While bank issuers have struggled to keep their dominance in the Schuldschein market during the credit crisis, sovereigns have stepped into the breach and developed a bigger appetite for this niche product. But as Francesca Young finds out, it is not to everyone’s liking and doubts persist as to how long term a solution it is for sovereigns.
Traditionally a very private product for German banks and companies bought by German investors, the Schuldschein market has enjoyed a public renaissance recently.
Tradionally buy-and-hold investors such as regional savings banks and insurance companies bought Schuldscheine. Their staple fare was mortgage Pfandbriefe from German banks. But with many of those German banks in the doghouse for the past two years — or tied up with long-running mergers that served to reduce the variety of issuers — these investors have wanted to diversify.
Corporate and sovereign borrowers offered the perfect solution. In the corporate sector, Schuldscheine have had an impressive two years, with deal sizes peaking at over Eu1bn in 2008 and deal numbers almost doubling this year.
But progress in the sovereign sector has also been strong, not only because of the typically high ratings but also the attractive spreads on offer.
Because of those spreads, the sovereign notes became more attractive to investors looking for a pick-up over German Federal State Schuldschein notes, the most common Schuldschein paper, which trade around 5bp-10bp over Euribor for a 10 year duration.
Another attraction is that Schuldscheine can also be treated as loans and receivables or held-to-maturity assets not requiring mark to market valuations, therefore providing much desired stability for buyers.
Investors are willing to take these notes at a yield discount to the issuer’s benchmark curve, providing the borrower with a saving on its cost of funding, which in turn, makes Schuldschein especially attractive to borrowers keen to keep the cost of public debt down.
But like in the MTN market, sovereigns are often unwilling to place a trade if the amount is too small to warrant the work involved, as funding teams are typically small, at least compared with those at supranationals and agencies.
"We’ve been approached about doing Schuldschein by two or three banks, but we are not authorised to do this kind of note," says Anne Leclercq, director of treasury and debt capital markets at the Belgian Debt Agency. "We want to be flexible and to diversify but it’s important to grow our activity in the private placement market gradually."
Poland has a minimum issuance size of €250m as do many others. Austria is the exception, and can be approached with €15m clips — a strategy that has won praise from dealers who hold it up as as a good example of how sovereigns should approach the Schuldschein market. Austria looks for a discount from its benchmark curve of between minus 8bp and minus 12bp for Schuldscheine.
But convincing other sovereigns of the benefits of Schuldscheine has not been straightforward, as there is a potential problem with public perception if sovereigns do off-screen, private trades. This is a concern for the larger benchmark issuing sovereigns who are anxious to be transparent to investors.
But the pick-up over Federal State Schuldschein is particularly prominent in the levels of the eastern European sovereigns. "Eastern European sovereigns are definitely a market that our investors are interested in," says Christoph Cremers, director and head of domestic sales/trading institutional sales for Germany and Austria at HSBC in London.
"Tapping the Schuldschein markets allows us to take advantage of a whole new investor base, and the reverse enquiry from German insurance companies has been strong," says Anna Suszynska, deputy director of the financial assets and liabilities department at the Polish finance ministry. "This year we decided that the interest had grown to such an extent that it was time to take advantage of the demand."
But how much longer this flurry in sovereign Schuldsheine will last is unclear. Because it is such a discreet market, it is hard to know how much is being traded. Dealers say interest in vanilla sovereign Schuldschein has already slowed as investors have been put off by tighter spreads.
But the structured Schuldschein market is stepping in as some southern European countries have this year traded CMS notes in Schuldschein format.
"It’s all about whether the issuer is set up to issue Schuldschein, and the size criteria as well — they’d need to be around €100m or larger," says a senior MTN dealer in London.
Other dealers say there is demand for lightly structured Schuldschein notes, but that issuers are unwilling or unable to sell complicated structures.
“There is a bid for European sovereigns to issue Schuldschein at the moment, especially for for lightly structured CMS products, but for various reasons these issuers are not keen to tap that demand,” says Julie Edinburgh, director, head of MTNs at Credit Suisse in London.
Dealers are unsure whether the increase in sovereign Schuldschein issuance this year will continue into next year, as its primary driver was the wider spreads. As investor confidence returns, buyers may be keen to move down the credit curve and back into financial institutions and riskier credits.