More and more German and international companies have raised money through Schuldschein debt in recent years. A niche financial instrument halfway between a loan and a bond, Schuldscheins have been mainstream financial products in Germany and Austria for years.
At first, German financial markets were proud to see that their unassuming promissory note was garnering international attention.
But two high-profile corporate failures have prompted concern about the stability of the Schuldschein. In January, British building firm Carillion Plc went bankrupt less than a year after raising around $155 million on the Schuldschein market. A number of Taiwanese financial institutions are thought to have lost out heavily as a result.
Then Steinhoff International, the German-South African retail group, announced it was in financial trouble after fraud allegations surrounding its executives. It held €730 million ($898 million) in Schuldschein debt.
Schuldscheins are placed directly with institutional investors, who like this German form of debt because of relatively good returns and a traditionally low level of default. Companies like Schuldscheins because they are less expensive than bonds, do not need to be registered at a stock exchange, and have a relatively low level of regulatory requirements – a Schuldschein can often be issued with 20 pages of documentation, a fraction of the demands made of normal corporate bonds.
Since the financial crisis 10 years ago, the Schuldschein market has grown to a total of €27 billion. What’s more, non-German companies are now issuing a lot more Schuldschein debt. While six years ago they represented less than 20 percent of the market, today they are more than 40 percent.
Mark Hoffmann, managing director of fund manager Robus Capital, says investors may not have looked too closely at Carillion and Steinhoff – they were relatively big names, after all. He says a greater worry is smaller, less robust companies issuing Schuldschein bonds which would not previously have found takers.
“Ten years ago, it was mostly large or large medium-sized companies, with revenues over €1 billion,” said Sebastian Zank, an analyst at Scope Ratings. But increasingly, smaller companies with weaker credit ratings have turned to the Schuldschein.
Scope estimates that 55 percent of new issues now come from companies with revenues lower than €1 billion. The smaller the companies are, the more likely they are to be hit by economic downturns, increasing their risk of default. Larger, more diversified companies can more easily ride out economic storms.
Even as the market changes, demand for Schuldscheins remains high as investors hunt for yield in an era of ultra-low interest rates. The differential between average Schuldschein yields and central bank interest rates has fallen in the last year, and now is just a single percentage point spread.
“The trouble is that some smaller institutional investors are not well-placed to assess weaker debtors.”
The big investors in Schuldscheins, according to research by the state-backed Landesbank Baden-Württemberg (LBBW), are large commercial banks, both German and international, which in total hold 66 percent of Schuldschein instruments. A significant portion of these are German savings banks.
Most Schuldschein bonds are placed with investors by German regional savings banks. They say the sector is not in danger: “These are rock-solid names,” a spokesperson for Helaba, one state-owned regional savings bank, told Handelsblatt. Over the last year, Volkswagen and Lufthansa have been among the larger names borrowing through Schuldscheins. A few weeks ago, the retail group Rewe borrowed more than €1 billion this way.
Because they are not easily sellable, Schuldschein bonds do not receive official ratings, but Scope Ratings estimates that between 30 and 40 percent of them can be regarded as weaker, non-investment grade. “The trouble is that some smaller institutional investors are not well-placed to assess weaker debtors,” said Mr. Hoffmann of Robus Capital.
Mr. Hoffmann added the situation reminds him of the Mittelstand bond market a number of years ago. In the wake of the financial crisis, many small and medium-sized German companies began issuing bonds in order to diversify away from the banks. But many retail investors were burned when the bonds proved to be riskier than assumed: as many as 37 percent had problems making interest payments. Trading in Mittelstand bonds has now largely ended.
Schuldschein bonds are unlikely to suffer the same fate. “Unlike with Mittelstand bonds, large commercial banks are involved here, and they test the creditworthiness of issuers,” said Hans-Werner Grunow, managing director of business banking consultants Capmarcon. Banks frequently also underwrite part of a Schuldschein issue.
Other experts agree that despite recent wobbles, the Schuldschein market is not about to collapse. Defaults remain below one percent, and only slightly up on last year, according to Mr. Zank of Scope Ratings. But, he said, banks need to pay more attention to the credit profile of companies for which they issue Schuldschein bonds in order to maintain the reputation of the market as a whole.
Andrea Cünnen works at Handelsblatt’s finance desk in Frankfurt, reporting on the bond markets. To reach the author: firstname.lastname@example.org