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Schuldschein: no country for old men

The Schuldschein market attracts a diverse mix of investors, with different tastes and needs. Amid the push and pull of a burgeoning market, the burning question is whether each of these differing characters will remain content ­— or whether some may get pushed out, as the market develops and changes shape. Silas Brown reports.

Some Schuldschein investors still remember the good old days, when only German borrowers from the industrial heartlands would find a way to their desks. It was a local market for local companies, supported exclusively by local investors. 

But that is changing — fast. Last year, for example, borrowers from as far afield as the US and Russia flocked to the market. “Last year was a new record in terms of volume, but it was less dominated by benchmark sizes,” says Rudolf Bayer, head of UniCredit’s private placement desk in Munich. “Average volume was down but the number of deals was significantly up”. 

Some are finding it hard to adjust to this racier pace of life. There was a moment in June last year when 26 borrowers were courting investors — a staggering figure for an older generation of investors, more used to dealing with that number over the course of a year. 

Some smaller savings and co-operative banks are struggling to cope with the dealflow to the extent that they are asking arrangers to slow down.

“We don’t want to be forced to choose between one issuer or another because we don’t have the time to look at both,” says one investor from a co-operative bank.

But new types of investors are arriving, including European and Asian commercial banks, more used to the cut and thrust of capital markets. They are multiplying in number and appetite to the extent that they rival the Sparkassen for market dominance. They are bringing with them customs not seen in the Schuldschein market before. Deals can be oversubscribed in a matter of days, as investors place soft orders before analysing a borrower’s credit quality, to be sure of a stake in the final placement. 

Process machinery firm Andritz launched a €200m Schuldschein in May that was oversubscribed in four days. It doubled to €400m, with the seven and 10 year tranches priced at the tight ends of margin ranges of 100bp-120bp and 120bp-140bp over Euribor. 

It took a mere day for car parts maker Hirschvogel’s €100m deal to be fully subscribed. Seven and 10 year tenors were sold at the tight ends of the 90bp-110bp and 110bp-130bp ranges.

Institutions squeezed

Borrowers hold the whip hand in the Schuldschein market. Any investor prepared to relax covenants or make concessions on margins is instantly popular, while the stricter lenders are quickly directed to the back of the queue.

This is particularly true for institutional investors, which are feeling the strain more than banks. Sticklers for financial covenants and minimum margin floors, they used to have one selling point above all else — a willingness to lend at tenors banks would not touch.

But this is changing. Commercial banks, as well as German savings and co-operative banks, are now prepared to buy Schuldscheine with comparable tenors to the institutional investors, at seven, eight or even nine years. 

“The maturity advantage that an institutional lender had has gone,” says Thomas Schneider, head of European corporate loans at Allianz Global Investors in Munich.

Bank lenders are also prepared to cede ground on covenants.  

“I sympathise with institutional investors that would like financial covenants if they lend for longer tenors,” says Richard Waddington, head of loan sales and private debt at Commerzbank in London. “The institutional lenders must offer something that other investors can’t.” 

They are at least trying to. Some large institutional investors including AllianzGI, Talanx and VKB have set up a working group to carve out a niche for themselves in the Schuldschein market. They want to lend to premium, or unquestionably investment grade, borrowers. Their offer to issuers will be similar to the pitch investors in Euro private placements make: fewer investors, offering larger tickets and confidentiality, in exchange for higher yields and financial covenants. 

“We know there’s corporate appetite for this sort of arrangement,” says one institutional lender. “And the other institutions are on the same page, too.”

No favours

Others have yet to be convinced borrowers will be interested in an institutional premium Schuldschein market.

“Ultimately, it’s a seller’s market, and most of those sellers are interested in lower margins and few covenants — it’s as simple as that,” says one Schuldschein banker.

But this seller’s market could change if covenants and margins fall too far. Eventually, resistance will be felt. And there are signs, albeit tentative, that investors are beginning to dig their heels in.

Telefonica Deutschland was forced in late January to issue a second round of price guidance on its €150m Schuldschein issue, after investors’ appetite turned out weaker than expected.

The arrangers, DZ Bank and LBBW, launched it with margin ranges of 55bp-65bp, 70bp-80bp, 80bp-90bp and 90bp-100bp over Euribor, for seven, 10, 12 and 15 year tranches. 

One German investor said: “I saw Telefonica offering 55bp for a seven year tranche and I thought, ‘Forget it’.” This was a view widely held by investors and rival arrangers alike. 

“Our jaws dropped when that pricing came out — we certainly weren’t [pricing Telefonica] at that level,” said an arranger at a rival bank. After feeling the coolness of the reception, the leads published new guidance at the wide ends of the ranges: 65bp, 80bp, 90bp and 100bp. 

But pricing wasn’t the only reason why the deal initially struggled. Porsche and Rewe, considered quite similar to Telefonica Deutschland among Schuldschein lenders, despite their very different industries, were marketing at the same time, and some felt investors already had enough on their plate. 

“It’s hard to say about whether we’ve reached a pricing floor, but the market is certainly a little overheated,” says one Schuldschein banker.

Some investors even say ultra-tight pricing is a bigger reason for downscaling their activities than credit problems such as those at Steinhoff and Carillion, both recent Schuldschein issuers.

Default response

Just six months after BayernLB and HSBC had brought Carillion to the Schuldschein market for the first time, the UK construction and support services group lost 70% of its stockmarket value in July last year, after declaring an £845m provision against bad contracts. 

By January 15 it had gone into liquidation after running out of cash, despite being the UK’s second largest construction firm and listed on the London Stock Exchange.

Shares in Steinhoff, the acquisitive South African retail group, plunged in early December and roughly 100 lenders were stuck with about €630m of Schuldschein debt sold in June 2015. 

The question in hushed conversations around Frankfurt was, would Schuldschein investors freeze up after the Steinhoff and Carillion debacles? Many felt investors might call for more financial covenants and higher yields for the risks. 

And yet, the optimists in those discussions have so far been proved right. There is little sign of a retreat and last year’s issuance was a record €27bn, by a record 153 borrowers. 

It seems the shocks of Steinhoff and Carillion were muffled because of the nature of the Schuldschein investors themselves. 

Traditional Schuldschein lenders, like German savings and co-operative banks, go through a painstaking analysis of credit quality. 

“You can’t do much if the audited financial statements turn out to be questionable,” says Paul Kuhn, head of debt capital markets origination at BayernLB in Munich. “Steinhoff was rated investment grade by Moody’s when it got into trouble.”

Steinhoff, as it affected more Schuldschein investors, caused more concern than Carillion, which was a niche credit in the market. But the vast majority of Schuldschein participants believe that the problem lies with the issuer, not the market itself.

However, 10-15 lenders to Carillion and around 100 lenders to Steinhoff still came up against the product’s illiquidity.

As the issuers stumbled, the investors struggled to work out how to proceed, as there were few previous cases to guide them, and little secondary market activity. 

Investors usually have scant appetite for selling Schuldscheine, as they have traditionally had a buy-and-hold culture. But that culture might change if more borrowers get into difficulty — a real possibility after the credit cycle turns.

Hoping to answer that need, Debitos, a fintech company based in Frankfurt, has launched a secondary debt trading platform with a specific focus on non-performing assets. Debitos says it has 298 investors prepared to buy non-performing loans, including Steinhoff’s Schuldschein debt. 

“We have a bid out there from an investor looking for Steinhoff tickets up to €10m at 70, which is the best bid out there,” said Timur Peters, managing director of Debitos in mid-March.

“It’s not a surprise that with the growth of the market come more similarities with capital markets more generally,” says one commercial bank lender.

“Everyone needs to adapt to the new normal, or else move on.”

The relevance of credit defaults in the Schuldschein market is often overstated, and the same can be said for trading platforms.

But in the rare case of credit difficulty the Schuldschein investor’s characterstic stance as a buyer and holder might be shown to be merely skin deep.