German Market Outlook 2014

Mid Cap Financial Markets in Times of

Macro Uncertainty and Tightening Bank Regulations






For contact details
please see contact list
at the end of this report









Contents
Global Economic Outlook and Prospects for the
German Economy 2
Corporate Germany:
at Crossroads to Financial Markets? 10
German Private Equity Market 13
Corporate Market 17
Corporate Schuldscheindarlehen:
Tongue Twister Goes Abroad 19
Leveraged Market: Borrower Friendly is back 21
European High-Yield Market: Coming in Strongly 22
Mid Cap Bond Market 26
Credentials 29
Contact Details 30
Visit us and Meet us 31
Disclaimer 32

2013 A Good Year
for Germanys Financial Markets
The following highlighted snapshots of the financial
markets in 2013 reflected the healthy state of
Germany's economy:
A 21% DAX outperformance over its European
peers surpassed only by the 33% and 22%
performances of the MDAX for mid-caps and
SDAX for small caps, respectively
A 33% growth in buyout transaction volumes with
DACH involvement driven by the return of larger
transactions
Over 8bn raised in the Schuldschein market
with a record number of foreign issuers entering
the market
Ca. 3bn capital raised in mid-cap bond markets
despite concerns about defaults and weak
creditor protection.
However, the strong loan market performance needs
to be benchmarked against a lackluster credit
demand given the slow capital expenditure.


2014 Where did all the Risks go?
Will the memory of a dooms day sovereign debt
crisis in mid-2012 fade away?
No noticeable headwinds and continued liquidity
provision through central banks result in optimistic
outlook:
German GDP growth expected at 2% in 2014
Pick-up in capital expenditure and investment to
bolster growth, in particular overseas
Likewise, increased M&A and buyout activities
given improved outlook, still attractive valuations
and ample "dry powder"
Further deleveraging in the banking sector driven
by Basel III and ECB stress tests.
Consequently, we expect a steady increase in
issuance activities by mid-cap companies across
Europe including the German Mittelstand.

We would like to take this opportunity to thank
our clients for engaging in numerous interesting
discussions, exploring ample business
opportunities and offering constructive feedback
regarding how to further shape our business,
and better address our clients needs. We look
forward to working with you in 2014!


German Market Outlook 2014



December 12th, 2013 2


Global Economic Outlook and Prospects for the German Economy
Industrialized
economies still
struggling with
possible stagnation
concerns
Global growth is set to recover in 2014 on the back of strong industrial output growth of
emerging markets, a stabilizing Eurozone as well as robust growth in the US. Germany,
by virtue of being an exceptionally open economy with a strong industrial base, should
benefit from this development. As a result, the growth in the German economy should
accelerate from 0.6% in 2013 to around 2.0% in 2014.
In 2013, the industrialized world and its policy makers have struggled to shake off the
remaining concerns over possible balance sheet recessions and their deflationary
impact. The consequences of ambitious fiscal consolidation measures in the Eurozone
have further magnified such concerns and have delayed any significant recovery in
business and consumer confidence. As a result, key central banks have continued to
initiate extraordinary monetary policy measures in an effort to support their respective
economies. This has led to a significant increase in central bank balance sheets and real
money balances especially in the US, Japan and Great Britain.
Credit growth poses
concerns for
Eurozone growth
prospects, but the
2014 outlook has
improved
Credit allocation to the private sector is still shrinking in many Eurozone countries,
thereby enforcing balance sheet adjustments for households and corporations. However,
the pace of economic decline has moderated and the Eurozones GDP appears to have
turned the tide, showing positive growth in the second and third quarter of 2013. Given
the reduced need for further fiscal tightening in 2014 and signs of a revival in confidence,
we expect a moderate recovery in the Eurozone economy, suggesting a sizeable
turnaround in the Eurozones contribution to the global growth in 2014. In addition, the
US economy is expected to grow around one percentage point higher next year, while
the Chinese growth continues to surprise on the upside despite concerns over a
possible property bubble and an inefficient allocation of savings. Not surprisingly, global
growth is expected to be at least one percentage point higher in 2014 than what it was in
2013.

Fig. 1: Industrial Production



Source: CPB; IKB

Global growth
continues to be driven
by industrialization of
emerging markets

Since the beginning of the new millennium, the industrial output of emerging markets has
emerged as the major global growth driver. In the 1990s, the growth was primarily driven
by industrialized economies mainly due to their service industrys growth and to a smaller
extent by their industrial output. Since then, around 75% of global growth dynamics can
be attributed to the industrial output growth of emerging markets. As a result, the current
global growth dynamics strongly favor open economies with a high industry/GDP ratio,
that is, economies that can participate particularly well in the global production of primary
and secondary industrial goods.
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German Market Outlook 2014



December 12th, 2013 3


Fig. 2: Average GDP Growth and Industry Share of GDP



1) Average 2005 to 2012
2) Average 2005 to 2010
Source: Eurostat

German economy has
globalized on a broad
scale and should
benefit from the
expected global
recovery in 2014
The German economy is one of the most open economies in the world. The country also
has a stable industrial base, with output in excess of 20% of GDP. Both of these features
suggest that Germany has not only focused on export markets to ensure adequate
demand for its products. The economy has also adjusted its supply side to be in tune with
a changing global environment and increased competition. This is evident from the high
percentage of foreign production found not only among DAX companies, but in particular
among mid-sized German companies. Companies supply and demand profiles bear
evidence of an economy that has globalized on a broad scale. Not surprisingly, the
German economy is in a particularly favorable position to benefit from the reviving global
growth dynamics in 2014.

Fig. 3: Exports and Imports as % of GDP (2012)




Source: E.I.U.; IKB

Confidence revival
induces recovery in
investment spending
across the Eurozone,
favoring German
exports
Over the last two years, the growth in the German economy was driven by foreign as well
as domestic demand, with net exports to GDP falling marginally to around 7%, just short
of the pre-crisis peak of 8% in 2008. The reasons for the relatively reserved export
growth include a general reluctance among many European economies to raise their
investment spending, which is a major demand component for Germanys industrial
exports. Given the increasing revival in confidence across Europe, we expect investment
spending to recover in 2014, albeit from fairly low levels, given the ample spare capacity.
The decline in real investment spending appears to have turned around in the second
quarter of 2013, as is evident across all major Eurozone economies.
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Portugal
Denmark
Italy
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Austria
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Japan
China
France
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Exports Imports

German Market Outlook 2014



December 12th, 2013 4


Fig. 4: Real Investment in Equipment



Source: Eurostat; Federal Statistical Office; IKB

German GDP growth
expected to reach
around 2% in 2014

Falling inflation, solid wage rate growth and a robust labor market have ensured healthy
real income growth for German households. Not surprisingly, domestic demand,
especially private consumption has become a stable growth driver in the last two years.
This trend is likely to continue, as accelerated GDP growth will create enough room for
productivity gains to unfold without exerting excessive pressure on the labor market.
Therefore, 2014 will be a year in which domestic demand and strong exports support
Germanys growth prospects. The German economy grew at 0.7% in the second quarter
of 2013, followed by 0.3% in the third. Leading indicators confirm a renewed revival of
growth in the final quarter as well. Given the expected global growth dynamics as well as
the pent-up demand for investment spending in Germany and the Eurozone, we believe
a growth of around 2.0% in 2014/15 is fairly plausible.

Fig. 5: Outlook: GDP Growth


2011 2012 2013F 2014F 2015F
Germany 3.4% 0.9% 0.6% 2.0% 2.0%
Eurozone 1.6% -0.6% -0.4% 1.1% 1.7%
UK 1.1% 0.1% 1.4% 2.3% 2.3%
USA 1.8% 2.8% 1.7% 2.7% 3.2%
Japan -0.6% 2.0% 1.9% 1.6% 1.4%
China 9.3% 7.8% 7.7% 7.8% 7.6%


Source: IKB

Manufacturing
sectors output growth
set to accelerate in
2014

Many sectors of the German economy experienced negative output growth in the first
half of 2013. However, a general revival has been witnessed in many sectors in the
second half. Given the improving global prospects, we expect the output growth to further
recover in 2014. This is especially the case for sectors such as automotive and
machinery the two primary export sectors of the German economy both are rather
sensitive to the local and global business cycles.
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December 12th, 2013 5


Fig. 6: Outlook: Sector Output Growth


2010 2011 2012 2013F 2014F 2015F
Food 1.0% -0.2% 0.0% 0.7% 1.0% 0.7%
Textiles and clothing 7.5% -0.4% -7.7% -0.2% 0.7% -0.3%
Wood and forestry 6.0% 12.4% -0.1% 1.8% 2.3% 2.0%
Paper 7.7% -1.7% -1.6% 0.5% 1.7% 1.6%
Chemicals and pharmaceuticals 11.0% 1.0% -1.9% 1.8% 3.0% 2.7%
Rubber and plastics 12.8% 4.4% -1.5% 2.9% 3.1% 2.7%
Building material (non-metallic
mineral products)
6.6% 9.6% -4.0% -1.6% 1.9% 1.6%
Metal production 20.4% 2.2% -3.4% 1.6% 4.0% 3.3%
Metal products 14.1% 11.1% -0.9% 1.6% 4.3% 3.8%
Electrical engineering 16.3% 11.9% -2.0% -2.4% 4.5% 3.9%
Machinery and equipment 9.7% 13.8% 1.9% -0.6% 3.6% 3.0%
Automotive 24.9% 13.1% 0.2% 1.3% 5.6% 4.9%
Furniture, other manufacturing 5.0% 3.9% -1.2% -3.8% 1.0% 0.8%


Source: Federal Statistical Office; IKB


SWOT-Analysis





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High level of globali zation among German
Mittelstand
Specialization has led to high level of global
competitiveness
Globalized market penetration allows
participation in all growing markets
Fiscal consolidation largely completed
High personal saving rate hampers accelerated
growth of private consumption expenditure
Demographics limit potential output growth
Renewed breakdown of investor confidence and
continued deleveraging could hamper demand
for investment goods
EU concerns over Germanys current account
surplus could lead to domestic policies that
erode competitiveness
A minimum wage rate could affect labour market
and consumer confidence negatively
Strong Industrial Base
Global Recovery
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Global recovery should favour an open economy
Increased recovery of investment spending
supports German exports
Mittelstand increasingly globalized and less
dependent on German labour market
Strengths Weaknesses
Threats Opportunity

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December 12th, 2013 6

Inflation, Interest Rates and Monetary Policy

Inflationary pressures
in the Eurozone are
well contained

Inflation in the Eurozone continues to surprise on the downside. Starting the year with an
inflation rate of around 2% in January 2013, the annual change in headline CPI fell to
0.7% in October, largely due to energy prices. Credit allocation to the private sector has
continued to put deflationary pressures, although this process should gradually reverse in
2014. As a result, inflation is expected to increase moderately over the next 18 to 24
months, but should remain well contained due to the rather moderate medium-term
growth prospects for the Eurozone.

Fig. 7: CPI-Inflation in the Eurozone



Source: Eurostat; IKB

Possibility of negative
ECB rates cannot be
discarded

The ECB expects the headline inflation to remain well below 2% for 2014, possibly
warranting further monetary policy easing to speed up the turnaround in the credit cycle.
In this regard, the option of a negative deposit rate on banks excess liquidity held with
the ECB continues to be debated. Whether such a move will trigger increased credit
allocation is questionable, since interest rates are already at record low levels and the
impediment to an increased credit demand is rather based on the lack of business and
consumer confidence. Nevertheless, such a policy appears to be a possible option for the
ECB. Another option the bank can exercise is to follow in the footsteps of the Bank of
England regarding its Funding for Lending Scheme (FLS). In this case, the central bank
provides relatively attractive funding to banks under the provision that such funds are
used for lending to the real economy.
Money market rates to
remain at current
levels at least until the
middle of 2015

The ECB has clearly stated in its forward guidance that rates will remain at the current or
lower levels for an extended period of time. As the key ECB lending rate has been cut to
0.25%, concerns over the impact of a continued reduction in excess liquidity have been
abated. Money market rates are essentially capped at around their current levels, a
situation that should prevail at least until early to mid-2015. From then onward and on the
assumption that the Eurozone economy and credit supply recover on expected lines, a
forward-looking central bank might see a growing need for normalization in its policy
stance meaning a reversal to real positive interest rates starting 2016.

Fig. 8: ECB and Money Market Rates


Source: Bloomberg; ECB; IKB

US labor market to
improve slowly
The monetary policy in the US continues to be dictated by labor market developments.
However, even with an economy growing in excess of 2.5% in 2014, it is unlikely that the
unemployment rate will fall much below the Federal Reserves target of 6.5% before early
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German Market Outlook 2014



December 12th, 2013 7

2015. This, however, would be consistent with the Feds forward guidance, which points
toward a reversal in the interest rate policy of the US Central Bank in 2015.
No quick termination
of Feds QE program

The tapering of the Feds quantitative easing program (QE) should commence over the
next couple of months. However, the Fed appears to be in no hurry for an early and
complete termination, given the prospects for the US labor market. Further, the Feds
next chief Janet Yellen follows closely in the footsteps of Ben Bernanke and considers an
active policy of supporting the economic recovery as the Feds primary responsibility.
According to Yellen, the surest way to an ultimately normal monetary policy is decisive
policy action over the short-term.

Fig. 9: Long-term Interest Rates (10-Year)



Source: Bloomberg, IKB


Long-term bond yields
should drift higher on
both sides of the
Atlantic

Besides the labor market prospects, the reaction of financial markets will be another
important determinant for the pace of the Feds exit strategy. Long-term bond yields have
reacted quite sharply to the initial announcement of a possible tapering, increasing by
over 100bps in the US and inducing a global repricing of financial assets. Since then, and
despite the Feds postponement, yields have not receded to their previous low levels. A
forthcoming reduction of the QE program by the Fed is expected, reducing the risk of
major surprises. Nevertheless, with an improving economic outlook, long-term bond
yields in the US should drift higher in 2014, causing German bond yields to follow.

Fig. 10: Outlook: CPI Inflation, YoY % Change

2011 2012 2013F 2014F 2015F
Germany 2.1% 2.0% 1.5% 1.7% 2.0%
Eurozone 2.7% 2.5% 1.4% 1.4% 2.2%
UK 4.5% 2.8% 2.6% 2.4% 2.1%
USA 3.1% 2.1% 1.4% 1.9% 2.4%
Japan -0.3% 0.0% 0.3% 2.2% 1.5%
China 5.4% 2.7% 2.7% 3.1% 3.0%


Source: Bloomberg; IKB


Fig. 11: Outlook: Short and Long-term Interest Rates

25 Nov. in 3M in 6M in 9M End 2014
3M-Euribor 0.23% 0.22% 0.22% 0.22% 0.24%
3M-$-Libor 0.24% 0.26% 0.28% 0.28% 0.28%
10-Year Bund 1.72% 1.90% 2.00% 2.30% 2.50%
10-Year U.S. Treasury 2.73% 2.80% 2.90% 3.00% 3.20%
EUR Swap 10-Year 1.98% 2.20% 2.40% 2.70% 2.90%
US-$ Swap 10-Year 2.81% 2.90% 3.00% 3.20% 3.40%

Source: Bloomberg; IKB
2010 2011 2012 2013
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December 12th, 2013 8

Outlook for the /US$ and other Exchange Rates
Feds policy has
triggered significant
financial market
volatility

The Feds monetary policy continues to have a significant influence on global financial
markets, as an increasing flood of US dollars chases financial returns around the globe.
Unintended consequences of this policy have become evident in May 2013, when the
Fed for the first time contemplated a reduction in its monthly asset purchases. Markets
reacted quite sharply, especially in emerging economies, as a significant amount of US
dollars found their way back into the US, causing a general depreciation of emerging
market currencies.


Fig. 12: Federal Reserve Bank: Total Assets



Source: Fed; IKB

Feds policy to favor
dollars strength in
2014
Financial markets in general, and foreign exchange markets in particular, will be shaped
by expectations surrounding the Feds policy change in 2014/15. However, given current
bond yield levels and the Feds forward guidance, the impact of tapering and eventual
termination of the Feds QE program on asset prices should be contained. Nevertheless,
US long-term bond yields are expected to drift higher, widening the interest rate
differential between the US and other major economies. This, in turn, supports the
possibility of a dollar appreciation in the first half of 2014.


Fig. 13: Long-term Interest Rate Differential USA vs. Germany


Source: Bloomberg; IKB

Euro to strengthen
over the medium term

The Eurozones economic stabilization should fundamentally improve the sovereign risk
profile of many of its member states in 2014 and beyond. This together with prospects of
a sustained economic recovery, supports the notion that German bunds will continue to
lose their attractiveness as a safe haven. This should prevent an excessive widening of
the interest rate differential between the US and Germany, and support the /US$
exchange rate over the medium-term.

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German Market Outlook 2014



December 12th, 2013 9

Short-term Euro
weakness is likely
and possibly wanted
by the ECB
The forthcoming changes in the US monetary policy as well as favorable US growth
prospects for 2014 increase the probability of a short-term dollar appreciation against the
Euro. This should be a welcoming development for the ECB, as it eases deflationary
pressures within the Eurozone. Over a period of time, the Euro should be supported by
the recovering Eurozone economy, declining sovereign risk premiums and a gradual
reduction of the US-Eurozone growth differential.

Fig. 14: Outlook: Selected Spot Exchange Rates


25 Nov. in 3M in 6M in 9M End 2014
/US$ 1.35 1.33 1.29 1.32 1.36
/ 0.84 0.84 0.85 0.85 0.89
/ 137 132 131 131 135
/CHF 1.23 1.23 1.24 1.26 1.30


Source: Bloomberg; IKB



German Market Outlook 2014



December 12th, 2013 10


Corporate Germany: at Crossroads to Financial Markets?
In Southern European
countries, a credit
crunch can be seen
Despite a revival in bank lending, falling margins and low default rates, German
corporations will be increasingly looking to tap the capital markets. The reasons include
long-term bank funding costs, regulatory aspects and a higher acceptance of market-
based financing solutions. These range from increased usage of Schuldscheindarlehen
over direct lending vehicles to bond issuance.
Large German corporations are currently enjoying a comfortable financing environment
as rosy as it was in 2007 on the back of buoyant bank lending and capital markets.
This is in stark contrast to their Southern European peers where a situation similar to a
credit crunch could be observed in the past 15 months; the loan supply to companies has
been constantly declining in absolute figures.
This credit cutback has been driven by the local banks limited lending ability given their
liquidity/refinancing constraints and the volume of non-performing loans and weak
borrowers. In this macroeconomic environment, even better-rated companies are facing
limited finance supply.

Fig. 15: Loans to the
Non-Financial Sector

Fig. 16: CDS: 5-Years
Senior Spreads





Source: Bloomberg; IKB



Source: Bloomberg

In Germany,
corporations have
changed their balance
sheet structure from
an equity ratio of 20%
to 30%
As the ECB through its choice of policy instruments attempts to stimulate bank
lending and credit provision in Southern Europe, German companies continue to enjoy
the luxury of relaxed financing and lending conditions. However, they do not seem to
derive full advantage of the financing environment. German corporations, especially
manufacturers, have improved their balance sheet structure over the last decade from an
equity ratio of less than 20% to approximately 30% (fig. 17). This was mainly achieved by
increased retained earnings and also by mezzanine instruments accounted for as equity,
thereby restraining themselves on both investment activities and credit growth.

Fig. 17: Equity Ratios
of German Firms

Fig. 18: Share of Corporate
Investments of GDP





Source: Federal Statistical Office

Source: Federal Statistical Office
2005 2007 2009 2011 2013
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Germany France
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2007 2008 2009 2010 2011 2012 2013
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Commerzbank
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German Market Outlook 2014



December 12th, 2013 11

The share of bank
loans in total liabilities
was reduced from
more than 20% to
around 13%
In light of the ongoing uncertainty in financial markets and discussions about the
Eurozones future, corporations have remained rather cautious in their investment
decisions. Similar to 2012, investments in long-term assets such as machinery and
equipment are expected to decline again in 2013. Muted investment activity was to a
large extent funded out of operating cash flows, bringing down the share of bank
liabilities as a percentage of total liabilities from more than 20% to 13% over the last 10
years.
Further, with concerns about the impact of Basel III regulations and possibly negative
experiences among banks during the 2008/09 financial crisis, many mid-cap companies
have started to look at capital markets as a way to diversify their funding sources (fig.
19).

Fig. 19: External Funding Structure of Companies in 2012


Source: Bloomberg; IKB

Corporate finance is in
the midst of a
structural
transformation
process: New
financing solutions
beyond the traditional
bank loan are evolving
Consequently, in 2013, the German mid-cap financing market has been marked on the
one hand by improved credit quality and muted demand for financing, and by an
improved credit supply through a slowly recovering banking sector on the other.
With further economic recovery likely to occur in 2014, investments in new machinery
and equipment are expected to rise steadily in 2014. In addition, export companies in
many sectors are expected to focus on expanding their production and development
capacities in growth markets such as Asia and North America for strengthening their
market position.
Regulatory framework
supports the trend
towards market-based
financing solutions
With the ongoing changes to the regulatory banking frameworks (Basel III) as well as the
insurance industry (Solvency II), it will be interesting to see how long-term financing
demand will be covered, and which instruments will provide long-term funding. The
regulatory objective to create stronger banks requires higher core capital ratios, which
can only be met through a further deleveraging of bank balance sheets. This will clearly
affect the ability of the banking sector to meet the growing credit demand in 2014. The
introduction of a net stable funding ratio will limit, especially long-term bank lending,
which in Europe has been traditionally the dominant pillar of investment financing. With
an increased link between ratings and risk-weightings, we believe this development will
be most pronounced for corporations at the lower end of or below the investment grade
space.
We, therefore, expect the trend toward market-based financing solutions and to some
extent disintermediation of the banking sector, to gather pace in the coming years.
Financing solutions for
the German
Mittelstand
There is a need for adequate financing solutions for the German Mittelstand. Such
financing solutions have been pioneered by us and other institutions over the last couple
of years:
Expansion of the Schuldschein market: Historically, the Schuldscheindarlehen
market (see the specific section for more details) has been an investment grade-
focused market with a minimum issue size of c. 50m. Investors appetite to put
money at work opened up this market for both crossover credits as well as smaller
issue sizes (e.g. IKBs 30m issue for Analytik Jena AG in 2012).
Insurance-based solutions: With the long-term investment needs of the insurance
companies and the Mittelstands long-term investment focus, numerous initiatives
32.0
19.0
6.0
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Trade credits,
prepayments
Bonds
etc.
Pensi on
provisions
Shares
etc.
Loans
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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



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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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