Schuldschein shines as private placements rise in prominence
Public capital markets are not the only game in town — indeed, one of the most exciting growth areas is private debt financing. This suits issuers that don’t want to have to conform to the sometimes restrictive norms required in public markets — and investors that are eager to find an edge, such as by being paid to do credit work and buy illiquid paper. Silas Brown reports.
For most of GlobalCapital’s 30 year history, few would have dreamt that, come 2017, one of the hottest topics in corporate debt financing would be private placements.
This product, which existed chiefly as the US private placement market, was seen as a curious backwater, the result of regulatory anomalies that made it efficient for US insurance companies to buy illiquid corporate bonds.
The exciting, fast growth was in the public corporate bond market, which has drawn in a host of investors and issuers across developed and emerging markets.
Nevertheless, since 2008 when public capital markets crumpled, private placements have gained a new shine.
Banks, investors and issuers have tried to create a European market to rival the well-established US one, which regularly swallows $50bn-$60bn of issues a year, at least 40% of them from non-US issuers.
So far, they have not succeeded in forming a single, harmonised European PP market — but private corporate debt financing has grown in prominence.
A key beneficiary has been Schuldschein — which before 2008 many capital markets professionals outside Germany had not heard of. Now, treasurers across the continent are being pitched Schuldschein deals by an increasingly international gaggle of bank arrangers.
The private placement mini-boom is being driven by three trends. Ultra-loose monetary policy has squashed bond yields making it difficult for fund managers to earn a return for savers after inflation. Picking up scraps of extra yield for buying illiquid paper is more attractive than ever.
Secondly, banks have balance sheet burdens and are happy to guide clients into raising money from capital markets, taking a fee in the process, rather than having to supply all their debt on balance sheet. Finally, companies have imbibed a new doctrine: diversifying their funding away from banks, lest they should one day prove unreliable.
Filling a need
The core private placement market for Europe remains the US one. It is the domain of some of the most rigorous credit investors on the planet: US insurance companies, and increasingly a few European players too, whose métier is buying credits they know are going to be sound. To do this, they conduct careful due diligence, turn down a lot of deals and insist on covenants.
US PP investors know that in the long term, they outperform public bond markets, partly by charging a little more spread, partly by suffering lower losses.
But that record needs defending, and this means there are a lot of European companies they are chary of lending to — or conversely, which do not want to endure the thorough legal workover required to secure US PP debt.
Hoping to fill that gap, and to rectify the apparent wrong that Europe lacked a PP market to match that in the US, came the Euro PP initiative by French banks, issuers and investors, starting in 2012.
With enthusiastic backing by French financial authorities, it was soon taken up by the International Capital Market Association and Loan Market Association, both keen to foster the market and in some cases provide template documents.
However, the space into which the Euro PP market has been able to expand is constrained. Unlike in the US, unrated companies can issue public bonds in Europe at efficient prices — and bonds below benchmark size. The old corporate banking culture in Europe has not gone away, so as banks have recovered, bank credit is also plentifully available.
If companies are definitely set on a private placement, the strongest credits among them can go to the US PP market, especially if they want dollars.
As if that was not enough, Euro PPs have another competitor — the market whose star is currently in the ascendant. Schuldschein has delivered over €50bn of funding since the beginning of 2015, including last year’s €26bn record total. So far, 2017 is keeping up the pace, with €8bn of deals in the first quarter, including jumbo offerings of €958m for forklift truck maker Kion and €900m for Volkswagen, its first return to direct capital markets borrowing since its emissions cheating scandal in 2015.
Kion and VW are German, but much of the Schuldschein’s growth is international. “The Schuldschein has a different league of issuers from the international area — typically larger companies, and typically larger deal sizes,” says Andreas Petrie, head of primary markets at Helaba in Frankfurt.
Of the 122 Schuldschein tranches issued in the first quarter, according to NordLB, 56% were from German issuers, 11% from Austrian and Swiss firms and 33% from nine countries further afield, including the Czech Republic, Luxembourg and Poland.
Last year almost half of corporate Schuldschein issuance was for non-German companies, up from a quarter in 2015.
The growth of foreign issuers goes hand in hand with that of foreign investors. This once-obscure market has attracted snowballing demand from investors outside Germany, many of them banks wanting to lend to European companies.
“HSBC is now organising workshops for Asian investors,” says Ingo Nolden, co-head of debt capital markets at HSBC in Düsseldorf. “Asian investors need international diversification and German names already have strong Asian links.”
Many traditional German investors — Sparkassen and insurance companies — are still happiest lending to German firms, and often price out international investors from these names. Foreign buyers have a bigger presence in non-German deals.
But Kion was keen to find Asian demand for its five, seven and 10 year fixed and floating rate debut Schuldschein, and held a roadshow in the region.
VW’s deal, which tripled in size during marketing, was over half sold to foreign investors, with Asia prominent.
The Schuldschein market is becoming more sophisticated in other ways, lending in a variety of currencies, like the US PP market. VW set a record by raising $500m of its deal in dollars. Even non-German issuers are using the Schuldschein to fund in dollars — like Huhtamäki, the Finnish cup maker, and Neopost, the French postal equipment maker. UK builder Carillion raised dollars and sterling in January.
“The multi-currency Schuldschein trend is driven by issuers looking to avoid cross-currency swaps as — due to regulations — currency swaps are a costly exercise,” says Nolden.
It also suits investors like Asian banks, used to funding and lending in dollars. Swiss franc, Czech koruna and zloty tranches have also appeared.
Euro PP finds its niche
In contrast to the surging Schuldschein, the Euro PP lacks momentum. No substantial deal has emerged since Atos Origin’s €300m seven year deal in October.
“You might have political, or institutional, support,” says Nolden. “But, ultimately, it is the market that decides.”
In December Groupe SEB, the French kitchen goods firm — exactly the kind of issuer Euro PP’s early promoters hoped for — issued an €800m jumbo Schuldschein, 70% placed outside Germany.
“The Schuldschein pricing seems to be always lower than the other private placements,” said Emmanuel Arabian, vice-president of group finance and treasury at SEB, at the time.
The Schuldschein’s lighter documentation and flexibility also appealed to SEB. But the Euro PP market is still active. “The Euro PP has a different market philosophy to the Schuldschein,” says Fabien Calixte, private placement specialist at BNP Paribas in Paris. “Euro PP has a club deal approach — institutional investors focusing on a different population of smaller, crossover credits. Foreign issuers raising funds in the Schuldschein market will find bank investors looking for implied investment grade firms.”
The future of Europe’s private debt markets looks diverse. The US PP and Schuldschein — both tightly defined by legal documents — and the looser world of Euro PPs, each have pros and cons. Given the variety of companies in Europe, that is a good thing.