In the good old days before the Lehman Brothers bankruptcy and the Basel III capital accord, small and medium-sized companies in Germany called on their friendly house banks for loans. They had no reason to do otherwise pricing was generally tight, structures were loose and tenors were long.
However, those fateful days in September 2008 unleashed a profound change in the banking industry, which has not yet fully played out. Banks are being reshaped by crisis, regulation and politics. They are still the mainstay of corporate financing for Mittelstand companies but treasurers are increasingly keen to find alternatives.
"The bank market in Germany as a whole is contracting," says Michael Legeland, head of DCM loans Germany at Commerzbank corporates and markets in Frankfurt. "Look at the major public sector banks, which have been an important element in mid-market financing. Some of them are obviously reducing their lending activity to an extent. In any case, the official statistics suggest the overall loan market volume is stagnating."
Hard evidence for a credit squeeze is difficult to come by companies may just be borrowing less because they are unwilling to invest in uncertain times, and keen to delever.
However, alternative sources of finance are thriving. The very German Schuldschein product not an alternative to banks, as it is essentially a bank loan is having a busy year. There is also a growing trickle of Mittelstand bond issues, usually 10m-50m in size and listed on special exchanges.Listings lead to growth
The Stuttgart Stock Exchange was the first to design a specific platform for these Mittelstand bonds, which because of their small size are often sold to retail investors. "We started the BondM segment in May 2010 with Dürr and Windreich companies which already had bonds in the market," says Sabine Traub, head of the primary market group at Börse Stuttgart.
Industrial systems maker Dürr had previously issued a 200m high yield bond which was then listed on BondM, while wind energy producer Windreich had committed to a BondM listing during the sale of its bond in March 2010.
In September 2010, for the first time, two Mittelstand bonds were actually placed through BondMs platform, again by Dürr and by agricultural company KTG Agrar.
Since then, Mittelstand bond issuance has spread. By November 8 2011, 38 Mittelstand bonds had been issued through and listed on SME-bond related platforms in Stuttgart, Düsseldorf, Frankfurt and Hamburg-Hanover (see box for more on the different SME-bond platforms).
But this market is not a panacea investors are still aware of credit risk and their appetite ebbs and flows.
"Investors are anxious at the moment," says Dirk Elberskirch, CEO of the Düsseldorf Stock Exchange. "You have to have a marketable brand name like [family-owned German publishing house] Bastei Lübbe. They did well while others had difficulties."
Bastei Lübbe issued its 30m bond through bookrunner Close Brothers Seydler and Conpair, a financial adviser that specialises in SMEs, in October. The company, rated BBB by Creditreform, secured five year financing with a 6.75% yield and over 75% of institutional investors in the book.
"We would not launch a deal without having 50% coverage from institutional investors after pre-sounding," says René Parmentier, CEO of Close Brothers Seydler in Frankfurt. "Especially in the Mittelstand bond area, it is very important to have 50% of the book covered. Selectively, we speak to regular customers to figure out the yield requirements demanded by investors. You have to invest a lot of time in advance before you can safely launch a deal and sell it."
Thomas Schierack, joint chief executive of Bastei Lübbe in Cologne, says the company is pleased with the new bond. Bank funding would have been cheaper, but it was attracted by the prospect of financing certainty for five years, more independence and no need for banking-style covenants.
"Two years ago, Commerzbank and Dresdner Bank were our house banks and as they merged we had to find new sources of financing," says Schierack. "Bank financings are obviously also dependent on political and economic decisions."
Bastei Lübbe considered issuing a Schuldschein but, as an IPO might be an option in future, it wanted to "sniff the air in the capital markets with reporting obligations and being more in the public view".
The Mittelstand bond listing platforms Düsseldorfs Mittelstandsmarkt, Hamburg and Hanovers Mittelstandsbörse Deutschland and the Frankfurt stock exchanges Entry Standard all also offer equity listings for SMEs.
Alexander von Preysing, head of issuer services and responsible for Börse Frankfurts platform, says that despite the recent volatility across financial markets, many SMEs are waiting to access Frankfurts bond and equity markets.
It is difficult, he says, to work through this pipeline because investors are risk-averse. "Companies would like to raise capital through both segments but there are few matches at the moment," he says. "We expect that before the equity market comes back, it is more likely that the bond market returns, as investors see it as a bit less risky."Tight and flexible
For larger SMEs, as well as for big companies, Germany also offers the Schuldschein market a kind of hybrid of bonds and loans.
Deals are sold privately, mainly to banks, and the market has fewer formal requirements than bonds. Issues can be tailored to the borrowers wishes and generally do not require a public rating. One of the products most important advantages is that legally, Schuldscheine are loans, which means most investors can opt to hold them to maturity at par, without marking them to market.
"The Schuldschein market did not really suffer from any crisis over the summer," says Commerzbanks Michael Legeland. "The only thing that happened is that pricing went up, along with the other markets, in particular over the last one to two months. But there is no liquidity limitation. It is a small market but within the framework of this market it has not been a problem at all."
Car parts maker Grammer sold a Schuldschein in September, raising 60m of three, five and seven year debt through Commerzbank.
"Schuldschein loans were the right type of financing for our demands," says Alois Ponnath, chief financial officer of Grammer in Amberg. "We wanted to refinance an existing credit facility and straighten out our maturity profile slightly. Therefore, the Schuldschein was the most flexible product for us, as it was also quicker and cheaper than the bond market."
Grammer, listed on Xetra Dax, has also previously issued bonds, Ponnath says. The company generally decides which financing product to use depending on what the funds are needed for.
"For organic growth, Schuldscheine are a good product," he says. "A bond could make sense if we needed to raise more capital over a longer period and possibly had to distribute risks differently."Thriving on bond jitters
UniCredit analyst Sven Kreitmair estimates that 3bn-4bn of Schuldscheine were issued in January-September 2011, and that the full year total is likely to reach its typical volume of about 5bn. Issuance was quieter in the first half of this year, while bond markets were thriving, but has accelerated in the second half, with about 20 companies marketing deals in November as this report went to press.
Kreitmair believes the Schuldschein market is repeating the surge of deals it experienced in 2008 and 2009, when bond market volatility drove bank investors to prefer the non-marked to market product.
This feature means pricing can be much tighter than on bonds, one reason why some companies with access to the bond market are still using Schuldscheine instead.
Porsche, the unrated luxury sports car company that is a popular name in the bond market, nevertheless issued a Schuldschein in July. LBBW placed the dual tranche deal with private banks, regional banks and savings banks and was able to double the size to 500m.
In November, Lufthansa, rated Ba1/BBB-, sold a five tranche Schuldschein totalling 300m of 5.5 to 10 year debt. The starting point for the pricing was 100bp inside Lufthansas public bond curve.
Porsche and Lufthansa are not SMEs, of course but the Schuldschein market is open, Kreitmair argues, for larger Mittelstand companies of good credit standing, with revenues usually of 200m or more.An intriguing subject among Schuldschein specialists is the prospect of deals for foreign firms. Banks are certainly pitching the idea.
|Exchanges foster retail interest in Mittelstand bonds|
|Germanys Mittelstand bond market is enjoying a boom, thanks in large part to the support of stock exchanges, four of which have opened dedicated platforms for the notes.
The platforms help the bonds appeal to retail investors an important source of demand, since some larger institutions are reluctant to buy smaller bonds, for fear of illiquidity.
Since the launch of the first of these in May 2010, 38 Mittelstandsanleihen have been issued and listed, 30 of them this year.
Düsseldorf Stock Exchanges Mittelstandsmarkt listed its first bonds in November 2010, while Hamburg and Hanovers Mittelstandsbörse was launched in January 2011. Frankfurts Entry Standard for bonds opened in February.
The platforms are trying to distinguish themselves from each other through terms and conditions. However, René Parmentier, chief executive at Close Brothers Seydler, whose bank has supported 10 placements, says the choice of platform is not important to them, although sometimes geographic location counts. "We, together with the company, decide which exchange to use," he said. "In the case of Bastei Lübbe, the company is based in the Düsseldorf region, therefore it made sense."
The Mittelstandsmarkt, which has eight SME bonds listed, requires issuers to have support from a capital market partner a company with an established relationship with the exchange, including law firms, rating agencies and brokers.
Dirk Elberskirch, CEO of the Düsseldorf Stock Exchange, says bonds on its platform can be as small as 10m and that it is "the only exchange with a requirement for companies to have at least a double-B rating".
Börse Frankfurt began courting SMEs on the equity side, with the launch of its Entry Standard for shares in 2005.
"The Entry Standard segment is a very successful listing venue for shares of Mittelstand companies," says Alexander von Preysing, the exchanges executive responsible for the platform, where nine bond issues have been placed so far. "There is a lot of experience and an extensive community has built up of about 100 listing partners who are active in this segment."Naked access
Where Düsseldorf and Frankfurt require companies to have a sponsor for their bond issues, Stuttgarts BondM lets SMEs make placements entirely on their own. BondM also underlines the importance of retail investors.
"We want to reserve 50% of any new issue for retail investors for at least two days," says Sabine Traub, head of the primary market group at Börse Stuttgart. Twenty issues have been sold through the BondM platform since 2010, and Traub believes that its liquidity guarantee is one of its plus points. "We aim to guarantee good liquidity, therefore we buy a certain amount during the subscription period so that we can smooth out price movements," she says.
However, not all observers are unqualified fans of opening up the Mittelstand bond market to retail investors. Such bonds are unsecured instruments and some fear retail investors might not understand the risks."By cutting out the middle man you are cutting out an element of diligence," says Marc Plepelits, a partner at law firm Shearman & Sterling in Frankfurt. "Those bonds usually dont have any high yield-like covenants and investors have very limited, if any, protection. Thats a market that may work until the first defaults and then it is going to be very difficult to see further issuances."