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Monday, 20 November 2017

IFR German SME Funding Roundtable 2015: Part 2

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IFR: There has been a little bit of seepage, though …

Marion Schiller, UniCredit: Exactly, because of liquidity. This really concerns me. On the syndicated loan side it can create real problems.

Martijn Kamps, ING: If you look at where we are in the cycle, we are discussing late credit-cycle features such as covenant-lites and we are moving investment-grade products into the high-yield/sub-investment grade or crossover areas. But if you look on a macroeconomic view, we see early-cycle indicators in Europe so if a company’s business model is right and we understand the model, I can understand why there might a certain amount of appetite for high-yield or sub-investment grade Schuldschein.

When it comes to restructuring of course, it’ll be a big headache so from a product point of view it’s true that it is not a good idea.

Reinhard Haas, Commerzbank: I think you’ve answered your own question. It is not the ideal product at all. The circumstances where we see a substantial amount being raised by a company that banks appraise as crossover [is OK if] the credit you are buying into has a return to lighter waters in terms of its story. If that holds true, that may work but to say that generally, for let’s say the equivalent of a double B flat or minus, that that would be the right product, is misleading your client. And we don’t advise our clients that way.

Joachim Erdle, Landesbank Baden-Wuerttemberg: But I agree with what Stefan said, that there is a clear tendency to see Schuldschein in the crossover and non investment-grade markets. The big concern we have as an institution is we are watering down a very good product for investment-grade corporates and risking a market which is crucial in terms of finding alternative funding opportunities for corporates.

We saw similar developments in the small-cap bond market, for example in Stuttgart with the BondM segment. What happened there was the result of a clear lack of quality and quality control. The results speak for themselves. I am slightly concerned about the Schuldschein market, however I’m sure we won’t see the same development and consequences there because we as banks will take care that it won’t happen.

Thomas Haas, Bayerische Landesbank: And this tendency is supported by the biggest Schuldschein ever – the €2.2bn acquisition take-out by ZF Friedrichshafen – which was non-investment grade. What we are also seeing is that documentation is moving closer and closer to the LMA standard, which is not the idea of the Schuldschein product. It should be, as Reinhard said, very thin documentation that helps to negotiate quickly to provide a cheap funding source for small corporates.

Michael Bures, Raiffeisen Bank International: I’m taking an intermediate position here because between crossover credit and real hard core high-yield credit, there is a big gap. I would agree with Ingo that if we have a double B plus or a double B flat this should be digestible by banks because we are talking with professionals and they should know what they are doing.

I am not so worried about genuine crossovers, which for me means being close to investment grade. For the high-yield market, it is totally the wrong instrument but I have to say I am not aware of any real high-yield issuers in the Schuldschein market.

Stefan Bund, Scope Ratings: Crossover is a key word here. Different credit departments in banks can have different views. One bank might see it as a Triple minus and the other as Double B plus but that is not the area of concern. Where the concerns come is if we go further down the credit curve. In our sample, there were names as low as Single B minus.

Commenting on what Thomas said, which is that moving towards LMA standard documentation is not a good thing; I personally think it is a good thing because everybody knows what to look out for and you have a certain standard in the market. A lot of investors are bank investors, which is confirmation of what I said earlier that bank lending is being substituted by Schuldschein lending so it is opening up the market. That is one of the reasons for the strong competition you have in this segment.

I saw a poll recently asking how many investors were prepared to go into sub-investment grade Schuldschein. I think the number was about 22%; whereas our observation is that the share of non-investment grade issuers is close to 40%, suggesting a lack of transparency. These might all be crossover credits but I’m with Joachim here: it’s probably better to be alert early than having to sort it out later.

Reinhard Haas, Commerzbank: I don’t disagree on that point. I think what Joachim said is completely pertinent. You need to be careful and not come up with some freak product which does not address the needs of the borrowers you have. But we shouldn’t blow it out of proportion either because the Schuldschein market, as much as we all love it, is a niche market – I think annual volumes are between €10bn and €15bn – whereas the loan market is a multiple of that.

So what we are addressing here is just a small portion of the market. With all of us agreeing that there is abundant liquidity available to SMEs, the only thing you can tell your client is if you are in a certain risk situation you should actually engage into a product that addresses your general situation. There is no intrinsic need to have this or that format at any price.

If you are sub-investment grade, you are better advised keeping to loan format. That is widely available in all different sizes. And it doesn’t have to be pressed into Schuldschein format, which is not meant to address a more cyclical or higher risk environment.

I don’t think this is too big of an issue because it’s not a broad phenomenon. I would agree on the proportions that have been mentioned, at least from the Schuldschein that we handle. I don’t think there is a portion that we would consider to be sub-investment grade. But we try to advise our clients to have the best structure in certain risk situations and if that is sub-investment grade it would be a loan.

IFR: One development I think has been quite interesting – and I wanted to test this in a German context – is the evolution of the pan European private placement market. Now the French invented the Euro PP product and they are looking to attract German sub investment grade companies for the exact point we’ve been discussing: that the Schuldschein market is not ideal for some of these borrowers.

So are German corporates looking at private placements, be they US private placements, Euro PP or German PP? For crossover mid-cap German corporates, does the PP market work, bearing in mind we do have standardised documentation templates under the ICMA pan-European Private Placement Working Group initiative.

Ingo Nolden, HSBC: When it comes to Euro PP (according to what we can observe from the data) I’m not seeing a big uplift in that market. It feels to me to have been driven by yield and by implicit sub-investment grade companies. With the recent spike in yields, maybe it’s coming back a bit but as of the last three to six months, there has been less and less liquidity in this market given it hasn’t been able to hit investors’ yield targets any more.

But contrary to the Mittelstand bond market, the Euro PP Market is an institutional market which I think is a plus and a key differentiator from markets like BondM. Institutional investors need to pay the price if there is a default; but nobody can complain.

I feel the Euro PP market isn’t exactly dying but it is slowing down. In terms of the issuer breakdown, we’ve seen predominantly French companies. Some Italian issuers have tapped it as have some Belgians (as an alternative to the Belgian retail market). Certainly to my knowledge no German company has issued in Euro PP format. My point is that there are local niche markets available to these companies.

IFR: But your basic point is that German companies wouldn’t necessarily look to this market as a funding alternative?

Ingo Nolden, HSBC: We can certainly offer it to clients but when we talk to German clients it is the market of least interest to them. As a mid-cap German company, you either have the Schuldschein market or you have the loan market. And if you are real high-yield, you can say: “OK I’ll bite the bullet and jump into the high-yield bond market”.

Sven Janssen, Oddo Seydler Bank: But there is a gap between the two and this is where Euro PP fits in. The Euro PP market was primarily driven by regulatory changes in the French insurance code, hence it is dominated by French investors. I would agree it’s been a quiet Euro PP market in Germany so far and German issuers are definitely not running towards Paris.

However, there is a general interest from companies who say: “we don’t really qualify for a proper Schuldschein because our balance sheet is a bit shaky and we don’t have the size for the high-yield market”. Ruling out the German SME bond market, this is precisely where the Euro PP would fit in – but it’s a relatively recent market.

On anecdotal evidence, I can say that there is interest from corporates that don’t qualify for conservative German criteria around Schuldschein but which don’t consider themselves high-yield issuers.

Reinhard Haas, Commerzbank: I agree. There is interest but there has been similar interest in the past that led to BondM and you know what we saw in that market around small companies with a high-yield profile. There is a need for a product maybe below the threshold of the traditional high-yield bond that has not been filled. But given that there have been so many European private placement initiatives, why doesn’t any of them gain momentum?

There are five or six different initiatives around Europe, be it with the LMA or ICMA or the equivalent in the bond market, trying to come out with a format to suit everybody. The lack of infrastructure on a European basis lies at the origin of all of these initiatives going only so far. You would have to have a unified way of appraising issuance from a risk perspective as you have in the US and you need a unified way of taxing bonds, which you have always had in the US.

Sven Janssen, Oddo Seydler Bank: And a secondary market…

Reinhard Haas, Commerzbank: Right: that would have to function in order for that market to be liquid. But I think as long as that infrastructure does not exist … I understand that the plan for Capital Markets Union may lead us closer to that goal but we are far from it right now and we can only hope that that infrastructure will be built over the coming years.

That would hopefully in the end lead to a pan-European market. But so far it is probably a little pretentious for most of these initiatives to call themselves European because they really aren’t.

Martijn Kamps, ING: Plus I think the product needs to differentiate itself from other products. One of the big successes of USPP is that it would offer longer tenors compared to, Schuldschein or traditional bank loans. It’s worth pointing out, incidentally, that the US PP market is not so big if you look at volumes but for a certain type of company with a recognisable name or active in a well-known industry it is certainly a market to go to.

Sven Janssen, Oddo Seydler Bank: We certainly need to broaden the investor base in Europe; investors who can invest in products like Euro PP (although I am not happy with that term because it is so vague and I think it’s over-used). But I go back to what Reinhard said: it lacks any standardisation. But that sometimes makes it very convenient, of course. We all argue in favour of standardisation but then again we are all quite happy at times that we don’t have too many standards in order to satisfy the needs of our clients and to be unique and come up with creative solutions.

Another point is that my experience of marketing Euro PP to German corporates and attending meetings in France is that in contrast to US PP, issuers like the fact that they won’t be exposed to US investors or the US regulatory environment or legal system and that is in relative terms a great strength because people are wary of that.

Michael Bures, Raiffeisen Bank International: I agree on the private placement side that standardisation would be a killer because that is partly why issuers go for private placements in the first place: they want the flexibility. But what is really lacking is the infrastructure in Europe; it is very fragmented. A counterpart to the NAIC is missing and that’s a problem. I hope we can prevent too much standardisation but rather focus regulators’ minds on putting an infrastructure in place.

Ingo Nolden, HSBC: I fully agree. Another thing I wanted to bring up is the fact that we lack a pan-European rating agency that is doing the work the NAIC or the SVO is doing for the US PP market. As for the German PP initiative, which you mentioned Keith, Germans are not as good at marketing as those in other parts of the world but I think GPP was a good initiative but never got off the ground because it started out as a clubby arrangement and wasn’t really supported although that might change.

But I think it was a good starting point because I would say we have even more investors in Europe potentially interested in PPs than in the US PP market. If you look at the USPP market, it’s maybe 40 to 50 investors; no more. We’re not talking about the bond market, so it’s a small market, but they have infrastructure and standard documentation in place. But I ask myself whether we should really start with documentation or rather with a standardised risk approach and then it’s up to investors.

The risk approach needs to include – and that was one of the major mistakes made under BondM – the documentation aspects of whatever product it is and what the security options are. Then, of course, you can gauge as an investor what you want to go for.

Reinhard Haas, Commerzbank: So, in the end, Ingo, you’re agreeing you need standards. That’s the basis; you need to have a way of appraising the accounting standards of an individual company; you need a way of addressing insolvency law, which is different in different countries; it’s also an issue of withholding tax and general taxation: what happens to the investor when he invests in this?

Getting a number of standards that investors can rely on lies at the origin of this market. Then it becomes more reliable for issuers that liquidity will be there if they come up with an issue. So standardisation really lies at the origin; documentation is just one aspect of that.

There’s a huge amount of work to be done before we have a unified market in Europe and we need to find a common way to address these kinds of issues.

IFR: Stefan, can you just answer Ingo’s point about the lack of a pan-European rating agency?

Stefan Bund, Scope Ratings: I fully agree that there’s a need for a pan-European rating agency. We have S&P, Moody’s, Fitch and, at a distance, DBRS which is moving into Europe. But they’re predominantly North American agencies and not necessarily suited to address Europe-specific issues in the debt capital markets.

In Europe, there are 23 rating agencies registered under ESMA but nobody really stands out as a European player. You have national players who only focus on one product, like corporates or banks, and you have industry players – like, for instance, A.M. Best which only focuses on one industry but on a pan-European or global basis.

We want to be a pan-European player across corporates, financial institutions, structured finance and funds. That’s our ambition.

To see the digital version of this roundtable, please click here.

To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com

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