In an age when banking products are becoming ever more sophisticated and complex, it is rather refreshing to see an old-fashioned market, Schuldscheine, making a comeback. Philip Moore reports.
Schuldscheindarlehen generally translated as German promissory notes are enjoying something of a revival as an alternative source of funding for German financial and corporate borrowers.
"Four of five years ago the Schuldschein sector was deemed to be a dead-end market by people who believed that accounting principles were becoming such that marking to market would become necessary for all investors," says Martin Gipp, director in the debt syndicate at Dresdner Kleinwort in Frankfurt. "But that hasnt been the case, and Schuldscheine are still very attractive to local insurance companies and pension funds that treat them as loans for accounting purposes and do not have to mark their positions to market."
Schuldscheine also appeal to an increasing number of non-German investors, according to Gipp. "We have seen rising participation from non-German banks with branches or subsidiaries in Germany but which dont have any Hausbank relationships," says Gipp.
Solid demand among buy and hold investors, say bankers, has not gone unnoticed among issuers from outside Germany most notably among those in its German-speaking neighbours, Switzerland and Austria. But issuers from further afield, such as the Spanish cajas, are also reported to be looking with more interest at the potential of Schuldscheine. Issuance size is typically anywhere from Eu50m to Eu250m, although these are by no means the limits of issuance.
For the most part, however, Schuldschein issuers are concentrated principally within Germany, for a range of reasons.
The fact that there is no requirement for issuers to be rated is especially appealing to local borrowers, especially from the Mittelstand sector. The simplicity of the product is also an attractive feature for smaller corporate borrowers. "You dont need a listing, documentation is in German and is relatively slim, and from a legal perspective the process of issuing Schuldscheine is relatively straightforward," says Alexander von zur Muehlen, co-head of client coverage for Germany at Deutsche Bank in Frankfurt.
Another advantage of the Schuldschein market, says von zur Muehlen, is its flexibility relative to the traditional bank loan sector. "Schuldscheine are viewed as senior unsecured loans, whereas the vast majority of bilateral bank lending to mid-cap companies is done on a secured basis," he says. "That additional flexibility is very attractive to mid-sized corporates."
Flexibility of maturities relative to the bank market is another attraction, says von zur Muehlen. Although investors have been favouring shorter maturities since the credit crisis of the summer, as a general rule Schuldschein funding is available in maturities of up to seven years, which he says is slightly north of what would usually be accessible to Mittelstand borrowers in the bank market.
Clear cost advantage
While the cost of unsecured Schuldschein funding is unsurprisingly higher than the bilateral loan market, bankers say that it stacks up very well relative to the bond market.
At LBBW, which is now marketing Schuldscheine under the brand name of Euro-PP, head of corporate origination Christoph Zender says that in the first half of 2007 a typical corporate borrower with an implied triple-B rating could probably have expected to pay a premium to the corporate bond market in the range of 10bp.
Since the credit crisis effectively closed the door to all but the best-rated corporate names, says Zender, that premium has been reversed, with the Schuldschein market still open for business.
As a private and non-officially clearable market, there are no official statistics tracking the issuance of Schuldscheine, although there are some palpable indications of its growth.
One is the recent increase in the size and number of platforms for the securitisation of Schuldscheine established by banks as a means of warehousing smaller Schuldscheine and distributing them to the capital market.
An indication of the growth of this market is provided by Zender, who says that LBBWs first Entry programme securitised Schuldscheine of about Eu420m. "Currently we are marketing our second LBBW Entry transaction which is already of a comparable size to the first," says Zender.
Other banks report similar levels of demand. At Deutsche Bank, head of debt finance for Mittelstand companies Stefan Boden says that in the first phase its DB Schuldschein programme has securitised unsecured loans to some 160 companies worth just over Eu500m with maturities of five to seven years. "That programme worked very well and we are in the process of ramping up our second portfolio," he says. "Events in August widened spreads on those loans but I think exits via securitisation remain feasible."
Flow of deals getting bigger
A second pointer to the expansion of the Schuldschein market is the volume of individual transactions being arranged by fast-growing market participants. "Last year we arranged about Eu1.5bn in individual Schuldscheindarlehen," says LBBW's Zender. "This year, in spite of very difficult market conditions, we expect to achieve a new record of Eu2.5bn."
A number of other banks are also beefing up their presence in the Schuldschein market. Take DZ Bank, which has enjoyed success in recent years strengthening its franchise in the covered bond market.
More recently, according to its managing director and head of fixed income origination, Arnold Fohler, DZ has taken a strategic decision to focus more intensively on the Schuldschein product.
"We feel there is no reason why we shouldnt be as successful as the existing market leaders in the corporate Schuldschein area, which is why we will soon be opening a competence centre designed to better bridge missing links between issuers and investors," says Fohler.
"Schuldscheine are mainly unrated instruments where investors need to do a lot of credit analysis to make what is in effect a loan approval rather than a bond approval, and arranging banks need to make sure that relevant investors have sufficient information to be able to make that approval."
Providing that resource is just one way in which banks active in the Schuldschein sector need to make a considerable commitment to the market, which may explain why this product will not necessarily attract all banks.