high liquidity, more transparent prices, less
complicated documentation and reporting requirements (compared with credit
agreements), and good yield potentials. Some companies have even installed an
all-bond financing structure.
The traditional role of banks as the dominant external financing source is being
challenged. Unlike public companies that have access to equity capital market to
raise additional equity, an increasing number of private companies will be forced to
redesign their financing structure. Since banks are faced with more rigid rules to
meet Basel III requirements, the share of bank loans in percentage to total liabilities,
especially for private companies, is expected to continue to decrease in the future.
With the stabilization of economic activity in the Southern European countries and
growing investor confidence, companies from these countries are seen as attractive
issuers, due to the relatively higher coupons.
iTRAXX Crossover at
five year low
Due to high inflows into high-yield funds, and driven by the appetite for higher yield by
investors, corporate credit spread tightened substantially, whereas the synthetic iTRAXX
Crossover reached its lowest level for 5 years in November 2013. After a temporary
spread widening in June, on the background of market uncertainty and high volatility in
all markets, the iTRAXX stood at 320.6 on November 29th. The lowest level of the
iTRAXX was reached in February 2007 with 171. We see some additional room for
further spread tightening.
Primary yield A similar trend can be observed in the average primary yield of the bonds. The bond
break price has picked up slightly for the last three months, at 101.1, indicating strong
ongoing demand by investors.
20062007200820092010201120122013
0%
20%
40%
60%
80%
100%
UK Germany
France Southern Europe
Other
1)
2)
06 07 08 09 10 11 12 YTD
12
YTD
13
0
10
20
30
40
50
60
70
80
Sponsored Non-Sponsored
2) 2)
German Market Outlook 2014
December 12th, 2013 24
Fig. 43: iTRAXX Crossover
Fig. 44: Average Primary Yield
by Rating
Source: Bloomberg
Source: LCD
Maturity wall promises
high activities in the
next years
According to Bank of America Merrill Lynch, between 2015 and 2018, bonds of a total
volume between 33.3bn and 47.9bn will mature each year
2
. Since many companies
take advantage of the positive market dynamics and refinance their bonds already more
than one year before maturity, and a large part of the bonds carry call provisions, it can
be expected that 2014 will be another good year in terms of issuance activities in the
high-yield space. The same applies for the years thereafter, unless a real catalyst occurs
and dampens the market.
Fig. 45: Maturity Wall of European High-Yield Bonds
Source: Bank of America Merrill Lynch European High-Yield Bond Index
Outlook 2014 With the iTRAXX Crossover trading at a very low level, the question remains whether
2014 will be another strong year with good returns in the high-yield market. Is the high-
yield market already overheated? How long can the rally continue? Which event could
be a market trigger and mark the turning point?
Macroeconomic picture
supportive and strong
liquidity in the market
The macroeconomic picture in Europe is positive and even some Southern peripherals
are on a recovery path. Interest rates are expected to be kept low in the next 1 to 2
years. Hence, high-yield bonds will continue to be an attractive asset class. Given the
improved macroeconomic outlook for 2014, especially a strong German economy and
stabilization in the Eurozone as a whole (see section Global Economic Outlook and
Prospects for the German Economy), corporations are expected to benefit from an
improving macroeconomic environment and improve their operating results. Liquidity
continues to be another supporting element in this equation.
2
Bank of America Merrill Lynch European High-Yield Bond Index.
Dec-
2008
Dec-
2009
Dec-
2010
Dec-
2011
Dec-
2012
Dec-
2013
0
200
400
600
800
1,000
1,200
1,400
ITRX XOVER CDSI GEN 5Y Corp
1
H
0
9
2
0
0
9
2
Q
1
0
4
Q
1
0
2
Q
1
1
4
Q
1
1
2
Q
1
2
4
Q
1
2
2
Q
1
3
3
M
E
2
2
/
1
1
/
1
3
0%
2%
4%
6%
8%
10%
12%
14%
B BB
0.00
4.02
33.60 33.28
36.74
47.88
25.67
29.63
15.50
2013 2014 2015 2016 2017 2018 2019 2020 2021 or
Later
0
10
20
30
40
50
60
b
n
German Market Outlook 2014
December 12th, 2013 25
Balance sheet of
companies: in a healthy
state
Overall, companies are in a healthy shape: Most of the companies have a good equity
cushion and have streamlined their cost structure. Capex spending has increased, but is
still at a comfortable level in relation to the current operating cash flows. M&A activities
should pick-up in 2014, but given the strong balance sheet of many companies, we think
increased M&A activities would not have a negative impact on the credit profile of the
companies. We therefore see no significant impact, whether positive or negative in
nature. Rating movements should be limited to specific names.
Refinancing supportive
for the high-yield
market
Given the maturity wall of many companies, refinancing will be one of the core themes
for 2014. In view of the favorable financing conditions, new issuance in the bond market
is expected to remain high.
Conclusion We currently see no relevant macroeconomic nor fundamental triggers concerning the
overall credit quality of the companies on the near-term horizon. With the iTraxx
Crossover not having reached its tightest point, we even see further room for spread
tightening. One of the key factors is liquidity in our opinion and here the focus will be laid
on the tapering process in the US.
German Market Outlook 2014
December 12th, 2013 26
Mid Cap Bond Market
Record level of bond
issuance in the mid-cap
bond market
In the German mid-cap bond market
3
, we have counted 44 new issues with a total
placed volume of 2.5bn YTD. Although an increasing number of companies are seeking
bond financing as an alternative to bank loans, the average bond volume declined by
4.4m to 31.2m
4
compared to 2012. An increasing number of smaller issues are being
placed, whereas at the same time, the realized volume (86.8% YTD November 2013 and
94.6% in 2012) has also come down.
Frankfurt, with its three sub-segments (Entry Standard, Open Market and Prime
Standard), has become the leading market with 35 bonds placed in YTD. Thus, Frankfurt
has surpassed other markets such as BondM (Stuttgart), which brought the first bond
back in 2010.
Fig. 46: Mid-Cap Bond Issue Volume
Source: Bloomberg
Mid-cap bond market
as an excellent
platform for SMEs
With lower IG and non-IG companies still facing some constraints on the lending side in
terms of volume and covenants, the mid-cap bond market provides (in principle) a good
platform to raise funds for the purpose of refinancing or growth financing.
Investors are
becoming more
skeptical
However, after a wave of negative news flows, e.g. issuer insolvencies, rating
downgrades, operating result deteriorations, investors are becoming increasingly
cautious and selective toward this asset class. Hence, it is more difficult to place new
issues now, as is reflected in the lower placement quote of 86.8% (placed volume/
targeted issue volume) in YTD 2013. A number of announced issues have also been
downsized or even pulled out.
Low liquidity in the
secondary market
Another problem arising from the relatively smaller issue volume is the lower level of
liquidity in the secondary market. Even in the absence of any adverse fundamental news,
bond prices may be pushed down several points. In our view, a minimum issue size of c.
30m should be adhered to.
Low recovery rate in
case of insolvency
So far, nine issuers (or 7.4% of total issuers) have filed for insolvency with an average
recovery rate expected below 10%. Around 40% of total bonds are trading below par with
c. 11% trading in the distressed area (bond price < 75%). Approximately 60% of the
bonds currently trade above par and over 21% of these bonds trade over 105. These
data points underline our view of an increasing level of sophistication among bond
investors. Bond picking on the basis of fundamental analysis are therefore, crucial for this
market segment.
3
German Mid Cap bond market Universe comprises segments of the Frankfurter Wertpapierbrse (Prime Standard, Entry Standard and Freiverkehr),
Mittelstandsmarkt Brse Dsseldorf and BondM in Stuttgart
4
Excluding 6 larger bonds listed in the prime standard segment
795
1,716
2,260
2,880
713
1,510
2,138
2,499
0
5
10
15
20
25
30
35
40
45
2010 2011 2012 YTD 2013
0
500
1,000
1,500
2,000
2,500
3,000
3,500
m
Planned Issue Volume Placed Volume Number of Bonds
89.7%
88.0%
94.6%
86.8%
German Market Outlook 2014
December 12th, 2013 27
Fig. 47: Planned Mid-Cap Bond Size
5
Fig. 48: Mid-Cap Bond Price
6
Source: IKB research
Source: IKB research
Mid-cap German bond
coupon low
It is worth noting that some mid-cap bonds with lower sales, EBITDA numbers and
smaller issue sizes (even below 20m) were priced at yields around 6.5% to 8.5%, that
is, at a level similar to the high-yield market. This raises the question whether some of
these bonds are fairly priced vis--vis the bigger high-yield issuers.
Smaller segments
underperforming the
liquid high-yield indices
Figure 49 shows that smaller and less liquid indices (MiBOx, BondM Index) seem to
underperform their larger European high-yield peers. The smaller ones have come under
severe pressure especially in the last quarter, whereas the iBoxx Euro High Yield Index
rose slightly.
The Larger Mid-Cap Bonds-Index, which we calculated and includes mid-cap issues
with an issue volume of minimum 30m, delivered a slightly better performance than its
mid-cap peer indices. However, this index also suffered from a similar correction in
November 2013.
Fig. 49: Performance of Bond Indices (High-Yield vs. Mid-Cap)
1) Simple average of the rebased bond prices of mid-cap bonds with a minimum issue volume of 30m, excluding the
insolvent issuers, e.g. Getgoods, SIAG, Solarwatt, Centrosolar, FFK Environment, etc.
Source: Bloomberg
Market begins to
mature
As the mid-cap bond market begins to mature, we have observed an encouraging trend
toward stricter covenants and higher bond security over the past few months. The market
is becoming more professional and investors are becoming more selective in their
investment decisions. As issuers and arrangers are working together to ease investor
concerns, we expect further improvement of standards for mid-cap bonds in the medium
term.
Covenants become
stricter
So far, most of the mid-cap bonds carry the standard covenants such as negative pledge,
cross default, change of control clauses and call rights. More restrictive covenants such
as limitations on net leverage, asset deals, dividend payments, and the security
packages are increasingly found in recent deals. IKB has advocated these changes for
5
Targeted volume. From the 122 bonds we analyzed, 38 bonds, or 31.1% of total were not completely placed.
6
Bond price as of 28.11.2013.
17%
22%
38%
23%
>=100 Mio. >=50-100 Mio.
>=20-50 Mio. <20 Mio.
6.8%
4.3%
9.4%
23.1%
38.5%
17.9%
<50% 50%-75% 75%-90%
90%-100% 100%-105% >105%
90%
95%
100%
105%
Jan-2013 Mrz-2013 Mai-2013 Jul-2013 Sep-2013 Dez-2013
P
e
r
f
o
r
m
a
n
c
e
i
n
%
(
0
1
.
0
1
.
2
0
1
3
=
1
0
0
)
MIBOX Index BondM Index
IBOX Euro Liquid High Yield Index Larger Mid-Cap Bonds-Index
1)
German Market Outlook 2014
December 12th, 2013 28
some time now and with a more professional class of dedicated funds targeting this
segment, investors are pushing forward in the same direction.
Key question: how to
win the institutional
investors
The mid cap bond market will increasingly play an important role for small to medium-
sized companies in Germany, but given similar developments in other countries also
across Europe as a whole. The key question remains how investors will position
themselves in light of trading losses and defaults on existing issues and given the
inherent illiquidity of the market.
In our view, still a lot needs to be done to attract a healthy base of institutional investors
to the mid-cap bond market. In our view, measures should include a stringent
documentation template in line with the high-yield market and adapted to the needs of
mid-cap companies from a legal and accounting perspective, liquidity provision through
lead arrangers, a higher level of rating scrutiny and last but not least larger issue volumes
of 30150m.
Outlook 2014 For 2014, we expect a lower number of new issues, but with better credit quality and
stricter documentations benefiting investors. The average bond volume is expected to
increase, and the total volume of the market is expected to be around the level of 2013.
German Market Outlook 2014
December 12th, 2013 29
IKB Credentials
German Market Outlook 2014
December 12th, 2013 30
Contact Details
Financial Markets
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Phone: +49 (69) 79599-9558
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Phone: +49 (211) 8221-4610
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Phone: +49 (211) 8221-4101
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German Market Outlook 2014
December 12th, 2013 31
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German Market Outlook 2014
December 12th, 2013 32
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