The retail bond market is one of Germany’s proudest financial innovations of recent years, and has been seen by many as a model for other countries. But that achievement is now facing its first serious test, with the default of an issuer, wind turbine maker SIAG Schaaf.
The German retail market is quite different from those in many other European states. In the UK, Belgium and Austria, all of which have their own markets for specifically retail-targeted corporate bonds, the issuers tend to be large companies with multi-billion sales and a household name brand.
These markets are useful, for both issuers and investors, especially if the borrower wants no more than €100m-€250m. But there is a limited range of companies that fit the bill — big and stable enough to be accepted as safe by the investors but small enough not to want a full institutional deal.
Italy’s market is different, in that mega-deals of €3bn are possible, but there are so far only two issuers, Enel and Eni.
Retail investors, of course, can buy institutional bonds if they have a small denomination, but many companies deliberately avoid retail sales by using €100,000 denominations, for fear of contravening the complicated EU laws about selling to retail.
The retail-avoiding camp is likely to shrink slowly, as bankers widely acknowledge the pricing advantages of having a €1,000 denomination — which issuers like Daimler, Deutsche Bahn and RCI Banque already enjoy.
But the market-making arrangements for institutional bonds are not designed with retail buyers in mind, meaning there is space — at the bond market’s current stage of development — for specific retail issues that are listed and quoted on appropriate, easy-to-access platforms.
This is what the London Stock Exchange’s Orderbook for Retail Bonds has provided in the UK, leading to a revival in retail bond issuance in the past two years.
Tailored for the Mittelstand
Where Germany has led the way is in harnessing the retail bond’s main attribute — its small size, dictated by the limited pockets of the investor base.
Four German stock exchanges have put this necessary smallness to good use by encouraging issuance by small companies, which could never hope to issue a conventional institutional bond.
Specially designed listing platforms in Frankfurt, Stuttgart, Düsseldorf and Hamburg-Hanover make bonds of small size available to investors online. Some of the deals use a bank or brokerage to aid with distribution and as a sponsor; other issuers are supported perhaps only by a law firm.
The market has taken off quickly. At the top end of the scale, a few substantial companies like Dürr, the industrial systems maker, and Air Berlin have issued.
But much smaller players have also raised funds, with deals such as publisher Bastei Lübbe’s €30m six year issue in October paying 6.75%; golf clothing supplier Golfino’s €12m five year in March at 7.25%; and a €50m 8.75% sale, also in March, by Ekosem Agrar, German parent of a Russian agricultural firm.
The product has become so popular that institutions are now important investors — indeed Close Brothers Seydler, one of the leading deal arrangers, likes to sell at least half a deal to institutions.
Because of this variety of issuance, the German ‘Mittelstandsmarkt’, as the market has come to be known, is clearly performing an important economic function — making bond finance available to companies that would not otherwise be able to obtain it.
But with the market’s flexibility and low costs come what some sceptics have long warned are light controls. Not all the issuers have credit ratings, and while the deals are all properly documented, some bankers argue that due diligence is not as comprehensive as in the classic institutional market.
Some big German banks have avoided getting involved in the market, fearful that when the first default came — as it inevitably would, with any sequence of issues by smallish companies — there could be a scandal. The market’s reputation might be damaged and retail investors might drop the product like a hot brick.
Crunch arrives
That moment has now come. SIAG Schaaf has filed for insolvency, less than a year after issuing a bond on the Frankfurt Stock Exchange. The bond has sunk to trade at less than 10 cents on the euro and been delisted from the exchange’s Entry Standard segment, though it can still be traded on the Open Market segment.
Ironically, SIAG was one issuer that had a Standard & Poor’s rating — at one point, though this was withdrawn in October at the issuer’s request. The Frankfurt exchange was unable to confirm how big the bond was, but S&P had said its corporate family rating of B- was subject to SIAG raising at least €40m of bonds, so it may have been smaller than that.
What happens in the coming weeks will be crucial for the German retail bond market’s future. So far, the signs are encouraging: the Golfino and Ekosem Agrar deals were both completed after SIAG filed for insolvency — though perhaps the news was not yet widely known by then.
Credit investing is about taking risk and forming a diversified portfolio, and retail investors are grown up enough to know that. No one objects when retail investors buy small companies’ shares, which regularly turn to dust, so why not debt?
There is everyone reason why the Mittelstandsmarkt should withstand this knock and carry on. One bad apple should not ruin the whole barrel.
However, the rational outcome is not always the one that comes to pass. How Germany’s retail and institutional investors react to this default could depend to a great extent on how well handled the insolvency process is seen to be, and whether any wrongdoing is found to have occurred.
If the situation is managed adroitly, the hope must be that sensible issuance can continue — though investors should keep both eyes peeled for weak issuers.