Bond market volatility driving Schuldschein boom
The past few years have seen substantial activity in Germany’s Schuldschein market. With bond markets roiled by volatility and negative yields, many investors — including an increasing number of international players — are seeing Schuldscheine as an attractive alternative, and 2016 looks set to be one of the market’s biggest years yet, says Rudolf Bayer¬, Managing Director, and Jörg Stührwohldt, Managing Director, at UniCredit.
The Schuldschein market, Germany’s famous private placement market, has enjoyed some big years recently, with year-end transaction volumes reaching €19bn in 2015, according to UniCredit statistics. It’s a trend that looks set to gather steam, as investors turn to Schuldscheine in a bid to increase the investments in their loan portfolio and profit from attractive yields. At the same time, corporates are meeting this growing demand with a supply of increasingly large transactions — attracted by a combination of favourable pricing and a more stable and sustainable investor demand.
On the back of these two developments the Schuldschein market has become a focal point of supply and demand. And this trend is not limited to the domestic scene. Rather, we are seeing an increased supply of international participants in the market, with foreign investors particularly active. And as this development continues, it looks to be paving the way for a bright future in 2016 and beyond.
Investors seeking protection from negative yields
This growing demand for Schuldscheine comes in the midst of substantial volatility in bond markets, as negative Euribor and mid-swap rates eat into credit margins and investors turn towards alternative markets for more reasonable yields.
In comparison to the bond market, the Schuldschein market represents a compelling proposition in this respect — offering protection against volatility and negative rates thanks to the widespread inclusion of zero floor language. Indeed, Schuldschein contracts nowadays often stipulate that if the Euribor or mid-swap rate is less than zero, it will be considered to be zero for the purposes of setting the coupon — enabling investors to lock in at least the offered credit margin.
In addition to this protection, the Schuldschein market also offers the added advantage of diversifying investors’ portfolios — providing exposure to many corporates with an investment grade credit matrix which are not part of the bond market issuer base and with whom they have no outstanding relationship.
Other advantages are also contributing to demand. For instance, Schuldschein investors can benefit from a bilateral documentation process which leaves room for tailor-made maturities and structures to suit their needs. Equally, the Schuldschein’s non-mark-to-market status — which exempts it from reflecting the investment’s current market value in their financial statements — is a powerful incentive to investment and offers protection against volatility in the bond markets.
Issuers benefit from flexible repayment and favourable pricing
On the other side of the equation, issuers themselves are keen to tap into the rising demand for credits. As a result, we have seen an impressive increase in the size of transactions in the market, with some companies — including a number of frequent bond issuers — issuing notes in excess of €1bn.
Certainly, the Schuldschein continues to offer corporates robust benefits over alternative debt offerings — even with investors keen to use floor language to secure a minimum rate of return.
This is partly because issuers are already familiar with zero floor language from the syndicated loan market, where these conditions are currently more or less standard.
Even companies with the option of taking their business to the bond market will still see Schuldschein issuance as an attractive option because of the opportunity to secure favourable pricing. With investor demand for bonds tempered by volatility concerns, the safer Schuldschein is an attractive alternative.
Beyond pricing, companies looking at Schuldschein issuance will also see a chance to diversify their investor base. Just as investors are looking for a more diverse portfolio of investments to spread their exposure, so issuers can benefit from a wide range of financing sources. Since there is no overlap with bond market investors, the Schuldschein market offers a strong opportunity to find new funding sources.
Furthermore, Schuldscheine also afford corporates greater diversity than bonds when it comes to the repayment schedule. This is because they can be issued on a multi-tranche basis — an arrangement which sees the issuer divide the debt into portions, or tranches, which can vary in terms of amount, maturity and currency.
For instance, a company could issue a Schuldschein split into three tranches, with, say, three, five, and seven year maturities. This means the company can de facto repay or refinance its debt in instalments — a more flexible alternative to the bond market paradigm of settling the debt with a single bullet tranche repayment at maturity to ensure higher secondary market liquidity.
Schuldschein tranches can also be split between fixed and floating rate coupons. In particular, the floating rate tranche gives issuers further flexibility as the legal call right for loans enables them to repay or refinance their debt in advance of the maturity date.
What’s more, the range of available maturities for Schuldscheine is also highly diverse, with scope for maturities ranging even beyond 10 years — something which is rarely achieved in alternative markets such as the loan market.
And better still for issuers, this flexibility is not accompanied by overly burdensome documentation, as for instance in the US Private Placement market. Indeed, Schuldschein documentation is famously concise — making issuance quicker, cheaper and simpler than with other forms of debt.
Not only is this beneficial in terms of general efficiency, it also means that companies can issue Schuldscheine in smaller volumes than would be viable in many other markets, with figures as low as €10m perfectly possible. This is particularly advantageous for international Schuldschein issuers, who can use the instrument to broaden their investor base without necessarily having to issue large amounts of debt.
Investor base becoming increasingly international
Despite growing international interest, however, Schuldschein issuers remain predominantly German-speaking. Around 80%-90% of Schuldscheine are issued by companies from Germany or Austria, and the remaining 10%-20% are predominantly from French companies, with other European countries such as Switzerland, Belgium, the Netherlands and Luxembourg contributing just a small number of issuers.
The investor base, on the other hand, is becoming increasingly international. Greater participation from foreign bank investors accounts for much of this shift, but there is also growing interest from institutional investors. These international investors typically invest with above-average ticket sizes, but generally also demand higher spreads than the domestic investor base.
This increasing international interest comes as part of a wider trend towards investment in Europe's private placement markets, where investors are finding highly rated, profitable, alternatives to the low-yield bond environment.
Certainly, the Schuldschein market is reaping the benefits. Investor numbers and issue sizes continue to grow and the trend shows no sign of letting up — putting the market in a position to build on its recent growth with another impressive year.
Certainly, following strong years in 2008, 2009, and 2015, 2016 is already showing great promise, with transactions worth more than €3.5bn already closed in these first few months, and further deals worth in excess of €2.5bn set to be concluded in the near future. Based on this activity, 2016 looks set to live up to and perhaps even exceed last year’s total volumes of €19bn — heralding a bright future for the Schuldschein market.