June 14, 2013 / 3:16 PM / 5 years ago

Investors see through Germany's D-Bond marketing spiel

* Joint German Federal-regional bond debut fast approaches

* Strategists say motives more political than substantive

* Investors’ discount demands threaten to undermine concept

By John Geddie

LONDON, June 14 (IFR) - Germany has been doing its utmost to hype up its new-fangled regional funding initiative, the Deutschland Bond, but that has not stopped bank strategists calling the product a political charade and investors cursing its complexity.

The Federal Ministry of Finance has embarked on a widespread marketing campaign for the so-called D-Bond, stoking expectations that the first ever joint issuance between the Federal Republic and its regions is just around the corner.

Even Angela Merkel was quoted last week saying the initiative could be integral to funding EUR8bn of flood relief desperately needed in the country’s southern and eastern regions.

For some, however, the rallying calls fall on deaf ears.

“It was a useless sweetener,” said one senior credit strategist at a London-based bank, who wished to remain anonymous, citing client relationships.

“Politicians came up with the idea to assuage the regions, and now it has to be followed through.”

The origins of the D-Bond go back to June last year, when the government needed to get parliament to approve the eurozone’s fiscal compact, which aimed to enshrine budget discipline in national constitutions and pave the way for a permanent euro-wide bailout fund - bankrolled by Germany.

The dissenting voices of some of the regional prime ministers needed to be silenced; the “bribe”, as one strategist described it, was the D-Bond, intended to reduce funding costs for weaker regions.

Larger states quickly cooled on the idea, realising that the credit enhancement to the current ‘joint-Laender’ model - under which a collection of regions fund together - was negligible.

The Federal Republic would participate and be liable for its own share on a pro-rata basis - expected to be around 10%, said sources - but a joint and several guarantee was out of the question.

The value-added that the federal government promised the regions was access to international investors, increased size (and liquidity) and better regularity. By extension, it hoped this would offer better funding than the current joint-Laender model.

But the additional value it offered was never clear cut and six of the 16 states - Baden-Wuerttemberg, Bavaria, Hesse, Lower Saxony, Saxony and Thuringia - have since ducked out, said people close to the discussions.

In recent weeks, officials from the ministry of finance have been in Amsterdam, London and Switzerland, trying to persuade influential international funds to buy the new deal, tipped to be EUR3bn-EUR5bn in size and with a maturity of seven to 10 years.

But many of these investors are unfamiliar with, or have avoided, joint-Laender deals in the past. Distribution statistics confirm that around 90% of all recent joint-Laender deals was bought by German accounts.

PRICING CRUCIAL

The crucial element for the success of the new deal - both for the investor and for the project as a whole - is the pricing. If the funding costs are not more attractive than recent joint-Laender deals it will be viewed as a failure, but on the flip side, investors want their ‘sweetener’ too.

“We would always consider new markets/products/structures, as normally you would receive an initial discount to entice new investors into the market,” said Anthony David, a fund manager in the global markets team at Aviva.

“If we deemed this discount was attractive enough, we may well consider investing.”

Others are more accommodating, but emphasise that the complexity around the structure will limit international investors’ appetite for the deal

“If it trades halfway between the existing Laender bonds and explicitly guaranteed entities like KfW, then the relative value would be attractive,” said Michael Krautzberger, Chief Investment Officer of BlackRock Asset Management Deutschland.

“The disadvantage is that it is a relatively complex structure, so, as an investor, if you don’t want to just rely on the fact that all entities are interconnected, then you have to do very detailed analysis on each of the regions in the deal.”

“If a weaker eurozone country came with the same structure, I don’t think it would be successful because investors like a lot of clarity.”

Strategists believe that domestic buyers, and particularly public entities like KfW and the Landesbanks, will backstop the debut bond in the absence of the anticipated international demand, leaving many to question what the point really was anyway.

The premium that the existing joint-Laender funding pays relative to Bunds in public markets has been decreasing over the past year.

Laender 39 was issued last January at a spread of 93.04bp, Laender 40 in June that year at 65.9bp, Laender 41 in October at 52.9bp and, most recently, Laender 42 in January this year at 30.8bp.

With the Ministry of Finance’s plans to issue the new D-Bonds once every quarter, as one investor told IFR, it will not have the capacity to supersede the existing joint-Laender function.

Excluding the six regions that have indicated they will not participate in D-Bonds, the remaining states have around EUR63bn to raise this year.

In the year to date, they have already raised around EUR30bn, leaving at least a further EUR30bn on the table.

The new structure will provide a “mere add-on” to the funding toolbox of each individual finance ministry, said one German bank strategist. (Reporting by John Geddie, additional reporting by Jon Penner; Editing by Philip Wright, Julian Baker, Matthew Davies)

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