On March 9, 2014, a rather insalubrious anniversary went by. The date marked exactly five years since the worst of the global financial crisis hit, and the international banking community reflected on what the previous half decade had meant for their business.
For the German Mittelstand, the small and medium sized enterprises that many regard as the backbone of the German economy, the past five years have been dedicated to diversifying their financing away from bank lenders.
“For a long time before the financial crisis, there was a lot of talk about the need for Mittelstand companies to diversify their funding sources, to find new investors and to lessen their dependence on banks,” says Ingo Nolden, co-head of debt capital markets, Germany, at HSBC in Düsseldorf. “Especially since the crisis, the topic has been [intensifying] and it’s now really making its way through the markets.”
Given the traditional breadth and strength of the German banking sector, local borrowers have always been supported by their longstanding lenders. But while companies from the Mittelstand have, for the most part, continued to be supported by their banks, they have also embraced the need to diversify.
“The pressure on German companies, including those in the Mittelstand, to come to the capital markets is less than on firms in other countries,” says Joachim Heppe, head of debt capital markets bond syndicate at Commerzbank in Frankfurt. “Germany has a diverse banking sector and large numbers of institutions supporting corporates here. But ultimately, with the big picture changes expected in the banking sector, there’s clearly a strong incentive for everybody who has relied on bank funding to open up to different sources of capital and to get more flexibility for the future.”
Over the past five years, this need to diversify away from bank financing is a message that the German Mittelstand has taken to heart. A stream of mid-cap issuers have debuted in the bond market, and this growing interest from issuers has been echoed by an increasing appetite for the sector from yield-hungry investors. Indeed, while many borrowers have bitten the bullet of increased disclosure and signed up to ratings, others have found there has been enough interest in the sector to issue without ratings.
Across the bond markets, demand for Germany’s Mittelstand has been robust throughout the five years of crisis. Even after wind turbine maker SIAG Schaaf defaulted on its bonds in March 2012, the market remained open and another mid-cap issuer, Zamek Group, tapped the market only two months later.
Bankers close to the German Mittelstand feel that issuers have now caught on to the appeal of the bond product, and that the market is set in its course to further diversify towards the public markets.
“I think these companies now understand their options pretty well,” says Karin Arglebe, director in corporate bond origination at Commerzbank. “The education period is over. They know there is a possibility for diversification — they know who did what, at what maturity and with what pricing. They have that information as the basis for discussions and you’ll see more things in the market in the foreseeable future.”
An increased openness to issuing through the bond markets has also meant that these companies have changed their approach to bank financing. Rather than relying on lenders for all of their funding needs, treasurers have begun to cut their dependence on banks and build their own fortress balance sheets.
“Over the last five years, these companies focused on generating cashflow and building internal cash piles,” says Andreas Voglis, head of financial structuring and advisory, Germany, at HSBC in Düsseldorf. “Because of this, the demand for credit is decreasing. Strategically, companies are reorganising their banking groups and reducing the number of lenders they’re working with, and those bank groups will be with them for the next three or five years now. Most of them are well equipped and they have financing structures in place to cater for their growth over the next few years.”
Diversify or die
The theme of spreading the risk since the nadir of the financial crisis has not only become key for issuers, but also for investors.
“Investors now are looking to diversify,” says HSBC’s Nolden. “They are looking to move their portfolios away from supranationals and financial issuers, and that trend likely won’t disappear for some time. They are now open to new structures, new issuers. They are still searching for ways to invest, and with liquidity as strong as it is, we will see more exotic issuers and structures as investors move down the credit curve. We see investors buying names they wouldn’t have considered a couple of years ago as they search for yield pick-up and diversification. The Mittelstand is really benefiting from this.”
While in the bond market investors have moved down the ratings scale, with many even showing willing to invest in unrated firms and in smaller bond transactions, other investors have set up strategic partnerships with investment bank lenders to participate in syndicated loan transactions that were traditionally off limits to them. Since June 2013, French insurance firm Axa has had a financing partnership with Commerzbank that sees the German bank originate debt from medium-sized firms in Germany, Switzerland and Austria for the French firm to invest in. The joint venture allows Axa to participate in some syndicated loans, club deals, bilateral facilities and Schuldscheine. Commerzbank originates the transactions and retains a small part of the debt.
UniCredit has forged a similar relationship with Amundi — officially announced in January this year — where the asset manager will be presented with opportunities to invest in various deals originated by UniCredit. These deals will include bilateral loans, syndicated deals, club facilities or jointly lead-arranged Schuldscheine. The first deal completed under this scheme was a €25m Schuldschein for an undisclosed borrower in late October.
Looking forward
While the participation of institutional investors in loan transactions has opened a whole new source of funding to Germany’s Mittelstand, especially to those companies that are yet to tap the bond market, issuers from the sector are preparing for a future where they are able to tap into a wider range of financing.
Companies from the Mittelstand have always thought on a global scale. As the backbone of the German economy, many of them are export-oriented, and within their niche markets they are often leaders that are able to sell their products around the world. For example, when Volkswagen announced its plans to build a car plant in Indonesia in August last year, it requested that some of its local suppliers follow it to Asia in order to facilitate its supply chain management.
These Mittelstand firms are now bringing this global outlook from their operational strategy to their financing. As companies have reshuffled their bank lending teams as part of their refinancing exercises, many have focused on the inclusion of international banks with large global footprints that can cater to their increasingly international needs.
“With central banks pricing liquidity practically at zero, liquidity is a commodity in itself nowadays,” says Voglis at HSBC. “What treasurers are really looking for now is what added value a bank can offer to a Mittelstand company, and which banks will be sustainable.”
With Frankfurt one of a number of financial centres attempting to set itself up as the natural hub for remnimbi trading and settlement in Europe, Mittelstand firms may at some point be in a strong position to follow their blue-chip corporate counterparts, such as Volkswagen and Siemens, into the dim sum bond market.
Giving equity die kalte schulter
But while Mittelstand issuers have embraced the possibilities of the bond markets, they have shied away from embracing all types of capital markets. Although Germany’s mid-caps have spent the last five years opening up to the idea of greater disclosure in an effort to diversify their financing sources, the market is still far from embracing the truly public capital markets and for the most part has steered clear of listing on stock exchanges.
“Ever since the financial crisis, the non-private equity-owned German Mittelstand and the stock market have lived on two very different planets,” says Achim Schäcker, head of equity capital markets, Germany, at HSBC in Frankfurt. “Pre-financial crisis, while there was reluctance to go public, and to have to deal with disclosure and research analysts, family-owned Mittelstand companies, for various reasons, would at least consider such a step. Ever since the financial crisis, however, exploration of stock market options has decreased significantly. The number of IPOs from this group of German issuers each year can be counted on one hand and I don’t think that this will change any time soon. There are always exceptions, obviously, but in my eyes the overwhelming number of potential family-owned Mittelstand IPO candidates are likely to continue give the equity market the cold shoulder.”
This is not to say that the Mittelstand issuers remain insular and clandestine. Indeed, treasurers are embracing new ways of engaging with the investor base that may allow them to access the capital markets more flexibly and with greater control over the timings.
“Some corporations, even those without a rating, are looking at EMTN programmes,” says Commerzbank’s Heppe. “That’s a clear sign that they’re willing to provide the market with sufficient information. It’s not a huge trend, but more and more of the smaller issuers are doing that so they can get the speed of execution.”
Similarly, subtle shifts of focus suggest a wider flexibility from issuers in regard to their approach to the international markets — a recognition of the importance of a regional or global appeal for investors to source capital for future growth.
“Some firms are shifting their accounting from HGB to IFRS,” says Commerzbank’s Arglebe. “That really opens them up to new sources of funding, and maybe also paves the way for the structures that allow them to address new investors.”
