Germany’s Debt Management Office, Finanzagentur, finally has more borrowing to do. The government had already started to relax its notoriously balanced budget when Covid-19 hit, whose economic impact, as officials are ready to point out, reveals the purpose of schwarze Null (black zero) in the first place. Germany responded quickly to the economic consequences of Covid-19 with a wide programme of support measures ranging from regulatory forbearance on solvency and tenancy and subsidised Kurzarbeit (shorter hours), to a series of programmes providing financial support for companies, including KfW’s guaranteed lending scheme. Germany’s comparatively low debt-to-GDP ratio is expected to rise as a result to 75% from 60%.
How will these measures be refinanced? OMFIF talks to Tammo Diemer, co-chief executive officer of Finanzagentur, Tim Armbruster, senior vice-president, treasurer and head of the financial market department of KfW, and Frank Scheidig, global head of senior executive banking at DZ Bank, about the market implications. The corporate measures, including KfW’s, will be hypothecated into the Wirtschaftsstabilisierungsfonds (WSF). How will it be funded? How will the Finanzagentur’s issuance schedule adapt, and what is the market response, including to the recent constitutional court ruling, so far?
Refinancing the Economic Stabilisation Fund
John Orchard: Germany is gradually emerging from lockdown. How have capital markets been handling working from home?
Frank Scheidig: It’s better than we expected before the crisis. We carry out 90% of these activities remotely and it works quite well. I hope things don’t stay this way forever, but I expect this situation to last a few more weeks. We will move to a 30% presence in the bank over the next weeks, and then we will hopefully go back to normal over the summer.
Tammo Diemer: 90% of our employees are working from home, too, and I can only echo what Frank said: it works well.
Tim Armbruster: Yes, it’s the same with us, it’s working well.
JO: Germany has acted quickly to set up schemes to assist the economy, especially small- and medium-sized enterprises, which account for around 80% of GDP. These include a guaranteed lending scheme via KfW, and the establishment of the Wirtschaftsstabilisierungsfonds (‘Economic Stabilisation Fund’ or WSF). This entity, set up using the ‘SofFin’ law from 10 years ago, will fund the emergency measures. How will its refinancing work?
TD: The WSF offers three instruments to support the German economy and two of them have an immediate impact on the Bund’s liquidity needs. The third instrument won’t have an immediate refinancing impact. It is a guarantee scheme where the WSF can support corporate liabilities up to a total nominal volume of €400bn to help corporations improve their refinancing scope in the capital and banking market.
The other two instruments will have an immediate refinancing impact. The first, which has a potential capacity of €100bn, is the option to recapitalise corporates directly. The second is to fund parts of the refinancing activities of KfW, where we can issue German government bonds and transfer the proceeds to refinance their special loan programme.
I’d like to mention an element unrelated to the WSF, which also has an impact on our funding needs. The core federal budget is foreseen to have a budget deficit in 2020 of €156bn, which clearly also needs refinancing.
JO: What would you expect the WSF to refinance in total?
TD: The WSF will be refinanced by German government securities. How much of what I just described is actually drawn down and how much refinancing is needed is fairly uncertain. Our current issuance planning includes around €100bn refinancing for the WSF altogether in 2020. But the amount can be higher or lower; there is a lot of uncertainty around this number.
JO: Tim, presumably the purpose of this design with respect to KfW is not to impact the borrowing schedule for the year you have already announced, at around €75bn?
TA: Yes, as you said the WSF support is directly linked to the KfW special programme, up to the amount of €100bn. As Tammo mentioned, that depends on the use of the programme in the next months.
Demand for KfW’s ‘special programme 2020’ guaranteed lending scheme
JO: Tim, what has take-up been like for the guarantee scheme at KfW?
TA: Immediately after the lockdown in Germany in mid-March, we launched the ‘KfW special programme 2020’ consisting of various loan facilities. We did that in very close co-operation with the German banking sector and the federal government which, I must say, has gone very well. The programme has already been extended to increase the universe of eligible enterprises and its attractiveness. As of 12 May, we have received approximately 38,000 loan applications with a total volume of more than €34bn. It is increasing by around €1bn a day. Smaller loans are driving demand. Around 90% are for less than €800,000. We have granted loans to 99% of all applicants, totalling €21bn, so it’s very fast processing, thanks to the digital platform and the close co-operation with the banking sector.
I should add that the larger loans need more intensive risk assessment, which takes longer, especially for those exceeding €500m, which require a final decision by a government committee. In terms of numbers of loans currently, the top sectors are commerce, car maintenance, consumer goods, hotels and, of course, restaurants.
JO: Has the take up of loans been as forecasted? And will they be refinanced through the WSF?
TA: We expect demand broadly to be in line with forecast. The refinancing is in the first instance covered by prefunding through our short-term instruments and it is then replaced by long-term funding up to €100bn via the WSF, as Tammo described.
The Finanzagentur’s increased borrowing plans
JO: Moving on to the capital markets impact of these activities, Tammo, what does the increased borrowing look like for the Finanzagentur – for the quarter, and for the year, in as much as you know it.
TD: There is some uncertainty as I already mentioned. We have fixed our plans for the second quarter. For the full year, we expect around €450bn of new issuance. We have an emphasis on the short end of the curve, with an increase in bills, as well as adding new bill maturities. We’re running a bill programme, if you like: with 12 months, 11 months, nine months, six months, five months and three months paper. We’re increasing our volume in two years, five years, 10 years and 30 years. And we added two new maturities in our plan for 2020, a seven-year one and a 15-year one. All of this will ensure that the necessary government measures can be transferred quickly to the real economy.
JO: Your schedule says that capital markets instruments will go from approximately €40bn to over €60bn, and money markets instruments from €15.5bn to €72bn. Might you expect similarly proportioned increases in the second half?
TD: We designed the second quarter such that if we continue along that pattern then we will reach the target that I just mentioned. However, there is uncertainty and we address that through two other measures. One is that we benefit from the repo market to carry out refinancing activities. The repo market is a short-term money market with banks, where we offer German government bonds as collateral. It’s a highly flexible instrument that we can use to help cover the planning uncertainty on the refinancing volume.
Second, we tapped a large number of our existing bonds into our own books. This is a liquidity reserve we can use to address the uncertainty. We can either use these bonds as collateral for repo transactions or sell them into the secondary market at some point as funding.
JO: I see that your stock of 30-year bonds has gently increased over the last five years to around 25%. Would you expect that trend to continue?
TD: Yes, we have continuously increased our 30-year issuance activities and will do so again this year, albeit we will increase all of our maturity brackets. This isn’t a change of the strategy we developed over the last few years: we have an emphasis on the long end and the short end of the curve.
JO: So the volumes may increase but the proportions will stay broadly the same.
TD: That’s a fair summary.
JO: Short-to-medium term, Germany’s debt-to-GDP ratio is due to rise like everyone else’s – one estimate I heard was to 75%, still low in comparison to other developed economies, nevertheless this implies several hundred billion in additional borrowing.
TD: Yes, remember that includes our sub-sovereign borrowing, too. I’m sure that will go up as well as the central government’s. What the actual, final debt-to-GDP ratio will be, I don’t know yet. But it’s going to be higher than 60%, where it is now. Many market participants have a neutral-to-positive view on our support measures because even though our debt-to-GDP ratio will increase, if the measures are successful they will enable the economy to restart in good shape in 2021.
Money market operations as optional funding
JO: Tammo, you were just talking about creating money market liquidity, which you may or may not use as funding if you need it later. Is that in part to replace the liquidity that banks used to provide before their increased capital and regulatory requirements of the last 10 years?
TD: We have been active in the repo market for many years. In the past, we predominantly did it for cash management, but also to offer special German government bonds to market participants. So, within the purchase programmes of the central bank, and the Bundesbank in particular, there was a need in the repo market, and demand for German government bonds on a lending basis, so we were more active in the repo market to support that even if we didn’t need the funding. Today, our attitude here has changed. We are not only supporting the security market, but also taking advantage of the funding.
Market responses to increased SSA borrowing
JO: Tim, do you think the huge increase in SSA borrowing will impact KfW’s issuing plans over the next years? We’ve said the overall volume isn’t likely to change, but will the structure of borrowing and the instruments that you use potentially do so in response to the market?
TA: We have no increase overall in our capital markets borrowings, as the WSF complements our regular activity on the capital markets. It’s fair to say that it has affected our short-term funding needs a bit, because as mentioned before, we pre-fund the KfW ‘special programme’. We feel comfortable with this as we are prepared, especially regarding flexibility. We have the European commercial paper programme and, of course, access to the dollar market via our US commercial paper programme which we recently increased to $20bn. And we have prudent liquidity reserves in our central bank accounts.
JO: Turning to pricing, Tammo, the Bund has a negative yield curve right the way through to 30 years, having been slightly positive at 30 years six months ago. KfW trades at a spread to Bunds but can also borrow at negative yields.
TD: Absolutely.
TA: KfW trades in line with the Bund. Broadly speaking there’s been an increase in the spread KfW v Bund from 20 to 40 basis points since the crisis.
JO: Frank, is the SSA market suffering indigestion more broadly yet, based on all of this new issuance?
FS: I would say suffering is the wrong word. Initially, when we saw the first tremendous amounts in the market from some sub-sovereigns, we saw spreads widening. Meanwhile, the spreads have tightened halfway back to where they started, if not more. Once again it is rather difficult to find credits. The two we have here for example no longer have anything in positive territory along the curve, except the ultra-long. We’ve seen a lot of activity among the sub-sovereigns as well, such as the German Länder. They clearly had a spread widening overall, too, but with similar tightening later, and some of the new issuance performed well on the secondary market.
Initial impact of the German constitutional court ruling
JO: How do you think the German constitutional court ruling (on the ECB’s public sector purchase programme) might impact Bundesbank ownership of Bunds, and do you have any initial instinct how that may play out for you as the issuer, Tammo?
TD: The immediate market reaction to the court decision was very calm. Clearly it has no impact on the supply side; we follow our funding route, as explained. It may have an impact on the demand side. But as of today, we can’t see any changes. For the next three months we must wait for the European Central Bank’s reaction, including the additional information they have been asked for. For now, at least, I don’t see any event that may change the current supply and demand situation.
FS: I wouldn’t see it as a big problem anyhow, because the market participants and, particularly, the banks would appreciate it because it would result in more liquidity in the secondary markets and it would be much easier for us to trade. I don’t see it as a big Damocles’ sword hanging over us.
Recent investor behaviour
JO: Do we see any change to the demand in euros outside the euro area?
TA: Our investor base at KfW is very much balanced between central banks, treasuries and, of course, asset managers. In recent weeks, we have not seen a material shift in our investor base. There are a few trends to mention. Up to maturities of 10 years, our euro bonds are trading, as I said before, in negative territory. Of course, some central banks still have problems with the negative yields. Bank treasuries look more for relative value. Swap spreads widening made our bonds more attractive for those kinds of investors, as is also the case for asset managers.
TD: We have access to Bund auction group members’ secondary market trading activities, but this comes with a delay of two to three months. It is therefore too early to say whether the developments over the last two months have already had an impact.
We carried out a syndicated transaction this week. And there was very strong demand, the largest order book in the Federal Republic’s limited history of syndicated deals. But there were very few Asian investors, and Asian investors typically play an important role in German government bonds.
FS: Yes. I think it’s clearly different to what we saw 10 or 12 years ago in the last major crisis. There has been very strong internal demand within Europe for its own SSA issuers.
Regarding Asia – the region is still very much based on emerging market countries. SSA investors, including central banks, have to look to stabilise their local markets first. So it’s quite normal for them to be more cautious than before Covid-19. I expect this demand to return once their domestic markets have settled down. As Tammo said, they are big investors in this sector.
JO: What are your investors asking you at the moment?
TA: Most questions, of course, relate to how our funding targets might change this year in particular, along the lines we have discussed here. They ask about the special programme, but also the development of our regular business including for KfW-IPEX Bank, KfW Development Bank and DEG.
TD: I think investors are clearly interested in what this year’s activities mean for the next years, for example if and how this huge amount of short-term funding will be replaced over time with longer-term refinancing. Our response is that it will be, which means that our issuance calendar will have a higher volume for the next two years. We’re also asked whether the Bund will engage in the ultra-long sector, such as 50 years or 100 years. We follow this market with interest but for now we will stick to the 30-year maturity, which works better for us.
Finanzagentur reconsiders syndication
JO: Tammo, tell me more about your heavily oversubscribed syndicated bond.
TD: It was a 15-year bond with a volume of €7.5bn. We planned it to be tapped over the rest of the year to reach roughly €20bn, in line with the typical volume of other German government bonds. We were very happy with the huge demand for this maturity and this bond, and with the good order book both from a pricing and investor perspective.
JO: The Finanzagentur typically doesn’t do much syndication for the obvious reason that you don’t particularly need to. What drove you to syndicate in this case?
TD: Clearly, we will rely on auctions going forward. The syndication is a tool to increase our capacity in 2020 in the primary market. We’re focusing on the 30-year and 15-year sectors for syndications because with these maturities it’s easier for market participants to manage the resulting interest rate risk in that format. We will do another syndication in the second quarter, a 30-year tap, and there might be more in the second half of the year.
FS: With these maturities you need to have strong banking partners. I think in these uncertain times the Bund made the right decision not to take on risk, go back to what we haven’t seen since the 1980s for a syndicated book and try to make these successful deals. Obviously the first deal was successful. But it is very important to choose banks with a strong reputation in the market, especially for these long and ultra-long maturities. You need deep inroads into those customers, such as life insurers, pension funds, and asset managers who are interested in buying this year. But I also foresee times when it isn’t necessary. As a taxpayer, I hope that they can go back to auctions also in the 30-year maturities. I don’t know if they want to skip the 15 years for syndications after these special times. But I think in this regard, we could go back to business as usual.
Covid-19-related borrowing v ‘sustainability’ bond issuance
JO: The ‘sustainability’ segment of the SSA bond market has been growing in importance over the last decade. Do we think that Covid-19-related issuance might displace it?
TA: It’s still, from our view, the top priority. At the moment, it has moved to the background somewhat, due to Covid-19. But for KfW, the sustainability agenda remains totally unchanged. We have already issued green bonds this year and are targeting around €8bn for the year as already announced. It depends of course on the development of our underlying loan programmes but I am quite sure that the sustainability factor will remain key.
FS: Before Covid-19, most activity was on the green bond side. Social bonds were issued, too, but less predominant. This might change in the future. Social bonds could fit into Covid-19 funding requirements. What we should aim for in the SSA space is more in the way of United Nations sustainable development goals-compliant programmes which create more flexibility for issuing while also satisfying the various criteria for the different themes. The SDG bond market will be the major market for sustainability finance.
JO: Tammo, has the Bund got any sustainability issuance plans?
TD: Yes – we’re planning green bonds for the second half of 2020. This is still on our agenda.
Lessons learned
JO: Finally, what is the most important lesson you’ve learned so far from this crisis?
FS: The biggest lesson in my view is that we focus on what is most important: trusting, long-term relationships. And this counts for relationships between investors and issuers, banks and investors, banks and issuers, and so on. Those with strong and lasting relationships are the winners of the crisis, as we head back to the normality Tammo predicts for 2021.
TA: I started at KfW in unusual times. Luckily, I’ve had great support in the organisation and from the financial markets team. There is a great spirit of collaboration and trust as people take on the challenges together. I think the crisis has showed great outcomes in terms of working together, especially from outside the office.
TD: Keep developing and improving your market access in good and easy times – it’s a prerequisite to cope with the more challenging situations that we face.
JO: The finance ministry and economics ministry say the same. Similarly, people have been criticising Germany for ‘black zero’ for years and now we find out what it was for.
FS: I think if you take Germany’s action overall it is a credit to the country. From the Bund, the Länder and also the banks, I don’t think you would find one weak action or reaction. We have reacted rationally and carefully. That’s why we are the anchor for Europe. We want to help make sure that Europe stays stable.