Private corporate debt, once confined to isolated bases in Europe — the Schuldschein’s German Mittelstand fastness and the US private placement’s beachhead among investment grade companies — has spread across the continent.
Once an acquired taste of sophisticated treasurers, it is now on the menu proffered by every bank to corporate clients.
Euro private placements as small as €3m have been done in France; car parts maker ZF Friedrichshafen borrowed €2.2bn with a Schuldschein in 2015, its capital markets debut.
Russian, Chinese and Indian borrowers have issued Schuldscheine; it might even catch on in the UK one day.
Market practitioners argue permanent changes in capital markets have brought this about: stricter regulation for banks making them de-emphasise lending; the growth of institutional savings seeking yield; companies learning it is safer to have a variety of funding sources.
“The market share of the private placement market versus the public bond market has clearly increased over the last decade,” says Ed Barker, vice-president at Pricoa Capital Group, one of the biggest US PP lenders in the UK.
“There are many reasons why the PP market is attractive to companies. We advise companies to use all markets.”
Public bonds often require issuing a benchmark size, ratings, roadshows, registration — unnecessary with PPs.
But cyclical trends are also at work. This expansion has happened during a bull run for credit which has now lasted 10 years. After a decade of stimulus, interest rates still show no sign of peeling themselves off the floor.
No one would claim that these conditions will last forever — and while the end is not yet in sight, it never is.
The more aggressive direct lending funds, which have raised billions to invest in leveraged companies, have been on many financial players’ trouble watchlists for years.
But for the time being, the upper end of private debt is enjoying benign growth — not too fast, nor too slow, and without, apparently, losing its discipline on credit.
Fruitful chaos
At a time like this, two themes thrust themselves forward. One is the sheer variety of European private debt markets.
“European issuers have quite a few options,” says Kai Seeger, deputy head of global syndicate at UniCredit in Munich. “The Euro PP, the Schuldschein, potentially registered bonds that are not public. The issuer can pick among these instruments and select the target investors — with the Schuldschein mainly banks, with the Euro PP real money accounts, mutual funds, but if you go to longer maturities also pension funds and insurance companies.”
How these markets rub up against each other is a source of endless interest. There are few hard boundaries or exclusions, but in practice not many companies know enough about all the markets to make a transparent comparison, based on the hard facts of price and terms.
As is clear from the roundtable discussions in this report, the private debt choices offered to — and favoured by — any company still depend on cultural and national factors. As Patrick Klein, treasurer of the sophisticated Italian issuer Buzzi Unicem, points out, he was only recently told the French-based Euro PP market existed.
“The only European country that the Schuldschein has had real difficulty in is the UK,” says Andreas Petrie, head of primary markets at Helaba in Frankfurt. “It’s not the investors who are reluctant, it’s the issuers. The main reason is they are closer to the US PP type of thinking; they are used to using this market.”
That may be because UK banks never pitch the Schuldschein to their clients. The German banks have barely begun to start marketing it in the UK.
France offers a sharp contrast. All the big French banks now have Schuldschein desks and arrange deals for their clients. This is not mainly because of cultural affinity, but pricing.
French companies wanting euro private debt have been tempted away from the Paris-based Euro PP market by the keen Schuldschein pricing offered by German and international banks, wanting only to earn a credit spread — not the positive return after inflation sought by institutions.
Neopost, the postal machinery maker which issued its first US PP in 2003, is a classic French Schuldschein recruit. Christophe Liaudon, its group treasurer in Bagneux, is one issuer who does rigorously weigh up the three markets when preparing a financing.
“Each market has its pros and cons,” he says. “The Euro PP has some advantages for French companies — the proximity with investors, maturity of the debt, the capacity to adapt legal paperwork to the needs of the company. But that has a price. The Schuldschein pricing is pretty aggressive compared to the Euro PP.”
Neopost placed a €210m issue in the German market a few weeks ago.
Faced with losing clients to the Schuldschein, French banks have decided “if you can’t beat ’em, join ’em.” That is just the route trodden by UK banks to the US PP market 20 years ago.
While French asset managers have lost deals to German savings banks and Asian commercial banks, their UK peers have been able to join the US PP market, since its lenders are also institutions.
But the US life insurers are fierce competitors. With US public bond spreads as their guide and a favourable basis swap putting juice in their engines, US life companies have regularly beaten indigenous institutions to euro and sterling private deals in recent years.
“Historically people thought of the PP market as materially wider than the public market,” says Barker at Pricoa. “I don’t think that’s been true at all in the UK in recent years. There probably is still a premium but it’s pretty minor, less than 20bp, and in addition there’s arguably more demand in the PP market.”
The number of UK institutional investors in the public bond market was quite limited, he argued, compared with the pool of US money available in privates.
Bulking up
The second theme — intertwined with the variety of private debt markets — is how they are likely to grow.
“The US PP market used to be a $50bn issuance market, in 2017 it was above $80bn, and last year it reached $100bn,” says Michael Bures, head of debt capital markets, corporates, at Raiffeisen Bank International in Vienna. “Though this is a very big market, it has really managed still to grow.”
Some imagine the Schuldschein swelling from last year’s €26bn issuance to €50bn. Bures thinks this will be difficult, partly because most deals are about €150m. “There has hardly been a moment since the Schuldschein boom started when we thought there were too many deals and investors didn’t want to buy them,” he says. “But unless there is a significant move from bigger issuers to the Schuldschein market, it will be hard to get to much bigger numbers.”
Big companies tend to visit when public markets are tough, but in those circumstances financing volumes overall tend to be depressed.
Petrie’s glass is half full, however. “We will most probably see a new record year in 2019,” he says. “In the first half we have more or less topped last year’s volume and we are close to the figures of the year before that. The market is constantly increasing, driven mainly by three factors. The number of international issuers outside the German-speaking region has dramatically increased. We’ve seen at least 10 to 12 French deals this year and a lot of Scandinavians.”
Some bankers are hunting deals in Asia and emerging markets; others in Italy and Spain (see page 16).
Second, Petrie cites the market’s introduction last autumn, in co-operation with the Loan Market Association, of new standardised documents. Schuldschein terms were never complicated, but now that all banks are using the same ones, instead of their own versions, documenting a deal is much easier.
Institutional interest grows
The third factor is new interest from institutional investors, hand in hand with new asset classes. “Everything that has to do with mortgages and real estate investment, that leads to a stronger involvement of long term-oriented investors, so we see more insurance companies coming in, not only German ones, but on a European basis,” says Petrie. “They are especially looking for long maturities, 10 years-plus.”
Schuldschein investors are traditionally wary of property issuers, for fear of being structurally subordinated to their mortgage debt. It is difficult to make a Schuldschein secured, because there is no trustee and the loans are bilateral.
But seven or eight of Germany’s 1,000 housing companies have come to the market with unsecured deals, opening a completely new segment with fresh issuers and investors. It can only be a matter of time before Schuldschein bankers call on the UK housing associations who have in recent been busy users of private placement debt markets.
Still free
As private debt markets grow, they are facing new trials. One the Schuldschein market has so far largely avoided is a tightening of regulation.
But the trend towards authorities seizing control is strong in markets, and some voices argue the Schuldschein’s freedom from rules such as the Markets in Financial Instruments Directive and the Market Abuse Regulation is an anomaly.
“It is hard to predict what regulators will do,” says Bures. “Regulation can play a favourable role, or it can be bureaucratic. There are examples of really good regulation, like the Prospectus Directive and passporting. The danger is we get MiFID and MAR, which would increase the cost and make day-to-day business slower. I hope the Schuldschein will still be treated as any other loan.”
The regulators could decide to regulate Schuldscheine more tightly than ordinary club or syndicated loans, but Bures hopes this process can be avoided or pushed back if banks continue to be disciplined as arrangers and “not cause any trouble by going down the credit curve”.
Schuldschein fees are under pressure, both from price cuts and issuers using more arrangers on deals. That is one reason banks are so eager to make issuance more efficient through digital platforms (see page 28).
But in one respect, Schuldschein banks are lucky. So far, deals are nearly always arranged by a bank.
That is not true in US PPs. “Bilateral issuance has taken share from agented issuance to a significant extent,” says Barker. “We are biased — we do a lot of that business — but we think there are few reasons to use an agent.”
Companies wanting £500m-plus will definitely need several investors, and if the issuer wants a big group, Barker acknowledges agents make sense.
But while the best agents listen to issuers and fashion bespoke deals to suit their needs, he says others offer “cookie cutter” transactions, with little flexibility on tenor, size or number of investors. For deals like this, issuers will still need to do a roadshow and issue a certain size of deal, much like a public bond.
“A number of companies have done club deals themselves, and gone to a few investors,” he says. “They don’t need a full-blown agented deal. For companies that want £200m or lower, you can get it all from one investor.”
Barker argues the PP market is now transparent enough that issuers know what their credit should sell for. Not only can they cut out fees, but investors will often give them a better price if they borrow directly. Pricoa does over half its investing bilaterally.
This direct traffic is like a PP market within the PP market.
The Schuldschein also has its secret annex where deals are done unnoticed, although usually still via banks.
“There are public invitations in the Schuldschein market when big companies are issuing, but this is a private market,” says Rudolf Bayer, head of MTN and private debt syndicate at UniCredit in Munich. “You can do this with just an issuer and an investor and bring them together, because neither wants it to be public.”
Petrie estimates “a grey figure of minimum 5%” on top of the transparent Schuldschein market, or about €1bn-€2bn of corporate paper a year.
Missing a trick?
Yet there are surprising differences between the three markets. A trump card of US PP investors is offering deals with delayed draws. The borrower might take some money now, but other tranches in six or nine months’ time. This can be highly convenient for borrowers, and is a big advantage over public markets.
With typical efficiency, the US market has standard rates of pick-up investors receive for granting delays.
Euro PPs offer similar flexibility — many deals are staggered over two or more issuance dates.
But in the Schuldschein market, where nearly all lenders are banks, which ought to be able to provide liquidity, this happens very rarely, and only for prominent issuers, says Bures.
This could be an area for the Schuldschein market to explore.
Maturities are another differentiating factor. The US PP market is the traditional leader, with 12 year deals common and 15 and 20 year notes available for the right kinds of borrower.
But the extreme lows of euro interest rates in the past five years have forced even the German savings and co-operative banks to buy longer Schuldscheine. “Especially for domestic deals in Germany and Austria, investors are tending to go to longer maturities — seven and 10 years,” says Bayer. “If you calculated the average maturity over the last two years, compared with four years ago, for sure it is longer.”
Maturity is a principal consideration in another private market — Euro-MTNs. “These deals are negotiated, too,” says Bayer. “For me this is a private placement market. Sure, it’s issued based on an EMTN programme, which has standard terms and conditions, but it’s a market where investors are looking on a private basis for particular credits and formats.”
Many issuers may not want to issue a €500m bond at 20 or 30 years, but may be happy to lock in very attractive yields for €50m or €100m.
“On the long end, usually it’s very hard to judge if an MTN has come tighter or wider than the issuer’s curve, because there are hardly any comparables,” says Seeger.
Sometimes the issuer may appear to have got a good deal, relative to its curve, sometimes the investor, but ultimately both are meeting their needs. “It’s a matching exercise,” Seeger says.
The other hotspot for MTN business is the short end, especially up to two years where public bonds are rarely issued. “There is a lot of demand for short dated paper, and issuers can achieve very attractive conditions,” says Seeger. “It’s usually below the benchmark curve, but it can vary.”
Last orders
Sooner or later, however, Europe’s credit party must end. In a recent survey by Preqin, the alternative assets data provider, 55% of private debt investors believed the asset class was overvalued, and 35% predicted a correction within 12 months.
“My personal view is that over the next 18 months there is going to be some sort of economic correction,” says Barker. “There are quite a number of trends that are not dissimilar to 2006. Capital availability is really high, which is pushing LBO leverage and acquisition multiples very high. That is often followed by a correction. The drivers will be different from the financial crisis and the impact will be different. Corporates are in better shape now than in 2006-7, particularly big corporates. Leverage levels are better, liquidity is better, so their ability to withstand negative market shocks should be better.”
Some parts of the private debt market are going to get hit, however. Several retail and construction companies are already under pressure, and the defaults of Carillion and Interserve, with scanty recoveries expected, have given a foretaste of things to come.
But even the cautious Schuldschein market, with 150 deals a year, half of them from new issuers, is going to suffer some defaults.
The catalyst is not clear yet — it could be a hard Brexit.
When the time comes, private debt investors’ claims to be careful, rigorous credit underwriters will be tested.
Helaba surveys key credit metrics of outstanding Schuldschein issuers every six months, and has not noticed any deterioration.
For Bures at RBI, the Schuldschein is structurally unsuited to risky lending.
“We tend to do relatively covenant-lite deals, and it’s unusual to have a margin grid, so you need companies that will be stable for the life of the deal, because there’s no buffer if the ratios worsen,” he says. “And given German civil law, you can’t enforce majority decisions on the minority, so it’s good to avoid restructurings. Experience shows that banks have much lower tolerance for loan losses than institutions. They won’t go into riskier investments — the last thing they want is impairments on their loans. The Schuldschein market is not the place to go down the credit curve and test how far you can go. The typical investors in this market are not the right ones.”
Private debt markets came through the last crisis well. For them to get through the next one, after so much expansion and innovation, may depend on whether the changes of the past decade have left their essential nature unaltered.