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Corporate BondsPrivate debt

Schuldschein’s critical mass draws issuers and investors

The attraction for companies of having some private debt that is neither loan nor public bond is now well established — but the market that is reaping much of the deal flow from that trend is the Schuldschein. New investors are flocking to it, and so are issuers, even though bank loans are freely available to many.

6.1

To understand this paradox and more, GlobalCapital brought together a group of bankers, investors and an issuer in Frankfurt in early March. 

One answer, they suggest, is that success breeds success — investors know they will be shown plenty of deals, and issuers know there are hundreds of investors. Further growth looks assured.

Participants in the roundtable were:

Marcel Göldner, director, syndication, Helaba

Klaus Heizmann, head of treasury finance, SAP

Raoul Hessling, Schuldschein specialist, BNP Paribas

Klaus Pahle, head of Schuldschein desk, ING

Julian Piening, investment associate, Pricoa Capital Group

Jochen Schlachter, director, DCM origination, UniCredit

Dietmar Schubert, senior portfolio manager,

Allianz Global Investors

Jon Hay, moderator, GlobalCapital 

The purpose of private debt

globcap
: To begin with, we’re going to talk about why private debt markets exist, in particular when companies find it pretty easy to borrow. Klaus, SAP is a big company, so why is private debt useful to you?

Klaus Heizmann, SAP: Until 2009 we had hardly any exposure to the debt capital markets because our growth was mainly organic and financed by our strong operating cash flow. 

In 2008, we did our first big acquisition, which was partially refinanced in 2009 by our first capital market transaction. It was a Schuldschein of around €700m, in quite a challenging environment, in the middle of the financial market crisis. The Schuldschein market didn’t have the volume it has today, or the attention from international investors.

In 2010, we really started our acquisition journey. Since then, we have spent about $25bn on acquisitions. In the first step, we financed these via unrated euro bonds, because, at that time, we didn’t have an external credit rating.

In order to diversify our investor base and to directly generate US dollar financing, we also started to issue US private placements, in 2010, 2011 and 2012. At that time, SAP was the largest non-US issuer of US private placements, with $2.65bn.

However, in 2014, when we did the company’s biggest acquisition for $8.3bn, we also obtained an external credit rating.

We had already started our rating considerations in 2010. We thought about it thoroughly and decided to go for it when we were certain that our acquisition activity would continue in the future. There was a cost-benefit consideration, because a rating is expensive and from a capacity point of view it is a large project. But it pays off when you can finance yourself based on even more attractive terms and conditions. 

Based on the external rating we tapped the Eurobond market to refinance parts of the acquisition volume. Since then, we haven’t issued any further Schuldscheine nor USPPs, but one other quite interesting instrument. In August 2016, we issued a euro bond as a private placement — €400m for two years.

Marcel Göldner, Helaba: Most companies approach the private debt market as an additional source of funding with attractive conditions. For example, in the Schuldschein market, they have access to an investor base they do not have in the bond or syndicated loan markets. 

The savings banks cannot invest in an investment grade corporation via the syndicated loan market, because they are too small, they cannot sign the ticket sizes the bigger banks can. But they can via a Schuldschein. 

Then, as Klaus has said, it’s cheaper to issue a Schuldschein if you do not have to have an external rating, or the additional costs of public bonds.

Dietmar Schubert, AllianzGI: Can you explain what you mean by attractive conditions? If it’s attractive for the issuer, it’s not attractive for the investor.

Göldner, Helaba: If you just consider the spread, it’s maybe not attractive for the investor, but buy-and-hold investors such as savings banks do not need to mark Schuldscheine to market, like bonds. Schuldscheine have a very slim documentation and fast execution — they are all points to consider.

Schubert, AllianzGI: But the investors are not only savings banks. And I don’t know if it’s always a good thing if savings banks have thin documentation. 

By the way, thin documentation doesn’t mean the documentation is simple. You can also have documentation of two sides of paper which is very difficult and complex. 

So I can’t really accept that it should be cheaper for the issuer and at the same time more thinly documented than a normal issue.

Raoul Hessling, BNP Paribas: The common reason why companies use private debt is investor diversification, but you have two different cases where it really makes sense, despite the high liquidity at the moment of the bond and loan markets.

There are mid-cap companies that don’t really have the financing needs for the bond market, where secondary market liquidity is important. For these issuers, private debt is about building up a maturity profile, placing a non-benchmark amount in three, five, seven and 10 years, possibilities that a syndicated loan does not really offer. 

Then, on the other hand, you have multinational companies with external ratings that, from time to time, go down the private debt route because investors in that market are less driven by secondary market spread and more by internal hurdles and absolute returns. 

There are times when the bond markets are not functioning well, when investors ask for high new issue premiums. I think this was one of the drivers for SAP in its first transaction. 

Julian Piening, Pricoa: By its very nature, private debt is a private market. A lot of transactions we do are with private companies that don’t want their financials in the hands of too many investors or their competitors, and they don’t want to have 200 to 1,000 different bondholders. 

For them, it’s really attractive to have a private market where they can speak to one or a handful of investors and have trusted parties.

Jochen Schlachter, UniCredit: Another very important point is that with banks’ earnings under pressure, obviously the request for cross-sell is a key driver in the investment decision by any given lender.

When I talk to smaller companies, for many of them the question is: ‘we’ve got X amount of cross-sell to allocate to banks and we have this investment need. Why not place it as a Schuldschein to investors, which do not require an extensive cross-sell from us?’ 

6.2

Heizmann, SAP: Especially when the issuer’s experience of issuing debt is quite limited, the Schuldschein offers a very lean documentation compared to other sources of private debt, like US PPs or a public bond. So sometimes, the considerations are of a practical nature.

Why is the Schuldschein thriving?

globcap
: We’ve been talking about the rationale for private debt, but the Schuldschein in particular is going through a golden age. Issuance is growing, it’s internationally recognised and attracting interest. Why is it doing so well?

Klaus Pahle, ING: It’s a very old instrument, that dates back several centuries, and it has taken time to develop to the stage where it is now. 

It’s becoming a serious instrument for a lot of issuers, especially our foreign client base. They have quite varied instruments to hand — US private placements, Euro PPs, local bank funding, bonds. 

One of the reasons why they look at the Schuldschein is because it has really started to grow into a platform, which brings together a lot of issuers and investors.

It’s no longer just savings banks that invest, international banks bring a lot of cash to the table, as well as institutional investors, insurance companies, that do not have access to these kinds of credits directly.

Hessling, BNP Paribas: The growth is much more sustainable than in 2008 and early 2009, the first Schuldschein boom. At that point, it was big multinational companies driving volume, like BMW, Siemens, Deutsche Telekom. They went there because other markets were closed, not because they thought it was the ideal product. 

In recent years, the growth has been from a lot of unrated corporates from various countries that like the market’s features: the confidentiality, the various maturities, that investors do their own analysis and they can be unrated. They choose it although they have other alternatives; they think Schuldschein is the better choice. So I think we are on a good growth path. The question is where it can grow.

6.3

Göldner, Helaba: Yes, and more international banks are pushing into the market as arrangers, and bringing their client bases.

globcap
: Klaus mentioned the way the Schuldschein market has developed into a platform that is better organised and works better for issuers than it used to.

Heizmann, SAP: I would like to hear more about that. Our last Schuldschein was in 2009. The marketing and bookbuilding phase was quite time-consuming, and that’s a disadvantage of the Schuldschein. With a Eurobond, where you might have a debt issuance programme in place, you can issue at very short notice and make use of a positive market environment. When you are issuing a Schuldschein, the environment can change in the meantime. So has it changed recently because of technological enhancements and platforms?

Pahle, ING: It is still very time-consuming, especially when you’re coming to the market for the first time and really having to explain your business model, your credit standing and so forth. 

We see a lot of first time issuers in the market, and we spend a considerable time explaining the credit to investors. 

But for repeat issuers, the bookbuilding is much quicker, especially in markets these days — the books just go subject in a week or two.

What has changed are the rules and processes, especially for some of the investors. There is a Schuldschein documentation, and it’s always said that it is a slim and standard documentation, which, by the way, is not true, because a lot of the arrangers use their own documents, which entail some different features. 

But you have a more educated investor base now, especially foreign investors that are now accustomed to German law. They understand the civil code and the mechanics behind the Schuldschein documentation.

Hessling, BNP Paribas: I also think the success of the Schuldschein is not only driven by documentation aspects. It is that, to a certain extent, but it’s more the platform or this process where you bring an issuer to the market, prepare an issuer profile and draft documentation, and use a five week marketing period with an investor presentation and an investor call one week after the start. 

This set-up works for a lot of investors. It has moved away from a product that German issuers and investors owned, a few years ago, to a process that works for the German corporates, where you will have a lot of savings banks getting into the deal, but at the same time, for large French companies, where the investor base will look very different. You will have many more international banks, from Asia, France or Benelux playing, as well as institutional investors, and they may not be the German ones that dominated a decade ago, they may be French asset managers and Benelux life assurers. 

So I think the success now is more driven by this placement process rather than just lean documentation.

Schuldschein’s keen pricing

globcap
: In the last year or two, the Schuldschein market has been winning on price against other markets. Bankers who market Schuldscheine have told me: ‘a year ago it was a struggle, but this year I’ve been winning every battle’. Credits have been able to be priced more tightly than in other markets. A lot of the investors are the German savings banks, but others have plenty of access to other forms of credit investing. So why does this group manage to price aggressively in this format? 

Pahle, ING: I would disagree that pricing is really aggressive. For some companies, it does not make sense to go with a Schuldschein, especially when you have one large buyer in the rated euro bond market, which is the European Central Bank. There is a distortion and you will never come as tight with Schuldschein pricing as you can on a rated bond.

As for the USPP, if you want to go for very long tenors, it’s also quite difficult for the Schuldschein to be competitive on pricing.

Compared to bank financing, if you have local banks that finance on a relationship basis, probably a Schuldschein is also a little bit more expensive. 

But then, the qualitative aspects come into play, like diversifying your investor base, gaining more flexibility, getting into tenors that might not be available in the loan market. 

I wouldn’t say the Schuldschein always wins based on the pricing. The pricing is attractive, clearly, but there are also other elements.

Piening, Pricoa: Last year, a lot of companies replaced bonds with Schuldscheine. In principle, a bond should be cheaper because it’s liquid, there are plenty of investors. So why would I issue a Schuldschein, which has a thinner investor base, if not for pricing reasons? If I was an issuer, with a rating and public financials, I think the only reason for me to move from a bond to a Schuldschein would be the pricing. 

Especially last year, we had the impression that a lot of deals were won based on very thin pricing. My impression is that some banks may sell certain issuers at ratings which are a little higher than where we would see them.

6.4

Schlachter, UniCredit: You really have to distinguish between the externally rated market and the unrated market. For an unrated bond issuer, it’s certainly attractive to approach Schuldschein investors with a €200m or €300m issue size, which is generally cheaper in this environment than a bond.

But for rated companies, like SAP — and this is obviously because of the Corporate Sector Purchase Programme by the ECB — I have difficulty in seeing a situation where the Schuldschein market will actually be cheaper than a rated bond, unless there is a market disruption or a period of increased volatility, as last year in the first quarter, because of the growth concerns in China.

Göldner, Helaba: Even for a rated issuer, the bond market could be closed, while the Schuldschein market is still operating. You saw it in 2016: the market was partly closed for Lufthansa, but it issued two Schuldscheine at very attractive conditions and they went very well.

globcap
: Dietmar, you work for a very big organisation that invests in pretty much everything. What does private debt give you? Do you benchmark pricing against the public markets?

Schubert, AllianzGI: For us, the Schuldscheindarlehen is a means to asset diversification. Insurance groups like diversification. 

We have a lot of private placement units in the group. Our one is only responsible for Schuldscheine and registered note bonds, which are used if the maturity is longer than 10 years. Our team is currently responsible for the German market, for Austria, Switzerland, France and Benelux as well as some Nordic countries. We only invest in these countries because we understand these countries and their markets are very good.

We saw, last year, about 200 private placement deals in our team. About 100 didn’t have the quality requirements we needed. A further 60 were interesting, but the pricing was not interesting. So we made about 40 investments in Schuldscheindarlehen. 

Regarding your question, yes, the benchmark is the bond market. If the issuer’s bond, or a comparable one, has a 60bp asset swap, and the Schuldschein also pays 60bp, why should I invest in the Schuldschein and give up liquidity for nothing?

If it’s 65bp, it could be OK, but it depends on the maturity, the duration. 

If a lot of savings banks are accepting the prices, it’s OK. They have a different approach, but we’re investing the money of our insured people, we have to find a good price, and a good price can’t be the price of a bond which is liquid.

Perhaps some weeks later, we will ask if a private placement is possible, for another price.

This is our USP. We are not a bank, we are a buy-and-hold investor, and we are investing in longer maturities. We want fair documentation and also a fair price. And it’s possible. Not always, but sometimes.

6.6

Piening, Pricoa: This is exactly our approach, even though we invest in a different instrument. We make promises to people who purchase life insurance. We make these promises and we need to fulfil them. We also look at public bond benchmarks. We need to at least match these.

globcap
: You gave the example of a 5bp illiquidity premium — is that realistic?

Schubert, AllianzGI: It depends on the maturity, of course, it depends on the interest level. Five basis points is a lot now, in this environment. Four basis points is possible for eight or 10 years; not for three years, but this is not a maturity we are looking for. 

: If there are no comparable public bonds, how do the banks arrive at pricing? Do they tell investors: ‘this should come at this level because this is where we lend to them’ and they basically accept it? 

Schlachter, UniCredit: The pricing indication we give prospective issuers is always based on our internal rating assessment. Obviously, we also benchmark any issuer to peers out in the market. Let’s take the automotive sector, where you have several Schuldschein issues in any year, and you have an idea where the credit quality lies of each issuer. 

Then, it’s a question of our internal rating, which may differ from competitor banks’ or from the investors’ perception, and also of the latest automotive Schuldschein priced at a given maturity bracket. 

Heizmann, SAP: How do you think pricing could develop in future, given that more and more international investors are approaching the market who might face different regulatory environments?

Schlachter, UniCredit: It depends on whether they’re still going to be there in five years’ time, if markets turn. We have a deeper and broader market now, with new international investors, and to them the Schuldschein market seems to be fairly priced today.

The question is, in a different environment — spread-wise or interest-wise — in five years’ time, how they will react to a Schuldschein market that may not seem to be fairly priced, compared with the bond market and alternative investments.

Pahle, ING: What we’ve seen, in the last two years, is a lot of pressure on pricing, which has come down considerably. 

Is that due to more and more investors coming into the market? Yes, but also there were spillover effects from the bond and bank markets, because banks were equipped with so much liquidity from the ECB that they had to invest.

Hessling, BNP Paribas: Bank liquidity plays a big role in why the Schuldschein pricing is so attractive to issuers. Over recent years, international and savings banks have played a much bigger role than before, and they have pushed out, to a certain extent, the institutional investors.

A couple of years ago, banks were more focused on the short to mid-term tenors, three to five years, and anything beyond that, seven to 10 years, was really what the fixed rate-minded institutionals were looking for.

But in the more recent past, since margins have been so low, international banks are going into the seven year area, and German savings banks up to 10 years. 

And there are so many investors coming into order books, especially for German issuers, that allocations for each investor get really small, which is not so interesting for a lot of private debt investors that are looking for sizeable tickets. These effects really have pushed pricing down.

Investors proliferate

globcap
: There are not many markets where you get a noticeable change in the investor base from one year to the other. New buyers like Asian banks are coming in: is that going to continue?

Göldner, Helaba: If you have a German issuer, the savings banks are still reliable investors and a lot of the tickets come from them, because, compared with other banks, they have lower funding costs and therefore a tighter pricing is still profitable for them.

But if you have a non-German issuer, then — and also sometimes in the German issuers’ deals — you do see, more and more, the Asian and international banks. They are partly trying to build up a relationship, or do have a relationship, with the issuer.

Hessling, BNP Paribas: I think it’s more complex than just a relationship angle. Especially on the international side, the investor base is more limited because we don’t have hundreds of savings banks, most of them only have a mandate to invest in German companies. But we try to find spreads that work for banks or other investors on a standalone basis, without cross-sell.

So the relationship angle is not so strong, and the need to do cross-selling after a participation neither. These banks would, of course, like to get into a dialogue with the client, but it’s not as clear-cut as with a revolving credit facility.

globcap
: Just to be precise, we’re talking about an international deal, let’s say a medium-sized French company, which has three or four house banks. Then, other banks, from, say, China or Germany or Denmark want to get into those deals?

Göldner, Helaba: They are trying, and they are using the Schuldschein deal to build up a relationship. It’s not that there are no other banks going into Schuldschein deals, but most of the tickets, and the bigger tickets, are coming from relationship banks.

globcap
: Klaus, does it sound credible to you that a bank can start a relationship with a company by coming into a Schuldschein?

Heizmann, SAP: Actually, no. Like a lot of companies, we have a revolving credit facility in place, and the banks who participate in it are our core banks, and we allocate our treasury business primarily to our core banks.

So when we decide to go for a Schuldschein and we need to make a decision which bank to involve, it’s a matter of our overall bank relationship management. 

Based on this bank relationship management strategy, I really doubt that we would use a Schuldschein to enable a bank that is not participating in the RCF to become a core bank.

Hessling, BNP Paribas: In the order books we had last year, there were always some investors getting into it for this reason. They might be second or third tier banks for whom the RCF participation doesn’t make much sense. They are local banks somewhere in the world and they have a relationship with the company there, they want to support that with financing the head office. For some of them, the RCF is priced far too tightly and the cross-sell can’t compensate or the minimum ticket sizes to join it are too high.

Also, in recent years, lots of companies have come from a financing structure where they had an RCF and a term loan to just RCF and Schuldschein. They have reduced their bank groups on their undrawn RCFs from 15 to 20 in the past to a handful of core banks. 

But of course they had many more banks they had worked with. In such cases, the Schuldschein is an opportunity for them to stay in the lending relationship.

globcap
: Why have companies got rid of term loans and put in Schuldscheine? Is it because of what Jochen was saying, about not having to give cross-sell?

Hessling, BNP Paribas: Yes. With the Schuldschein you don’t have this relationship angle so strongly, it’s more priced on a standalone basis, and you have more investor diversification.

A further advantage is the maturity you can achieve — a syndicated loan often has one tenor only, so you have to find the maturity that works for everybody. In the Schuldschein lots of investors are more than happy to receive 30bp more for two extra years of maturity.

Documentation: lean or mean?

globcap
: Let’s talk about documentation. Dietmar encapsulated it at the beginning, when he said ‘it’s a thin documentation, why should I like that?’ It’s true, a thin document is in favour of the issuer, and obviously, in the USPP market, it’s not like that. You have a fat document because the investors want that.

Piening, Pricoa: The syndicated bank loan is even worse than the USPP. Work through an LMA document and then you will say ‘OK, the USPP doc is the ABC.’

Also, we have developed our own documentation which is shorter and more customer-friendly but contains financial covenants we need.

globcap
: Yes, the USPP investors definitely have that view. But why do so many investors put up with Schuldschein docs, Dietmar?

Schubert, AllianzGI: I don’t know. For us, it’s not important if the documentation is thin or thick. It’s important what the content is. We like documentation of 10 pages or 12 pages, but there must be special rights for us. 

It doesn’t make any sense if you have documentation of 50 pages and there are no covenants or rights for repayment if there is a covenant breach. If the documentation is too easy, if it’s more for the issuer than for the investor, we don’t accept this.

Sometimes we try to negotiate other rights, but it’s not always possible. If the order book is €700m and the issue is €300m, issuers don’t wait for our money. 

Then we might try to make a direct loan to the company or private placement, not with these banks. 

Sometimes documentation of two or three sides is OK, but it depends on the issuer. For example, I’m sure SAP would accept a negative pledge, but I am also sure SAP wouldn’t accept a leverage ratio covenant.

Heizmann, SAP: Your feeling is correct.

Schubert, AllianzGI: This is the point. We have to differentiate between issuers. Why should an issuer from the mid-market, from the Mittelstand have documentation like SAP?

Why should a company which is issuing its first Schuldschein and in former loans accepted financial ratio covenants, issue a Schuldschein without any ratios? Why should we be the first who have no security? Is the Schuldschein the right instrument for that issuer? I don’t think so.

globcap
: Is it true that in Germany, unlike the UK, for example, a lot of bank loans are un-covenanted, or at least there is less of a tradition of covenants?

Hessling, BNP Paribas: No, there are still financial covenants in syndicated loans.

But not all Schuldscheine mirror the loan documentation. German issuers, even midcaps, get a big bid from savings banks. They can live with very thin documentation where you would usually, at the moment, not see any financial covenants. 

On the international side, our approach to documentation is rather looking at the reps and warranties and the events of default on the syndicated loan, and then asking ‘what do we really need of that?’

On an RCF, if you need a change, you can just waive it with a two thirds majority of your house banks, which may be a one or two week process. On a Schuldschein each investor decides for its stake individually.

So certain restrictions, you really don’t want to have. You would not have a restriction on acquisitions, or on additional debt, because it’s sure there’s going to be another debt issuance in the next seven to 10 years. You take the loan documentation and you shorten and tweak it. 

Financial covenants are driven by investors’ needs — in Germany, very issuer-friendly; on the international side, more balanced.

Schubert, AllianzGI: But why? I’ll tell you: because the banks are competing to give the issuer this comfort. Who wins the mandate for the issuer? Not the bank who has the strongest documentation. Not the bank who has the highest price.

Hessling, BNP Paribas: Our job as arrangers is to present to corporates what is achievable in today’s market. And if it’s possible to finance without financial covenants, a corporate will not put them in just for fun.

This is kind of pushing the boundaries. However, there are limits to that. We usually work for corporates that we finance ourselves. We may be in a situation where, on the syndicated loans, we have financial covenants and there are none in the Schuldschein. But usually we take care that the documentation ensures, to a certain degree, that in case of a default, everybody is on the same footing, for example with negative pledge clauses. But it’s true, Schuldschein investors will be later at the negotiation table than the house banks.

Piening, Pricoa: If you are a bank in a syndicated loan that has covenants, and there is a Schuldschein without any covenant, it’s beneficial for you as a syndicated loan bank. You can negotiate, you can do whatever is in the bank’s favour; whereas the Schuldschein investors are not even at the table.

globcap
: Julian, Pricoa doesn’t invest in Schuldscheine, but you’ve devised your own document for the German market which is similar. Tell us why.

Piening, Pricoa: The USPP model form is indeed longer than the typical Schuldschein document. So we felt we needed to shorten our document without giving up our fundamental principles, one of which is that we only invest in issues which have financial covenants. We also make sure we’re pari passu with the banks, with respect to financial covenants and negative pledge and security.

I agree with Dietmar, there can be documentation which is 50 to 100 pages long and everything that’s in it is useless. So we felt we should shorten it, make it simpler, and also make sure that what’s important is in there.

Also, a Schuldschein is a loan document and so far we only invest in senior registered notes. That’s one of the differences. And most of our investors are in the US, so we have certain elements that are part of the package that aren’t in a Schuldschein document.

Göldner, Helaba: I think the fact that we have light documentation at the moment is not a product-specific problem of the Schuldschein, it’s market-driven. We also have light documentation and covenants in syndicated loans and on other debt instruments at the moment.

globcap
: One of the things that’s emerging is that perhaps the Schuldschein market is actually quite varied and flexible when it comes to documentation, covenants and so on, and it’s a varied ecosystem. Is that right?

Pahle, ING: It’s a loan documentation so you can make it very flexible towards the kind of features investors would like, and what the issuer is willing to offer. 

Documentation can also change over the years. We’ve had cases where issuers first offered financial covenants and ratios but, over the years, they established a higher quality credit, and then, with the next issues, dropped them.

The Schuldschein documentation can also cater for a lot of events, such as adapting it to take in new regulations, or different sets of investors.

We are thinking about what kind of adjustments we need to make to the Schuldschein documentation to really make it work for US investors.

globcap
: But not many US insurance companies, at least, would buy a Schuldschein, would they?

Piening, Pricoa: I doubt it.

Pahle, ING: That’s the future, I think. Looking over the pond and making that liquidity available, that’s the new era of the Schuldschein market.

New issuers arrive

globcap
: The issuers are also becoming more varied. That’s a good thing, but is there a risk that somebody lets their guard down and bad issuers get in, that we have defaults? If that happened, would it be a disaster or not?

Piening, Pricoa: From what we’ve seen, some issuers that have done Schuldscheine in the last year would not have tapped this kind of market in the past, but more the high yield market.

But that’s something to be tested over the next one, two or maybe three years. We all know there are credit cycles.

Pahle, ING: It’s more or less in our hands, on the arranger side. We have to make sure we bring the right quality of issuer to the market. 

It’s an unwritten rule, but the Schuldschein market is an implicit investment grade market. But some arrangers are probably testing the borders on how deep you can go into high yield territory. Currently, with all the liquidity in the market, there are really few defaults because there is always a source of refinancing. 

Meanwhile 40%, 50% of the deals are from new issuers, and that’s really making it very interesting because it’s growing the base of Schuldschein issuers.

Hessling, BNP Paribas: The market is focused on investment grade names. It’s very difficult to say what the next crisis is going to look like, and which industry is going to be hit. With over 100 issuers a year, some will have difficulties. But I don’t see why, in the next credit cycle, the Schuldschein should be more hit than syndicated loans or US private placements or any other products. 

Piening, Pricoa: It’s not like the mini-bond, for example, where everyone saw that coming. The average credit quality is higher in the USPP, Schuldschein and syndicated loan markets. I agree to that extent. However, the USPP and syndicated loan typically have some form of protection, whereas the Schuldschein often has not.

globcap
: You’re talking about the German retail mini-bond market, which grew quite fast with small companies issuing, and then there were a lot of defaults and issuance stopped?

Hessling, BNP Paribas: Yes, that is a good point. We all want to do Schuldscheine for many years, so if you bring issuers that get into trouble after a short time, in a big way, it would really destroy the market. I don’t think that’s in the interest of the arrangers. Rather, it’s the opposite: trying to find borrowers that make sense for this kind of investment grade-style product.

6.7

Schubert, AllianzGI: A lot of the mini-bond issuers had come to us and asked us for Schuldscheine before… as you can imagine, we didn’t do them. 

I agree with Klaus, the Schuldschein market should be more or less an investment grade market, but some actions from investors are testing that. How can it be that after 30 minutes the books are closed? What are they doing in this 30 minutes? Analysing? 

I think they don’t analyse the investment and this is the danger for the future, if there are savings banks or smaller insurance companies and they have defaults. 

Our default rate, looking back over 15 years, is equivalent to an overall A rating. This is not bad, I think, and the reason is we are always trying to find investment grade companies. But we have had defaults in the past, caused by fraud. This can happen.

Schlachter, UniCredit: But the new issuers coming to the market, in particular the international issuers, are typically companies with well-entrenched market positions. They are not start-ups, they’ve been around for a while, they’re credible, having a good credit quality. Sometimes from the crossover area, but certainly not high yield issuers. So it would highly surprise me if we saw a disproportionate increase in the default rate, if the cycle turns. The arranging banks have put a lot of emphasis on selecting issuers that can withstand an external shock, in particular the new entrants from France, the Benelux countries or elsewhere.

Schubert, AllianzGI: Especially if they sell it to the savings banks.

Göldner, Helaba: Yes, we have a responsibility to the investors too. We are usually not arranging for issuers we have no long term relationship with. So I do not see it going like the mini-bond market or something like that.

globcap
: To avoid bad deals, investors need to understand the credit risks. What kind of information do you give them about issuers?

Schlachter, UniCredit: We publish credit research or credit profiles of the issuer with every transaction, which have to be cleared by our compliance department.

Typically, there is one piece of research per deal. Let’s say two banks are arranging the deal, you split the work. One organises a roadshow, investor presentation and takes care of the research material, while the other looks after documentation and the like.

Göldner, Helaba: Normally, there’s a call for investors with the issuer, sometimes there’s a presentation. And investors with bigger tickets sometimes ask for one-on-one calls with the issuer, but that’s not the usual way for smaller ticket investors.

We share our internal rating with the savings banks, and our balance sheet analysis. But just with the savings banks.

6.8

Hessling, BNP Paribas: Yes, and some institutions in the mutual bank sector have the same approach. But apart from that, it’s not standard to share internal ratings with investors. They do their own analysis. And the issuer profile, or credit research, is a descriptive piece, it’s not giving a buy or sell recommendation. It’s trying to present the company in a condensed form so that the credit analyst has an easier read than going through three years of annual reports.

Piening, Pricoa: Before we invest in any issue, we always need to do our homework, including meeting the issuer’s management.

Pahle, ING: A lot of information is shared with the investors, and a lot of it is confidential. As it’s a private debt product, it stays private. And issuers give regular updates to investors during the life of the deal. It’s part of the creditor relations, like any company would do.

Private bonds

globcap
: Klaus, I wanted to ask about your other private deal that you referred to at the beginning. Why did you do that?

Heizmann, SAP: When we did our last big acquisition in 2014, we had a credit facility of €7bn, which we refinanced with €4.5bn of public bonds. We left a €2.5bn term loan, and we have committed to deleverage fast.

Last August, we were approached by one of our core banks with a private placement opportunity, and we saw a positive business case because we need to pay the spread on our term loan. 

There is a Euribor floor in it, so we can’t pay less than the loan spread.

The euro bond we issued, €400m with a two year maturity, was priced at a coupon of three month Euribor plus 30bp, but it contains a floor on the whole coupon, so we can’t pay less than zero. Currently it trades at 0%. We had a couple of German investors, predominantly money market funds. It was the first time we had been approached by our banks with such a short term opportunity. 

globcap
: And that was an MTN?

Heizmann, SAP: It wasn’t issued from our debt issuance programme because we hadn’t updated that, as we didn’t need it. It was issued on the basis of terms and conditions only, so we didn’t have to provide nor update a prospectus. But it was a bond registered on the open market. The documentation was quite lean, and so was the process.

I have a question regarding this kind of private placement, to you Dietmar. Are these privatly placed bonds, with lean documentation, valid instruments for Allianz?

Schubert, AllianzGI: Basically, yes, but we have a new mandate from our sponsors, in which we’re only allowed to invest in Schuldscheindarlehen or registered note bonds. In the past, it would have been possible for us to buy such an investment as yours, but we had no good opportunity to buy any.

Perhaps in the future, we will invest third party money, and in those cases it could be that this kind of deal works.

Bilateral nature of the Schuldschein

globcap
: Legally speaking, the Schuldschein is a collection of bilateral loan contracts, unlike a syndicated loan, which is a collective agreement. This can make it difficult if there is a problem.

In 2015 a French company, three months after issuing a Schuldschein, had to close a factory temporarily for regulatory reasons, and their Ebitda went down and they had a covenant problem.

They had to talk to 35 investors separately to get a covenant waiver. Some investors were fine, another group had problems but got there in the end, and a third group had to be repaid early. So what can you say about how this works in practice? 

Hessling, BNP Paribas: Most of the Schuldscheine can survive their tenor without having to be touched again, because the documentation offers quite a lot of flexibility. It’s probably fair to say that if an issuer comes to the market and there are problems very soon afterwards, negotiations with investors will be difficult.

Personally, I have had to accompany companies three times through waiver processes. Although you have, from a legal point of view, bilateral relationships with the investors, most investors approach such requests constructively and you get high consent — provided you’re able to explain your case, where the waiver comes from and what you want to do about it. 

Some investors just cannot accept these kinds of things, and then you try to find bilateral solutions. You may find another investor who is happy with the credit and try to do a transfer. 

Schlachter, UniCredit: It depends whether it’s an established issuer. We had a case where we had to approach a number of investors — an onerous process, obviously — but it turned out to be very constructive, because the reason was easily explained and clearly a one-off item.

The investor base knew the issuer quite well, so it was apparent that the management had taken the right steps to address the issue. It remains a respectable issuer in the Schuldschein market, and we believe that, despite all the difficulties, which we resolved without a problem, it will remain an active issuer.

Göldner, Helaba: Luckily, we’ve never had this problem. If there are big problems within the company and with the Schuldschein, we, as banks, also have the possibility to buy it back.

Hopes and predictions

globcap
: What would be the best thing that could happen to develop these private debt markets, and do you see any particular threats or problems on the horizon?

Schubert, AllianzGI: For me, the best thing would be if there were no, or low, defaults in the future. I hope there will be not a new standard of documentation but a good documentation from each bank; each documentation is different, each issuer is different.

Heizmann, SAP: Even though we have not really been active in the Schuldschein market in recent years, it is still a valid opportunity for us, especially when the bond market is in distress. It will be very interesting to see how the Schuldschein market behaves in turbulent times. 

If there was some positive development with regard to speeding up the process of marketing and bookbuilding of a Schuldschein, that would definitely make the instrument even more attractive.

Hessling, BNP Paribas: Looking at the private debt market overall, I think it would be nice if efficiency would increase, so we don’t have to discuss whether a Schuldschein or Euro PP or any other product is better, but rather find a format that works for all kinds of investor across countries, so that when we bring an issuer, we can present the broadest investor base, and let investors compete around who offers the best execution and pricing.

Maybe you will have public bonds for companies that work well with public information and external ratings; and a private loan debt market that works for investors who need three or five weeks to analyse a credit and do the deep dive. The Schuldschein is in a good position to become that European loan format.

globcap
: You’re in favour of harmonising different products?

Hessling, BNP Paribas: Absolutely. It doesn’t really matter whether today banks are more competitive than institutional investors. Maybe in three or four years institutional investors will offer the best terms because the ECB is not giving liquidity out. But the product and the process don’t need to change. 

Pahle, ING: My wishful thinking is that the Schuldschein market becomes a pan-European market, with a lot of very interesting companies coming from all over Europe, probably also some global companies and some hidden champions, whether they are family-owned or haven’t been publicly in the market. I’m very much looking forward to the market doubling in size by 2020.

globcap
: And you think it will?

Pahle, ING: It will.

globcap
: The Euro PP was launched as Europe’s answer to the USPP, but you think the Schuldschein is really where it’s at?

Pahle, ING: I think so because the Euro PP is really only looking to institutional investors and the Schuldschein market has banks that offer very competitive pricing in the shorter or medium term tenors, and the institutional investors as well.

Institutional investors don’t really decide on the format or the document, they look at the credit quality, and as long as you have a Schuldschein market that offers this credit quality, they will be interested.

Piening, Pricoa: We have heard that there’s supposed to be a shorter time to market, better pricing for issuers, leaner documentation, less relationship focus. 

I hope that, with all these things in mind, market participants stay disciplined. It’s been a very competitive market for the past two, three years, and you’re under a lot of pressure to compete with other players, but I think in our institution, we have always made the right choice by staying disciplined. 

For me as an investor, I still want to get the time to really analyse the credits I invest in.

I assume we agree that there are some credits where the investors need more time — and also that for some credits, the Schuldschein isn’t the right instrument because they’re super-private, they’re family-owned businesses, they don’t want 10 to 50 investors.

If market participants stay disciplined, I don’t see a reason why the Schuldschein market shouldn’t grow.

Schlachter, UniCredit: I think for the market to double in size and reach the €50bn mark, the new investors that have recently got familiar with it need to stay. I hope they do.

That’s one side of the coin. The other one is, if there were to be a significant consolidation in the German banking market, international banks might need to come up with the additional demand that would probably be lost. 

Especially for the smaller issues of €50m to €100m, you still rely on German savings banks and co-operative banks. Those sectors are very, very fragmented. In the current interest rate environment, we do see a tendency to consolidation … also among the Landesbanken.

If there was a wave of consolidation, I don’t think that in terms of demand for Schuldscheine one plus one would make two. It’s probably more like 1.5, because of diversification requirements.

Göldner, Helaba: Besides all the growth opportunities which are good for the Schuldschein, it’s good to keep the format as it is. It is an investment grade market with a simple and standardised documentation which allows us to execute deals easily for investors and issuers, and we should not try to push the Schuldschein into another format which doesn’t fit for the issuers and the investors.   

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