Germany 2006 Mittelstand gets sophisticated
In line with the pick-up in the German economy, demand for credit from the Mittelstand is on the increase. As this new cycle begins, the signs are that middle-market companies are looking at a range of funding alternatives, rather than relying upon traditional loans from their house banks. Michael Marray reports.
Banks are actively marketing mezzanine finance and quasi-equity to their Mittelstand clients. And there is also plenty of demand for Schuldscheine, a quasi-capital markets product for unrated companies or those without direct access to the bond market. In addition, asset-backed commercial paper (ABCP) conduits are increasingly being used by companies that generate stable flows of trade receivables with top-quality customers.
Companies at the very top end of the Mittelstand may be forging links with foreign banks for the first time in the syndicated loan market. Foreign banks which entered the German loan market to concentrate on the top hundred or so corporates are now targeting smaller companies, and marketing themselves to the top end of the Mittelstand.
In fact it seems that everyone is the Mittelstand customers. This is somewhat ironic, after all the gloomy predictions about a downturn in Mittelstand bank lending with the coming of Basel II and the disappearance (in summer 2005) of Landesbank guarantees.
The Landesbanks have responded by putting in place more efficient risk modelling systems, and re-priced their Mittelstand loan products, taking into account their own higher funding costs now that state guarantees are gone. But they remain competitive.
Indeed the entire German banking sector is in overall better shape than five years ago. After tens of billions of euros worth of loan write-downs, balance sheets have been substantially cleaned up, and there is plenty of capacity for new lending.
“We are seeing growing demand for new financings, and all kinds of small and large deals being discussed, including both syndicated and club deals,” said Michael Legeland, head of loan syndication at Commerzbank.
“Clearly it is quite a competitive environment, especially since many of the biggest corporates have already put facilities in place, and more banks are turning to the next tier and increasing price competition. But pricing for Mittelstand borrowers is generally more stable than for the very large corporations that are well recognised outside of Germany, and can therefore access a larger, more liquid market.”
Ulrich Mattonet, head of syndication at Bayerische Landesbank noted that with improvements in the German economy, most banks have addressed the problems that they had with credit exposure, so they are once again looking for new business, and are quite asset hungry. "There is definitely a greater appetite from the Mittelstand for new financing, and there are a lot of pre-discussions going on for both syndicated loans and Schuldscheindarlehen, so the second quarter should be quite busy," he said.
Schuldschein are hybrid loan instruments lying somewhere in between a syndicated loan and a bond. They are good instruments for unrated corporates looking to raise up to €50m. Documentation is much less onerous than would be the case for a bond offering, and bank arrangers can place the paper with institutional investors as well as with other banks.
“There are a lot of club deals being signed,” said a foreign banker. “German corporates are much stronger than they were, and they need new credit. In particular acquisition finance facilities are a major focus for us at the moment.”
Mittelstand companies are also strengthening their own balance sheets by putting in place a variety of mezzanine debt and equity-type products, some with profit participation. These products are originated by banks with the specific intention of securitising them.
For example, HSH Nordbank and Landesbank Baden Wuerttemberg have combined to offer Mittelstand customers the SmartMezzanine product. Type 1 is subordinated debt, while Type 2 has profit participation and is more like equity.
“We are seeing a high level of interest from Mittelstand companies in products such as SmartMezzanine, though for mid-sized corporates this will often be one of their first contacts with the capital markets, so the product needs a lot of time and explanation,” said Volker Meissmer, senior vice president and head of securitisation at LBBW.
LBBW provides the financing, warehouses the loans, and when it reaches critical mass, will launch a securitisation. But many other institutions offer products where the placement must be sold before companies get their funding. One such is Capital Efficiency Group, which has already done a number of securitisations, and in mid-March was readying another PREPS deal, to be led by JP Morgan and HVB.
“There are various motivations for companies taking up mezzanine capital,” Meissmer said. “Some companies simply want to improve their internal credit ratings with bank lenders, while others want to increase their equity base to generate leverage for the financing of future growth. In the current economic environment, an increasing number of Mittelstand companies are looking to grow their business, and some are looking to acquire other companies.”
Mezzanine products are being used to address the equity gap within the Mittelstand, and most company owners continue to prefer such confidential and flexible financing, and remain averse to bringing in new equity partners who want voting rights and some degree of control. There have been some company sakes sold to private equity investors, but this remains a steady flow of business for M&A bankers, rather than a rush to sell by Mittelstand owners.
The IPO market, while picking up significantly over the past year or so, has been quiet and there has been weak investor demand ever since the collapse of the Neuer Markt in 2002. “Equity markets typically demand too much transparency or dilution of control for family owners intent on independence,” said Edward Eyerman, head of European leveraged finance at Fitch Ratings.
Just as mezzanine products are specifically originated by banks with the intention of a capital markets exit, to a large extent German banks are also now modifying their conventional loan documentation to make loans suitable for inclusion in securitised asset pools.
So as the economy picks up and loan business with it, the new German banking model is on display, one where banks either sell off loans or lay off the risk, and are able to recycle capital into new lending.
Many banks have laid off Mittelstand risk via the synthetic Promise platform which was set up by KfW back in 2000. Banks keep the loans on balance sheet, but offload the risk. KfW charges a fee to use its Triple A rating to interpose itself in the structure as a highly rated credit default swap counterparty.
The credit-linked notes that are sold alongside the CDS have become an accepted asset class among European ABS investors. In addition, there are a growing number of true sale deals, such as Geldilux from HVB, where the loans are actually moved off the balance sheet.
“In recent years consumer lending in Germany has been steadily increasing on the back of mortgage lending, but the share of corporate lending on bank balance sheets is now growing again,” said Markus Herrmann, ABS Strategist at HSBC.
“The Promise transactions are highly granular, and may contain 5,000 corporate loans from the middle market sector. This kind of corporate risk is a good diversification away from consumer risk, so SME deals are quite attractive to investors, especially since there is some additional spread over credit cards or RMBS.”
Banks are also using the short end of the securitisation market by offering their corporate customers the services of asset-backed CP conduits. A survey by Demica, a Dublin based group which provides software systems for tracking receivables and managing portfolios, suggests that there will be strong growth of 39% in next two years in the use of ABCP conduits by German corporates.
The sum total of all these financing options is that the Mittelstand has many more choices than it did the last time the economic cycle was on the upswing. It is all a far cry from 2000, when KfW was launching its Promise platform amid genuine concern from the government about a credit crunch in the Mittelstand.
“Two or three years ago the Mittelstand was an unloved customer, and many banks cut their exposures to certain sectors fairly radically, but nowadays the mid-sized corporate customer is again a favoured customer, so the credit spreads have narrowed again quite significantly,” said one banker. “However many corporates have not forgotten what it was like to be in that situation, and have been warned that relying only on bank debt can be a dangerous funding strategy.”
This does not in itself mean an end to the house bank system, even if the large companies may sign the occasional syndicated loan with a foreign bank as bookrunner. It is rather that the house bank is expected to offer a wider range of credit products, and may act as an intermediary rather than a lender. Certainly there is a clear trend in the German corporate sector to put in place a more balanced mix of funding, even if many of the products they like to use are specific to the German market.