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IFR: Welcome to this IFR Roundtable on SME Funding, a very topical theme today. To enable us to focus our discussion, let’s define SMEs as companies with turnover around the €500m mark, which are those that perhaps have multiple options around funding. Most of the conversation around mid-cap funding has been focused around the bank deleveraging story so it’s quite natural that the conversation has morphed towards debt alternatives but I also wanted to explore how this story is playing out on the ECM as well.
In terms of capital markets themes in Europe, SMEs has come up more than almost another in the last 12 to 18 months. From the bank deleveraging story, it’s evolved through the development of European private placements; the conversation about reviving the securitisation market, which the ECB and Bank of England are very keen on doing. It’s also come up in conversations around direct lending from institutional investors and non-banks.
Reinhard, can I ask you just to kick us off with some general thoughts? The impression we get is that corporate treasurers and finance directors of SMEs, are getting knocks on the door from the private placement guy, the ABS guy, the institutional investor, the corporate banking guy, the DCM guy. How is this conversation evolving?
Reinhard Haas, Commerzbank: The whole idea of the mid-cap market evolving around debt capital markets has its roots way back. When you think about syndicated lending, for example, just some 10 or 15 years back, it was pretty much a large-cap game. Then in the early 2000s a market for mid-cap borrowers emerged. This was a first step and syndicated loans were still pretty close to the traditional way mid-cap companies had financed themselves on a bilateral basis.
Over time, that market has had its ups and downs. It developed strongly in the UK, and it’s very pertinent to make a comparison between the UK and Germany. The UK market is much more mature for SMEs than it is in Germany when it comes to product penetration. What we’re seeing in Germany now is a process of catching up with the situation in the mature debt capital market that is London.
But you see this happening elsewhere in Continental Europe. It’s also an outflow of the financial crisis when a lot of mid-caps suddenly discovered that banks were not in a position to lend to them easily, so they wanted to diversify their sources of their financing. In Germany, we’ve seen more interest in diversifying away from products like loans or Schuldscheine.
On the other side, the banks have had to address the fact that large-caps are completely over-banked in every market so the only growth perspective for a lot of the product people among us is to discover new clients. Mid-caps, especially the larger ones, are quite well suited for that.
IFR: So are we at the level where the lives of mid-cap finance directors are being transformed?
Reinhard Haas, Commerzbank: Little by little, but we shouldn’t over-emphasise that. Only some mid-caps are eligible for a broad range of DCM products. For many others, some work has to be done. I’d say it’s something that is taking place progressively but I wouldn’t over-emphasise the speed of this development.
Britta Holt, Scope Ratings: I think the variety of products has really increased for these types of companies. We have loans, as Reinhard explained, the syndicated loan product and we have the Schuldschein market, but non-rated bonds are increasingly also seen in the market. So the variety of products really has increased and makes it easier for those areas to fund themselves.
Michael Wiedmann, IKB: The key issue here is not that there’s not enough financing available for mid-cap companies, in some respects, there’s too much available. There is huge competition between banks and there are more and more banks entering Germany in the SME space so I don’t think you need to be worried about the clients; you should be worried about the banks as they’re cutting margins and their lending standards are getting looser and looser. So from that point of view I think you should not be worried about the Mittelstand in Germany.
IFR: That’s very interesting. The reason this discussion has come up in a European context is banks are either deleveraging or filleting their relationship banking models and the story that gets told is one of corporates being left high and dry. But Michael’s suggesting that’s not actually the case, Willi.
Willi Doerges, LBBW: I agree with Michael. The experience we glean from current market transactions is that there’s tight competition among arrangers, especially for capital markets products like Schuldschein and bonds. We are definitely in the right place for corporates.
On the other hand, we at LBBW keep asking: “how low is the new low?” Spreads are getting tighter and tighter, but regardless you can still find enough investors to invest in capital markets products. I totally agree with the argument that it’s not liquidity that’s in question; it’s more how long can banks still afford to invest in capital markets products?
Matthias Hellstern, Moody’s: One question with regards to how far we can go here: are we just discussing German SMEs or are we also discussing European ones? My observation is that in Southern Europe there is a need for SMEs to go to the capital markets because the banks are still not lending at levels prior to the crisis, which seems completely different to what we see in Germany. It fully reflects what you’ve said, Michael, and what I’m hearing from my bank analysts, that there is a lot of liquidity available in the markets in Germany.
Britta Holt, Scope Ratings: It’s worth noting that the bond market is relatively new for SMEs; the first market dedicated to SME bonds, the Stuttgart Stock Exchange’s Bond segment was only created in 2010. We’ve seen 165 issues in the German market since then, but a lot are coming due because the average maturity is just 5.2 years. Around €4.8bn will need to be refinanced out to 2018, with a strong peak in that year, so we’re facing a lot of refinancing risk.
The market has dried up a little because of the defaults we’ve seen. The default rate overall – 21 issuer defaults and 25 defaulted bonds – equates to a 14.5% default rate. That’s very high. Last year it was 8%. As a result of this we’ve seen the market dry up. There have only been 11 bond issues this year.
IFR: That’s interesting. What has the wider impacts of these defaults, both corporate and bond defaults, been on the psyche of the investor base? Is this a great concern to them?
Britta Holt, Scope Ratings: Well, we saw 11 defaults in 2013, so there has been a fair amount of scrutiny. When you look at the structure in these bonds, only one in ten that we’ve analysed has financial covenants so it’s a very risky market.
Reinhard Haas, Commerzbank: When you mention that specific market, you’re right: it has seen a lot of difficulties. But when you look at who in the banking community was active in these markets, you discover that there’s been a lot of holding back by established names, and there is a good reason for that.
What has been attempted through that specific segment has been to create some sort of smallish, high-yield bond market without creating the analytical environment or the support with respect to prospectuses or due diligence. There were a number of issues where it should be asked if they were adequate for companies of that size or of that risk quality. You’re just seeing the outcome of that.
When a large number of these issuers default during the lifetime of their transactions, it looks as if something may be wrong with the product or with the way it is marketed. This is why one might argue whether this is really part of the mid-cap segment financing. It looks more like an exotic evolution which could likely disappear over time.
Britta Holt, Scope Ratings: It is an exotic evolution, I think that’s right. It is very exotic because 80% of the investors are retail investors. This is also the reason why the market has been behaving as it has at the moment, because there are no demands for financial covenants, which should be present.
Reinhard Haas: I completely agree. Probably the most difficult part about this is that retail investors have been overly optimistic or they were possibly not sufficiently informed about the risks of these issues. This is why it’s hard to believe in the future of that particular market.
IFR: Can I jump in on that specific point? I understood that the regulatory process was supposed to be very focused on investor protection, so on the one hand you can say: “OK these guys were not sophisticated enough to be buying this paper” but on the other hand weren’t there risk warnings?
Reinhard Haas, Commerzbank: From the established banking community, of course.
Oliver Rupprecht, Nord/LB: The problem is that the ratings agencies have not done a good job here in that investment-grade ratings were assigned that should never have been assigned. Also, many of these companies need equity not debt; that’s part of the problem here.
IFR: Matthias: this is a criticism that gets levelled at ratings agencies a lot, in that you assign the wrong rating to companies.
Matthias Hellstern, Moody’s: It’s important to note that ratings are independent opinions about credit risk and our views may well differ from the opinions of other market participants. And by the way, ratings should not preclude investors from doing their own analysis.
Britta Holt, Scope Ratings: I think there are lessons to learn on many sides. Investors need to be aware that they’re making investment decisions. They need to look at financial covenants; they need to look at security and if there is security in the investment.
From the ratings side, we have to be much more forward-looking and look at cashflows. It’s cash that pays coupons and principle not balance sheet items.
Matthias Hellstern, Moody’s: And let’s not forget that a rating is an opinion about the creditworthiness of an issuer but this should not keep people away from making their own judgements and carrying out their own analysis and decisions as to whether to invest or not. We do not advise investors on whether to invest or not; that’s the investor’s decision.
IFR: There has been a lot of unrated issuance and/or debut issuance from SMEs in the bond market, which seems to have gone relatively well. Is that name driven or yield driven? What’s giving rise to this unrated issuance and should we be worried about it?
Willi Doerges, LBBW: Unrated bonds have experienced a renaissance over the last six to 12 months, and have garnered a good reception from the market. Most of the issuers are well known names in the capital market or with the investor base for which bonds represent an enlargement of available financing instruments.
We saw a transaction earlier this year for a well established German industrial that sold parallel Schuldschein and debut unrated bonds, both of which were very successfully received in the market. In that particular case, the company was a very established issuer of Schuldscheine and the unrated bond was the right step for them to broaden their financing options.
Reinhard Haas, Commerzbank: What Willi says is exactly right; the corporate unrated bond market is a market for established names, but don’t confuse this with the “Mittelstandsanleihe” or any of these various niche products. These classic unrated bonds are done by professionals and are marketed in a professional way. This is why these issues are a success. But at the end, you know, although we talk a renaissance – and I would agree with that – it is a very limited part of the market.
When you look at overall issuance volumes, we have not far off €200bn of issuance this year in EMEA, and only around €16bn has been unrated. So it’s a small portion. But it does work well in certain jurisdictions. We’ve seen sizeable issuance in Germany, France and, for retail bonds, maybe in Austria and Switzerland. But I don’t think it really goes a lot beyond that.
IFR: Is mid-cap, DCM impacting the Schuldschein market, Oliver? I only ask because the SSD market appears to be lacking supply.
Oliver Rupprecht, Nord/LB: I wouldn’t say that the Schuldschein market is going badly; it’s actually been quite a good year. We started out on quite a low basis but it’s catching up. We are also seeing bigger deals as well. I would say the Schuldschein market [is strong] for companies with investment-grade ratings. You typically need investment-grade ratings for this kind of product.
But we’re seeing very strong competition between the banks, as Reinhard said. The problem at the moment is that many banks are squeezing spreads and fees, especially for investment-grade companies. This kind of competition between the banks doesn’t help us.
Marion Schiller, Unicredit: But you can see that as the volume of non-rated bonds has increased, the Schuldschein market has come back a bit. Some volume is now placed in the unrated bond market and not in the Schuldschein market because the investors are there and asking for more paper, so more companies can switch from the Schuldschein market into the unrated bond market. The volume of unrated bonds has doubled in comparison to last year.
Jens Voss, Commerzbank: What you can observe across all of these products is that there is plenty of liquidity and we’re not seeing an over-arching tendency towards deleveraging at the moment. We have an over-supply of liquidity and issuers are getting it cheaply because there is a hunt for yield on the investor side. One of the issues here is that people are taking higher risks than are probably reasonable.
We still expect a tendency towards deleveraging, but in a long term. However, the short-term trend is going in the opposite direction, also due to the low interest-rate environment, which isn’t expected to turn around quickly. The market remains wide open for any type of product.
Within ECM, we’re seeing a lot of private equity, sponsor-driven business, coming to the market to raise or place equity, partly because of the attractive valuations. If you look at the corporate side, they’re waiting on the sidelines mainly because they are more than well capitalised in Germany and most are in a very healthy position and are sitting on large cash piles.
IFR: Do you think that from a technical perspective, leaving aside the rate environment, some companies have been pushed to raise debt when they should be more equity plays?
Jens Voss, Commerzbank: I wouldn’t say they’ve been pushed to raise debt; it’s just extremely easy and convenient, and you get that in all pockets and sub-products so there has not been the overall need [to tap the equity market] whereas I do believe the long-term trend towards deleveraging remains intact. That will come at some point but in the short term, the next two or three years, it’s just not on the horizon. Why should it be if any type of investor class is providing liquidity on very cheap terms?
Michael Wiedmann, IKB: If you look at what is currently happening, if there are companies who have a layer of mezzanine in their capital structure nowadays they can easily refinance it with senior debt. We as banks don’t like it, but if they can do it we can’t stop them.
IFR: You don’t like it because …
Michael Wiedmann, IKB: Simply because we’d rather have a layer of mezzanine below our senior.
IFR: One of the big themes is development of European private placements. There’s been a lot of discussion about PPs at the EU regulatory level as being one of the solutions that’s going to get us to our end game of funding mid-caps. Is Euro PP a big deal? Will it rival and exceed the USPP market or is this just a gimmick?
Reinhard Haas, Commerzbank: Well when you compare the Schuldschein market to the USPP market you see very quickly that although the US private placement market is a niche market, the Schuldschein market is even more so. It’s a solution that has existed for a long time in Germany and one that we’re currently exporting to other countries to fill a gap in the non-existent European private investment market.
You have comparable local solutions of this type in Austria, Switzerland, Scandinavia and France but you don’t have a Europe-wide solution. There is currently no uniform way of evaluating the risk of a private issue. The US has the NAIC, which does that for every US issue. A body like this is non-existent in Europe. I’ve talked to insurers repeatedly about it. Everybody is talking about the possibility of using ratings, but it’s too expensive for mid-caps when it comes from the established agencies.
There are ways of dealing with this, but there is no uniform way of handling it. Schuldschein are probably the simplest product to use, which is why it’s exportable. But in the end it’s a bank product. You completely lose institutional investors in corporate issuance in that particular market because it doesn’t live up to the standards insurers need. So there is a gap to be filled, but we don’t see that happening at this point in time.
Oliver Rupprecht, Nord/LB: It’s in the interest of some domestic insurers to fill this gap so they’ve create the German Private Placement (GPP); it’s an up-and-coming product and will be established in the Schuldschein market. But the problem insurance companies have is that the Schuldschein market is a seller’s market at the moment; everybody is getting their proceeds from standard SSD investors, like Sparkassen, Landesbanks or other banks, so they don’t need investment from insurance companies. That is why in this market situation they’re having problems establishing GPP. In the long run, though, there will be space for this product and investors.
Reinhard Haas, Commerzbank: But wouldn’t you agree, just by the name of that product – GPP – it’s another local solution? It is not answering the quest for European private placements. I think this product category, which sees US$50bn–$60bn issuance per annum in the US, is simply lacking in Europe. But there needs to be a unified way; it can’t be just an insular solution. As long as we only have that, we’re not making a step forward really.
Willi Doerges, LBBW: What we are experiencing, though, is that there is stronger competition arising from the insurance companies which because of the lack of yield from their current investments, are driving into a core market of the banks i.e. approaching corporates directly and engaging in direct lending via private placements on a bilateral basis.
They are able to fund tickets of multi-€10m apiece, which might be appealing to larger mid-cap corporate. Banks and the capital markets are experiencing a lot of competition at every single point from institutional investors, which have been driven to compete in a core bank market.
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