A combination of macroeconomic volatility and negative rates are eating into margins in the bond markets this year – prompting many investors to look elsewhere for attractive investments. It’s a trend that has overseen a storming year for Germany’s Schuldschein market – where volumes look set to be among the highest on record.
Volumes in Germany’s famous private debt market, the Schuldschein market, soared to more than €20bn within the first 10 months of 2016 – meaning that, with two months to go until year end, it is already on a par with 2008’s record year, which saw volumes of approximately €20bbn. In large part, this is due to increased demand from investors – many of whom are seeking refuge from the macroeconomic volatility and negative rates disturbing bond markets and looking to take advantage of cheap funding provided by the ECB.
Momentum is also being generated on the issuer side. Buoyed by attractive prices and high investor demand, corporates have been issuing increasingly large tickets throughout the year – including a number of record-breaking deals. These growing issue sizes are being supplemented by diversification among the issuer base, with non-German and non-Austrian issuers accounting for a greater share of the market. This internationalisation is being reflected on the investor side as well, as investors from outside Germany arrive on the scene, showing strong appetite for big deals.
Certainly, with little sign of a slowdown in terms of interest or activity in the market, the Schuldschein is well placed to surpass the high volumes of recent years by some distance – setting a new record for annual transaction volumes.
The floor’s the limit
It should come as no surprise that this uptick in Schuldschein volumes coincides with volatility in the bond market. Bond investors are currently finding their margins squeezed by negative Euribor and mid-swap rates – and this is making alternative markets an enticing prospect due to their relatively favourable yields.
For many investors, the Schuldschein market is a natural destination in the circumstances – not least because its contracts typically include zero floor language, stipulating that if the Euribor or mid-swap rate is less than zero, it will be considered to be zero when determining the coupon. This means investors can lock in at least the offered credit margin on a deal, without negative rates cutting into their profits.
What’s more, tapping the Schuldschein market is an excellent way of diversifying investment portfolios – offering access to an issuer base predominantly consisting of investment-grade corporates that are not tied to the bond market. Investors benefit from the Schuldschein’s bilateral documentation process, which affords the flexibility to customise maturities and structures according to the specific requirements of the deal. Likewise, the Schuldschein is a non-mark-to-market investment. This means investors need not declare the current market value of their Schuldschein positions– further sheltering their investments from bond-market volatility.
The big issue
The growing investor demand for Schuldschein that these advantages have spurred has not gone unnoticed by issuers. Indeed, corporates are reacting by issuing ever larger ticket sizes – with notes exceeding €1bn in some cases. For instance, German car maker Porsche placed a €1.1bn Schuldschein earlier in the year – a figure that rose from a launch size of just €200m. Indeed, issues right across the spectrum are expanding in size, with car rental and leasing company Sixt, for example, more than doubling its planned July issuance to €375m, in view of the overwhelming demand.
These increasingly large issues reflect the advantages that Schuldscheine continue to offer corporates. Indeed, while zero floor language might be seen as a disadvantage, most Schuldschein issuers are already familiar with this protocol from the syndicated loan market, where such conditions are still common practice. And with investor appetite for bonds dampened by negative rates, the Schuldschein market presents an opportunity for corporates to secure favourable pricing.
The strong momentum these benefits have generated has led to internationalisation on both the issuer and the investor sides of the Schuldschein market. Whereas in previous years issuers remained predominantly German-speaking – with around 80-90% of Schuldschein issued by German and Austrian corporates – in 2016, 25% of issuers hailed from outside the classic regions, with France being the strongest single country, accounting for almost 10%. Other countries/regions such as the Nordics, Benelux and Iberia are also contributing to this trend.
On the investor side, much of the international demand is coming from Asian banks, who tend to be tempted by larger deals with higher spreads, but institutional investors, too, are turning to Schuldscheine as a way of accessing high-yielding, yet reliable, corporate debt.
As a consequence, the Schuldschein market is booming, with investor interest and issue sizes both escalating at historic rates. Recent years have been kind to the Schuldschein – with 2008, 2009, and 2015 standing out as particularly busy years. And with volumes already touching record levels with two months left in the year, 2016 is set to be one of the most spectacular years in the market’s history.
Rudolf Bayer and Jörg Stührwohldt are managing directors at UniCredit