When it comes to corporate funding, most companies will head straight to their banks – they are, after all, a safe and reliable source of capital, certainly for everyday use. But whereas larger, rated firms might enter the debt capital markets when seeking a significant cash injection for a specific purpose (M&A, for example), their smaller unrated or lower-rated counterparts do not necessarily have that option.
This may not be a problem per se, but having a diverse source of funding, at least as a backup, is something most treasurers would favour under any circumstance. Knowing that other funding doors are open for every use, from the operational to the strategic, can give much-needed comfort not just to treasury, but also to senior management, the board, investors, buyers, suppliers and employees.
Under such circumstances then, it may be prudent right now for treasury to explore all the options. One funding source that has been steadily building a fanbase for some years now is the Schuldschein market (plural Schuldsheine). Although predominantly used by enterprises across the size spectrum in German-speaking countries, it has been quietly building up its volumes across other parts of Europe in recent years.
That said, it is still very much a niche market. Up until about four years ago, issuance volumes hovered below €10bn. For the last four years it has been over €25bn. In 2019, it actually did slightly better, reaching about €28bn. Generally, levels are travelling in an upwards direction.
Based on actual issuance, without cancellations and exchanges, UniCredit (using Bloomberg data and its own curated corporate news) calculated outstanding debt in the market of €89.1bn, as of February 2019. This, it concluded, meant that “demand for corporate Schuldschein loans as a stable and less volatile source of funding should continue unabated”.
Schuldscheindarlehen loosely translates as ‘a loan evidenced by a certificate of indebtedness’, the note itself being the ‘Schuldschein’. The market is governed by German law, being the result of hundreds of years of development in that territory. The offer is typically a senior, unsecured, private debt product that is a hybrid between a loan and a bond.
Although in documentary terms they are closer to a loan, they share similar marketing tactics to bonds. However, they are quicker to arrange and often less expensive than bonds as there is no requirement for Schuldschein notes to be registered at a stock exchange, and no corporate or debt rating is required.
They can be fixed or floating rate, with tenors usually set between three to ten years. Beyond ten years, Schuldscheine become Namensschuldverschreibungen (NSVs), which are legally a different (although obviously closely connected) product. More than one maturity at a time is possible – with bullet repayments, the borrower builds up its amortisation schedule with different maturities.
Lending amounts range at the lower end of the corporate debt scale, somewhere between €50m and €500m. Different currencies can be used, even within one issue. Euro is by far the most common, but USD, CHF and GBP are increasingly featured, with slightly more exotic currencies, such as Polish Zlotys, making the occasional appearance. Deals can be bi-lateral, privately placed arrangements, but the growth in the market appears to be syndicated, with perhaps three or four arrangers.
The initial set-up process involves an investor call or roadshow to drum up interest amongst the predominantly bank investor community. In much the same way as bond issuance preliminaries proceed, an information package will be created about the company, its intentions and prospects, detailing the proposed deal.
Borrowers, notes Penny Smith, Head EM Corporate Debt Origination and non-German Schuldschein, Commerzbank, seem to like the fact that they do not need a rating. It certainly saves the financial cost and administrative effort but, she adds, smaller companies are often looked less favourably upon by the big ratings agencies, even if fundamentally sound, simply because they do not have the financial weight to justify investment grade. There seems little point in depleting resources to achieve a low rating when, in this market at least, each investor carries out its own credit assessment anyway.
Because Schuldscheine are relatively illiquid, the debt is typically seen as ‘buy and hold’ by investors, which, as a result of that illiquidity, are mostly banks, says Richard Waddington, MD, Head of Loan Syndications & Sales, and Head of Private Debt, Commerzbank. However, with the market split between the domestic German and the International, investor bases are different, he notes.
In Germany, investors are, in the main, financial institutions – the Sparkassen and Volksbanken, with some Landesbanken and a few commercial banking players. Internationally, the investors are almost entirely commercial banks.
The institutional market (such as the insurers, pensions firms, and money market funds) do not seem to be overly interested, these players tending to be driven by investment policies that demand only highly-rated counterparties. If, however, a rated issuer is deemed a worthy target, Waddington says institutional investors will always weigh up the relative value of their Schuldschein versus bond options.
This is not to say institutions are not interested in unrated issuers. Indeed, he notes that some specialist investors will take unrated credit on an ad hoc basis, again making a call on the relative value of the asset versus other investment options. And some Schuldscheine are attractive in their own right. He cites a recent German state-owned rated corporate entering the market, offering an attractive pickup on German bund yield. With debt securities issued by Germany’s federal government currently negative, he says some institutional investors have taken the bait.
For the international treasury community, using Schuldschein just as a means of funding diversification could be a prudent move in itself, says Smith. But it also opens up a new investor-base for companies seeking an amount that would be too small (less than €500m) to warrant going to the bond market, and for those with no wish to get a rating. What’s more, she says, pricing is often favourable.
As privately placed debt, Schuldschein is only loosely aligned with the US private placement (USPP) market. As well as offering longer tenors, the US market has a totally different investor base, comprising mostly US-based (and a few Northern European) institutions.
For borrowers, there is a big difference. It’s difficult to pre-pay a USPP as it requires a ‘make whole’ exercise, notes Smith. This means that a business having issued a USPP when rates were high, has no easy escape as it watches rates go lower. “There is nothing they can do about it, because if they pre-pay, they have to pay all the interest that owed,” she explains. “With Schuldschein, a floating rate issue is pre-payable on an interest payment date at par – no fees, no penalties.”
Growing interest in Schuldschein has possibly bothered USPP players, Smith adds. Indeed, before Schuldschein started picking up volume around four years ago, USPP was very much a USD fixed-rate product. “Now it offers floating rates, euros, and much more flexibility in what can be done.” It suggests a USPP market responding to stiffening competition.
In 2016, Commerzbank placed the first ever ‘green’ Schuldschein. Worth €550m, and with terms of three, five, seven and ten years, with fixed or variable coupons, it was issued by German wind-power firm, Nordex. The proceeds were primarily used to finance the acquisition of Spanish competitor, Acciona Windpower.
Certification as a ‘green’ financial instrument by DNV GL Business Assurance opened up the market to ESG investors which accounted for around 25% of all subscribers. In total, just over 50% of funding came from international investors, the remainder mostly coming from domestic German savings and cooperative banks. Other green issuances soon followed.
When Royal FrieslandCampina – Europe’s largest dairy cooperative, and the second largest in the world – sought a new stream of funding, it knew that, as an unrated company, it would need to think on its feet. And so it did. It’s green Schuldschein programme scooped the Highly Commended accolade in the Best Financing Solution category of Treasury Today’s 2016 Adam Smith Awards.
With a requirement for €300m per year to support its Route2020 strategy, it was looking both at appropriate acquisitions and climate-neutral growth. Working with Rabobank as its green structuring advisor, the company issued in five, seven, eight, and ten-year fixed-rate tranches (respectively at 0.93% for €48.5m, 1.39% for €176.5m, 1.71% for €30m, and 2% for €45m).
The proceeds were aimed at eligible projects under FrieslandCampina’s green bond framework, in line with the Global Dairy Agenda for Action’s ‘Dairy Sustainability Framework’. Most of the funding went towards reducing the environmental footprint of the company’s factories, with sustainable farmer development programmes in developing markets, and the development of healthier products, absorbing the remainder.
Since then, Unicredit data shows more green corporate Schuldschein loans have been issued. In 2018 there were five, including Enercity (€100m for renewable energy), Volkswagen Immobilien (€100m for real estate), Encevo (€250m for utilities) and Verbund (€100m also for utilities).
Although green Schuldschein is far from a mainstream product, not taking off with as much vigour as has been witnessed in the regular loan and bond market, Smith nonetheless is seeing greater levels of interest. With the recent adoption of LMA Green Principles, Schuldschein is clearly making headway. Indeed, with issuances that reference sustainability and ESG KPIs when setting interest rate levels, it has provided yet more flexibility, with the potential to open up the market even further, adds Waddington.
Indeed, as the market grows, especially outside of Germany, and products develop, he feels that Schuldschein is maturing nicely on the international stage. With treasurers increasingly looking at diversified funding, especially as liquidity issues abound, it should surely be on the radar of continental European corporates. But with India’s oil-to-telecoms multinational conglomerate, Reliance Industries, setting up a US$170m deal in 2019, perhaps Schuldschein is set for entrance on the world stage in the not-too-distant future.