Germany is bearing the weight of Europe on its shoulders. Michael Turner reports on how its export finance bankers are fairing in these tumultuous times.
The eurozone’s woes have stepped up a gear of late. Italy and Spain’s ratings downgrade from Standard and Poor’s has put increased pressure on Southern Europe after the Greece problem refused to go away through extended European central bank bond buying.
The constituent countries have even readied themselves for the contagion spreading to France’s banks with their potentially overwhelming exposure to Greek debt.
Alongside the IMF, Germany is the engine keeping the euro motor going, even if only just. German chancellor Angela Merkel has been criticised for reacting to events slowly, but her September 29 victory in the Bundestag to increase the €440bn eurozone rescue fund, the Eurozone Financial Stability Facility (EFSF), shows that her politics are proving their worth to her government.
Her decisions haven’t stopped her country’s GDP slowing from 1.3% to 0.1% over the second quarter of 2011, though it is debatable whether there were any choices she could have made that would have prevented this. In theory, a combination of reduced interbank lending, a high price on US dollar lending in Europe and a reduced demand from China means that Europe’s manufacturing powerhouse is set for a tough time.
But for the time being, you would barely know it from the country’s export finance bankers. “The problems are even slightly positive for us as long as it is generating further attention on crucial risk mitigation and financing issues,” says Ralph Lerch, head of export finance at Commerzbank. “At Commerzbank, we see continuously huge demand for export finance. From our perspective, export levels might be lower in the second half of the year, but it’s still a pretty high volume.”
A similar sentiment is offered by Werner Schmidt, Deutsche Bank’s head of structured trade and export finance for Germany: “We are still seeing a relatively constant deal flow from business in the market and not too much of a drop yet on the long ECA financing.”
The export finance bankers know that this maintained high volume isn’t necessarily sustainable as the export market typically takes some time to catch up with economic events due to the length of the ordering process. Germany’s ECA Euler Hermes is still seeing a high volume of deals from 2010, for example.
This lag could lead to a drop in export transactions within the next two years, though Susanne Heinssen, head of department underwriting at Euler Hermes, believes differently: “For the future, there will be a higher demand for ECA cover because people now have the experience. It’s good for their business to secure long-term financing. I expect a stable market
for the next few years.”
Even if transactions don’t begin trailing off, another problem in the export finance market comes from transactions taking a lot longer to close now than they did a year ago. This phenomenon, which also occurred during the first phase of the recession in 2008, is caused not only by investors pulling out of deals but also investors demanding extra levels of due diligence to be carried out. Paradoxically, the extra checks regularly cause the running costs of transactions to mount up more, therefore making investor pull-out more likely.
Other factors, such as the private insurance market taking on more risk are also a possibility. Considering the strife banks are currently facing from all angles in the eurozone, a return to pure, unguaranteed lending still looks a way off.
Then there is the notoriously poor marketing of ECA products, with large sections of exporters still oblivious of this source of funding. “Many investors are still unacquainted with this particular finance product,” says Kai Preugschat, managing director of international origination of structured trade and export finance at UniCredit.
“Looking at our markets over the past 30 years, the proportional share of ECA finance support for most countries exports has been falling steadily, with countercyclical surges during crisis periods. This is clearly caused by the growing availability of alternative financing products developed by the markets. Naturally, such a trend goes hand-in-hand with the decline in product awareness. It is the shared challenge for ECAs, banks and exporters to reacquaint the market with this very useful, trade-stabilising product and all the benefits that come with it.”
While it may be taking a while for the message to get through, there has been a large uptick in the amount of German companies looking to export finance as a viable funding option, in part brought about by the financial crisis and the product’s anti-cyclical nature. Euler Hermes has seen covered volume shoot up by almost 90% since the heydays of pre-Lehman collapse.
In 2007, the agency guaranteed 1.8% of German exports, in 2010, Hermes was responsible for covering 3.4%. This is comparing a similar amount of total German exports in the time frame. Exports were worth €965.6bn in 2007 and €951.9bn in 2010, according to the country’s official statistic agency. Hermes and the wider German export finance market have clearly been working to get its products out there.
Heinssen at Hermes says: “We go out to the market and do the marketing for our instrument through things like road shows. This is especially important for small and medium-sized entities that haven’t had so much experience with ECA cover. “There has been a multiplication effect as clients talk more about our product.”
Selling export finance to exporters is looking easier with every swing of the eurozone crisis axe. Some companies are now better rated than their host countries and chief financial officers are watching government bonds raise to yields that are well over sustainable.
Companies might be able to succeed in a bond issuance now to finance their capital goods exports, but in the current economic climate there is almost zero guarantee that they will be able to get away with paying the same coupon on the next necessary bond issuance. This is where export finance can step in nicely; to offer a long-term and stable product.
“We have seen quite a few examples of clients considering either tapping the capital markets with bond issues, or using export finance,” says Deutsche Bank’s Schmidt. “They seem to be more inclined now towards export financing because of the longer tenors and the stability you have on the balance sheet for larger projects within an export finance scheme.”
Extra balance sheet stability is a useful negotiating tool for German financiers, as the price of the export finance product has been creeping up since the eurozone crisis began. Particularly as US dollar funding has got so high as to be genuinely prohibitive to European entities.
Quality of cover
The main factor that marks Germany out as Europe’s centre for export finance comes from the strength of Euler Hermes. Hermes would not comment on its positioning in relation to other ECAs, but quality of cover is the most important aspect that the German agency brings to transactions, according to all banks interviewed by GTR.
A deal coming to the table with ECA cover from a beleaguered country; Italy’s Sace or Spain’s Cesce, for example, would be a cause to pause for serious thought for many bankers in Germany. Having Hermes onboard is a strong credit improvement.
“From a bank’s point of view, an export credit agency guarantee is nothing else but a credit enhancement product, improving the obligor’s risk profile by enabling exposure transfer to a better rated entity,” says UniCredit’s Preugschat.
“Without any doubt, this effect will suffer with the downgrade of sovereign ratings currently experienced by some European countries and will result in modifications of relative attractiveness for individual ECAs.”
Commerzbank’s Lerch adds: “Banks are more obsessed with the quality of cover. It makes a huge difference between Hermes cover and cover from Spain or Italy. From my perspective this is focusing all the banks on the German market because it is without a doubt the best asset quality they can get. A lot of banks are struggling to get access to Hermes-covered loans.”
Cover from Southern Europe’s ECAs is still a viable option, though GTR has heard anecdotally that for export credit agency cover for agencies from the PIIGS countries of Portugal, Ireland, Italy, Greece and Spain, the price has gone up.
One banker even remarked that prices were “going up tremendously”. Italy’s Sace denies any overall increase in its premiums, and instead states that some countries, such as those involved in the Arab Spring, have come under review and are subject to premium hikes, just like at any other ECA.
That doesn’t mean that ECAs from credit-squeezed sovereigns don’t still bring something important to deals, but there is a much larger divide now between inter-European agencies. Collaboration between the weak and strong agencies is getting deals closed in tricky markets.
Earlier this year, Deutsche Bank acted as mandated lead arranger for a €93mn Hermes and Sace-backed loan to Russia’s NLMK for a steel plant in Kaluga. Both ECAs involved are providing a decade of cover for the transaction. For NLMK’s part, the firm is rated at mid-low investment grade, BBB- and BBB3 by Standard & Poor’s and Moody’s respectively. The plant brought in equipment from Germany’s Siemens
Metals and Technology and Italy’s SMS Meer. The appetite for Southern European ECAs is still clearly there, but any sway they had over Germany’s bankers has begun to evaporate.
While it is by no means definite, if the contagion of Southern Europe reaches into France, then Coface could be tarred with the same brush. Already, France is an easier ECA market to access than Germany. If French sovereign fiscal strength was to be looked upon poorly, and following half French-owned Dexia’s emergency €90bn financing guarantees from its owner countries this is a possibility, the number of solid ECAs in Europe would begin to wear thin.
German banks’ enthusiasm for their country’s ECA is compounded by the agency’s decades-old access to the pfandbrief market, which as eurozone worries spread, is coming to light once again as bank-to-bank lending tightens. The pfandbrief covered bond market is Germany’s highly-regulated systemic provider of long-term liquid funds, collateralised by long-term loans like mortgages or public sector loans.
“With its securitisation guarantee, Euler Hermes has provided an instrument that allows banks access to the high-quality and, fairly liquid pfandbrief market for more than 30 years,” says UniCredit’s Preugschat.
“Thus Euler Hermes, as a pure-cover provider, has created a systemic backbone, allowing banks to tap long-term matched funding. And due to the specific mechanics of this particular German-covered bond market, the benefits ultimately flow through to all German exporters, as opposed to other ECAs capital market products where solutions are often restricted to very large one-off transactions.”
The take up for this product is expected to become stronger should interbank liquidity dry up. This looks as though it could be the case as fear replaces optimism in the markets. While still in a normal range compared to the Bank of England’s base rate, the three-month Libor rate has already crept up by around 10 basis points from the start of August to the end of September as banks become less willing to lend.
Without a doubt the pfandbrief market, accessed via Hermes, will give German banks a distinct advantage in tapping liquidity should this trend continue.
“This [the pfandbrief] is one of the liquidity instruments that people are thinking about,” confirms Holgar Weiss, vice-president, principal expert ECA finance, at KfW-Ipex.
US dollar lending
But the pfandbrief market isn’t a sure-fire way for banks to raise funds. By looking to tap capital markets, there is a supply and demand situation between investors and bond issuances, and at the moment, there are a lot of institutions tapping the pfandbrief market.
One banker, who wanted to remain anonymous, tells GTR: “There are already so many users of the pfandbrief and it is to be seen how many investors are out there buying the product.”
The trick for all German banks is to find ways to raise long-term dollar funding. This has proven difficult to attain at reasonable prices. While the weak euro has proven to be a great asset to eurozone exporters, the dollar is still the world’s reserve currency and comes heavily into play in Germany’s key industrial markets, such as petrochemicals.
Germany signs many petrochemical deals in US dollar-denominated regions such as Latin America and the Middle East and North Africa. This has led export finance bankers, and the larger banking community, to try and establish just where the best places to go for dollar funding are.
This has invariably led to the door of institutional investors and again the concept is being raised of turning export finance into an asset class that institutional investors can buy and sell.
“Large prominent export houses are saying that there are US dollars out there, they are somewhere, but they just have to tap that market where they are,” says KfW-Ipex’s Weiss. “Those who have funding difficulties have to convince those who have US dollars, probably the institutional investors, that the export finance product, is an asset class of its own merit and it’s worth investing in.” (KfW-Ipex told GTR that it does not have funding fears itself, as it can leverage its relationship with parent bank KfW.)
The move will have unknown consequences for export finance. Weiss says: “You would need investors that buy your ECA assets as you have structured them, and you would need the pricing which fits investors’ needs. This combines to make it more expensive for the borrower.
Plus, you need an ECA product that capital markets investors find appealing, ie a clear first-demand guarantee instead of an insurance product.
“But on the other hand, it might end up cheaper. We saw project financing transactions in 2005 and 2006 where institutional investors participated and somehow spoiled the pricing because they are not a regulated bank and do not have the same fixed costs compared to a bank. So there are factors which could work to slow down the price-driving forces,” adds Weiss.
Better than most
The German export finance market is in a stronger position than its peers. Access to Euler Hermes is a potential game changer as although the ECA is involved in only around 3% of overall German exports, its weight behind a deal and access to the pfandbrief market is still very welcome to bankers.
Though the country’s export finance industry is doing well at the moment, the long lead times will eventually wind down and business volume could become sparser if the eurozone issues aren’t settled in a timely matter.
However, most evidence suggests that the eurozone, and one of its biggest beneficiaries the German government, does not have the funds nor the inclination to allow the problems to continue as they are for much longer. Over the Atlantic, dollar funding will remain a problem as long as the US crisis continues, regardless of whether banks can repackage their products as saleable items to institutional investors. But compared to all eurozone peers, German banks have the best
reason to feel confident. GTR