The Schuldschein market changed little for decades. A steady stream of German industrial companies collecting loans from sedate savings banks and co-operatives. The arranger’s role was rather simple, acting as broker between the two dignified parties.
But lately, the market has become racier.
Over 150 borrowers flooded the market in 2017 — some from far flung places like Hungary, Russia and the US — seeking cash from investors, some from even further flung places like China and Taiwan.
Now the mandates to be won reach beyond a bank’s existing relationship clients. The tactics used to win business have changed as well, changing the clubby atmosphere of the market.
For example, arrangers are offering to underwrite deals at very tight margins, or with chunky lead orders — methods they have taken from the fixed income playbook. Such gambits are often undertaken quietly, so that rivals do not get wind of them.
This could be seen as the sign of a healthy market, focused on achieving the best price for borrowers. But it comes with problems that are often hard to spot.
One rising trend is deals being launched and then pulled, because their tight pricing fails to attract enough demand. Because the market is private this can usually be done fairly discreetly, but it is still an embarrassing and uncomfortable experience.
Other deals get dragged over the line with orders from the arrangers. “Investors won’t be told, ‘we’re providing a lead order on this transaction’ [and that’s why the price is so tight] — the arranger would just say ‘this is just market conditions’,” said the head of Schuldscheine at one investment bank.
Investors feel hard done by
Meanwhile, many investors complain of being priced out of the market. Some feel the arrangers take them for granted, and do not treat them with as much care as they used to.
Asian and European commercial banks tend to be the most aggressive investors in deals from non-German borrowers. A clutch of these lenders have bought the tightest deals, which remain priced too expensively for the rich variety of other Schuldschein investors.
Institutional investors like AllianzGI are particularly frustrated, but even some Asian banks are finding the margins too tight to participate.
Arrangers are not treating this with much concern. "It's boo hoo for them, I'm afraid,” said one.
But they are wrong to be so blasé. Aggressive pricing and big orders from deal arrangers could hurt the market in the long term.
The Schuldschein market is an acquired taste. It requires an acceptance of illiquid debt and of a certain distribution process, as well as of unique documentation, which gives the investors no collective bargaining power.
The present, unprecedently large investor base for Schuldscheine has brought about the market's golden age. If these investors are driven away, the granularity of the investor base will decline again, and the market's competitiveness will ebb.
The present stress comes as the European Central Bank is taking its foot off the monetary easing pedal, which could lead commercial banks to stray away from Schuldscheine back into other markets.
An arranger's responsibility is primarily to the issuer, of course, but issuers are not getting everything their way. Investors are sometimes pushing back, and this will happen more.
One recent example was when Telefónica Deutschland was forced to issue a second round of price guidance on a €150m triple tranche Schuldschein, led by Landesbank Baden-Württemberg and DZ Bank.
It was offering fixed and floating rate notes at seven, 10, 12 and 15 years, and with margin ranges of 55bp-65bp, 70bp-80bp, 80bp-90bp and 90bp-100bp. The 12 and 15 year tranches had minimum coupons of 1.875% and 2.125%.
“Our jaws dropped when that pricing came out — we certainly weren’t [pricing Telefónica] at that level,” said one Schuldschein banker, who had pitched for, but did not win, the transaction.
There was less appetite at these margins than expected, so the leads published new guidance at the wide ends of these ranges: 65bp, 80bp, 90bp and 100bp. The issuer also added a new five year tranche, offered at 55bp.
Schuldschein Goliaths with quickest feet
Another fear, perhaps more worrying than tight pricing — which ought to shake out eventually, as any market does — is concentration in the market.
The firms pushing hardest are not upstart challengers trying to win marginal business, but some of the powerhouses of the market.
LBBW — one of the great Schuldschein houses — has won by far the most mandates this year, and GlobalCapital understands some were won with aggressive pricing, propped up by providing a lead order. ING — a skilful and effective new entrant — is also known for this, and has successfully increased its market share.
It cannot be denied that a borrower — on the lookout for cheap funds — benefits from this situation in the short term. One arranger said it was like a "free lunch" for them. But the practice is not sustainable, for the market or arrangers' books. It could put arrangers off and lead to a shrinking of the provision.
The Schuldschein market is an ecosystem that needs a thriving variety of borrowers, buyers and arrangers.
If it goes down a path that is too similar to the bond market, the market could lose a lot of the quirks that make it useful for borrowers — and end up with fewer investors, offering a smaller set of tenors to a narrower range of issuers.
None of its participants would want that.