How a Quirky German Credit Instrument Beats Volatility

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When a beloved local product ramps up production, there’s always the question of whether it can gain new fans without losing what makes it special. Something similar happened with a German debt instrument known as the Schuldschein, which until recent years was a hidden corner of the European debt market. It is flourishing as sales of corporate bonds and loans tumble as the region grapples with Russia’s war in Ukraine and inflation. Schuldschein’s issuance doubled in the first six months of 2022, its best start to a year as deals were postponed or withdrawn in other debt markets.

1. What is a Schuldschein?

Schuldschein (pronounced schult-shine) offers an alternative way to raise funds. Not quite a loan and not quite an obligation, traditional Schuldschein promissory notes were created by German lenders for well-regarded local borrowers such as property company Vonovia SE and supermarket chains Hofer and Lidl. Transactions can range from €10 million ($10.1 million) to more than €2 billion, and they can include tranches of different maturities and currencies. Raising a Schuldschein is similar to obtaining a loan: a company asks one or more banks to arrange a transaction, which is then syndicated before the final price is set. Each tranche is then divided into tranches of different sizes and issued to lenders, which sometimes number in the hundreds.

2. How is a Schuldschein like a bond or a loan?

Transaction maturities can range from a few months to 30 years. Tranches of up to seven years with loan-like structures are mostly underwritten by commercial banks that also participate in the loan market. Savings banks, cooperative banks and investors, including insurers and pension funds, are generally buyers of the longer-maturity tranches that mirror those of bond maturities. Investors and lenders can choose floating rate pricing, usually based on Euribor like loans, or fixed rate pricing on mid-swaps, like bonds. Commercial banks are becoming major players and most work on transactions as they would on loans. Marketing periods can be as short as a week or as long as a month for those that are generally more unionized.

Companies across Europe are turning to this alternative funding channel, which offers a stable liquidity pool where lenders tend to hold their debt to maturity, unlike bond investors who are more susceptible to market turbulence. market. Even though borrowers are paying high costs compared to previous years, Schuldschein pricing has become more attractive than bonds for the first time in years.

4. Does their profile change?

Small businesses with sales of less than 5 billion euros dominated the Schuldschein market, since German banks often use the notes to grant them loans. Local lenders have thus dominated the ranking of arrangers, although other banks have climbed the rankings in recent years as the market has expanded beyond Germany, Austria and Switzerland to include companies such as SIG Combibloc PurchaseCo in Luxembourg and Bunker Holding in Denmark, and included larger newcomers such as Vonovia and EnBW Energie Baden-Württemberg.

5. What are the benefits for borrowers?

Schuldscheins are preferred in Germany because they are private, simple to use and based on local legislation. The market is light on paperwork, with even €2bn deals only having deals lasting just a few pages at most – a marked difference from door-to-door-sized bond prospectuses. There is no obligation to publish the terms of the agreement as Schuldschein is not listed on a stock exchange or covered by transparency rules under the European Union’s MiFID II regime. Other cost savings come from not needing a credit score.

6. What about lenders?

The biggest lure is the relatively high yields from generally higher quality borrowers. Lenders can also expect Schuldschein borrowers to withdraw financing, which is better than receiving low fees for providing untapped revolving credit facilities. Also, unlike bonds, Schuldschein need not be marked to market. This is a boon for investors because the price of the instruments does not fluctuate like bonds.

7. What are the disadvantages?

Even with recent growth, only €20bn of Schuldschein was sold in the first half of 2022, around 13% of the amount raised in the European investment grade corporate bond market, less than a tenth of loans to businesses in the region. Renegotiating terms in the event of a cash shortage is cumbersome, as agreements must be made with each lender individually. For lenders, Schuldschein investing can involve more legwork than bonds due to the lack of financial transparency and credit reporting. The market is also less liquid than bonds, partly due to a predominance of buy-to-hold investors.

8. How is the market changing?

It has become mostly digitized, with online platforms set up to automate transaction management, replacing a jumble of manually updated spreadsheets, phone calls, emails and faxes. VC Trade is the largest, with major arrangers such as BayernLB and Helaba using the system, while finpair has even taken on the bookrunning role. The Schuldschein market is a strong advocate of sustainable finance, offering innovative structures to encourage growth. Deals with conditions tied to borrowers’ sustainability goals skyrocketed after the first deal for Duerr AG in 2019, with more than 20 borrowers surfacing for such deals by the first half of 2022, around a quarter of the total number of transmitters.

More stories like this are available at bloomberg.com

About Wanda Dufresne

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