The Schuldschein has gained a following among corporate borrowers as a means to raise money on the private placement market. Characterized by simple documentation and a high level of flexibility, the Schuldschein has been traditionally known for funding Germany’s industrial Mittelstand.
Nowadays it is increasingly used by corporates across Europe to diversify their funding base. As the relationship bank model makes large public syndications rare, it allows borrowers to look beyond relationship banks as well as providing an alternative to the bond market.
But what benefits can Schuldschein offer investors? Below, Penelope Smith considers the benefits and opportunities for international investors seeking to expand their investment portfolio into Schuldscheine.
Who is investing in Schuldschein right now?
Dominating is a mix of German and international banks - commercial banks, savings banks, cooperative banks, Landesbanks, large and small. Some institutional investors, such as insurance companies and pension funds participate from time to time. As the majority of Schuldschein are issued by unrated borrowers, investors tend to be organizations able to perform their own credit analysis - hence the larger number of bank investors.
What are the attractions of Schuldschein for these investors?
The Schuldschein provides an opportunity for investors to participate in solid European credits that would otherwise be unavailable. Revolving credit facilities (RCFs) have become relationship-driven and big syndicated term loans are rare. Most banks are not big investors in the bond markets, and prefer the non mark-to-market and much less volatile Schuldschein.
Investors also find the simplicity and flexibility attractive for a term loan exposure, and have a wide choice of borrowers to pick from now. Deals vary in size from €50m to €1bn or more, from a range of sectors and nationalities, and an investor can participate with the tenor and ticket size that suits them. Initially the preferred tenors were three to five years, but as the market has matured and investors’ search for yield has intensified, five to seven year tenors now dominate. Investors can choose floating or fixed interest rates, and generally benefit from a zero-rate floor. The Schuldschein is a tradeable instrument although in reality most investors buy to hold. English is now seen as the binding language for international deals which makes it much easier for most international investors in their approval process.
How do the yields on Schuldschein compare with other instruments?
Historically a Schuldschein was priced above loan pricing given the lack of relationship providing ancillary business. Schuldschein yields tend to be higher than those of rated, investment-grade bonds but lower than those of unrated bonds. However, ECB action recently has changed this dynamic and bond spreads have tightened considerably for both rated and unrated names.
There is talk about QE in Europe coming to an end. What would that mean for the Schuldschein market?
The end of QE could have various implications for Schuldschein. On the positive side it could potentially make the market more attractive to borrowers because Schuldschein are far less volatile and should be able to hold the current tight pricing levels, whereas bond yields would be forced to widen. However the wider spreads could also mean institutional investors move away from Schuldschein in search of better yields elsewhere leaving the traditional audience of bank investors.
What has growth in the market been like?
Volume figures for the Schuldschein market aren’t public to the same extent as loans/bonds so it’s hard to say definitively but we have seen a number of years of continuous growth. Last year was a record year with just under €26 billion in volume across 129 deals, according to Thomson Reuters, compared to €20 billion in 2015. Arrangers and other monitors such as Bloomberg probably have higher or lower figures.
Growth has continued into 2017, with €13.9 billion across 74 deals for the first half of the year, (Thomson Reuters) and it is possible a new record might be reached by year end again.
However, the profile of the market has shifted this year. In 2016, we saw more than 10 benchmark deals including from France and Switzerland. This year we have seen far fewer benchmark size deals but also far more small transactions and by number of issues, the total is well up on 2016. It is likely 2017 will see the highest number of deals ever, even if the overall issuance volume isn’t surpassed.
How is geographic and sector coverage developing?
Germany continues to command the lion’s share of the market, but, the product offers exposure to a range of nationalities. Alongside major “mature” markets like Austria and France, 2017 has brought interest in Schuldschein from Central and Eastern Europe with Polish, Czech, Hungarian and Russian deals coming to market this year.
Although we still see many industrial and manufacturing borrowers, recent issuers have also come from utilities, construction, transport, real estate, service sector, media and technology backgrounds – almost any sector you care to name. It’s all about the credit story.
What would you say are the key questions an investor needs to be asking when appraising a deal?
Investors should review the credit quality as well as making sure the yield and other terms (such as covenants, maturities, interest structure) work for them. We see investors demanding international standards of documentation, having specific KYC requirements and generally paying more attention to the arranger group. In particular we notice many investors prefer Arrangers to be long term relationship banks, so even if they have no ticket, they have large credit exposures elsewhere. This helps ensure the Arrangers remain involved and committed to the Borrower through the life of the transaction and their interests are aligned with the investors.
We continue to see the international investor base expanding, and it is not unusual to see a first time investor in nearly every deal. Arrangers still make efforts to widen the investor base further, visiting new regions and removing the miscomprehensions many still harbour about what is now an international product. As the investor base increases, the volume and number of transactions will also be able to increase and the future continues to look bright for the Schuldschein market.
Author: Penelope Smith Director, Head of non German Schuldschein Origination, DCM Loans at Commerzbank
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