In the wake of the financial crisis, with a dysfunctional bond market, Schuldschein loans saw massive issuances (in excess of EUR 1 billion), by the likes of BMW or Siemens. While these peaks have not been reached again in recent years, the interest in the instrument has continued with more and more international investors and issuers becoming curious and the Loan Market Association has recently published a product guide, but what is a Schuldschein loan and what is its specific appeal for issuers and investors?
Schuldscheindarlehen (literally: loans evidenced by certificates of indebtedness) have been around for decades in Germany, with predecessors dating back hundreds of years. Predominantly they have been used by the Federal State, the Bund, as well as by the Länder (states), municipalities and by credit institutions in refinancing programmes, however Schuldschein loans have also been issued by corporates. This overview focusses on the latter market.
The term Schuldschein is mentioned in certain German statutory provisions. However, there is no statutory or otherwise fixed definition of the term. Legal literature, somewhat vaguely, describes a Schuldschein loan as “bond- like loan” or “capital market-near form of financing”. While legally simply a loan agreement, in commercial terms, a Schuldschein loan is more akin to a bond. Schuldschein loans can best be defined in a negative way, by what they are not: First, they are not securities, which means that the detailed statutory rules for the issuance, trading, depositing and administration of securities do not apply. In particular, no prospectus needs to be approved by supervisory bodies and published. Secondly, they are not in bearer or registered form. Schuldscheine are not transferred by transfer of title to the document itself, but by assignment of the loan receivables or transfer of the loan contract. Thirdly, they do not qualify as certificates of indebtedness for the purposes of the Act on Certificates of Indebtedness (Schuldverschreibungsgesetz). Finally, clearing systems cannot be used for Schuldscheine and they cannot be listed or traded on an exchange. However, it must be noted that the granting of Schuldschein loans to German borrowers may potentially be subject to the German Banking Act and require the investor to have a German lending licence and, in case of a German borrower, in some circumstances require a deposit licence. Short term Schuldschein loans may also qualify as regulated money market instruments.
The name Schuldschein loan is derived from a certificate of indebtedness, which can be characterised as an “I owe you”, separate from and in addition to the loan agreement: the Schuldschein itself. Historically, a Schuldschein was customarily issued in connection with a Schuldschein loan agreement. Modern Schuldschein documentation often does not comprise a separate certificate. It is either included in the loan agreement’s text or omitted altogether.
There is no market standard form for a Schuldschein loan agreement. Nonetheless, the agreements used in the market are similar and have a lot of traits in common. They are rather short (10 to 15 pages) and laconic as they rely on and incorporate the detailed provisions of the German Civil Code. This makes them hard to understand for someone not privy to German law. Unsurprisingly, the growing interest of foreign investors has resulted in typical clauses from LMA templates being imported into Schuldschein documentation. Schuldschein loan agreements are extremely “covenant-light”, often only containing an obligation to provide annual accounts and a negative pledge clause. Schuldschein loans are bilateral loans and there are no provisions on agency, decision making between several lenders etc. Often a bank, (e.g. the arranger), is appointed by the issuer to handle the payments under the loan. Typically, a Schuldschein loan is unsecured. Guarantees, e.g. by a parent entity, are however not uncommon. While generally straightforward, Schuldschein loans are very flexible and can accommodate complex structures as well as a simple loan. Documentation for a Schuldschein loan may be structured with a senior and a junior tranche, secured by real estate and other assets, held by one or several security trustees, or include convertible or derivative features.
The issuer case
Generally speaking, the financing costs under a Schuldschein will be higher than a syndicated loan and there is a lack of a liquid secondary market. However, for an issuer, financing via a Schuldschein may have a number of distinct advantages. It allows the issuer to tap the capital markets without going through onerous rating, prospectus and other regulated processes. It may expand the investor base beyond the relationship bank group. As Schuldscheine are not listed or monitored by e.g. Bloomberg or Reuters, they are ideal for discreetly raising debt funding. Issuance costs are comparatively low compared to bonds because of the simplicity of the documentation and the absence of publication or reporting requirements. Low issuance costs make smaller issuances possible, allowing issuers to flexibly and quickly respond to market developments and their financing needs. Relatively short book-building periods contribute to the flexibility of the instrument. Average deal sizes can be between EUR 50 m and EUR 300 m, with much smaller and also much bigger issuances possible. The bilateral nature of Schuldschein also allows for terms to agreed and amended individually with each investor.
The investor case
Schuldschein investors tend to be insurance companies, pension funds and credit institutions, in particular savings banks and co-operative banks. Schuldscheine offer spreads and maturities above those available in the syndicated loan market. Investment levels and “ticket size” are generally smaller which makes the market more accessible to a range of investors. Also, the instrument allows investors to acquire exposure to entities that are not active in the bond market. The flexibility of the Schuldschein documentation means that coupon and term can be tailored to best suit the needs of individual investors. Institutional investors often prefer fixed coupons with a longer maturity, whereas commercial banks generally prefer mid-term investments and a floating rate coupon. Schuldschein loans can, if they meet certain criteria (in particular in relation to credit risk and financial ratios, be included in the so called “restricted assets” of (German) insurance companies. In addition, Schuldschein loans may be eligible as collateral for financing facilities provided by Eurosystem central banks. Legally, Schuldschein loans are freely and simply transferrable. However, as the liquidity of the secondary market is limited, most Schuldscheine are held to maturity. This is aided by IFRS accounting rules, which do not require the “marking to market” of Schuldschein loan assets. Finally, due to the very limited covenants investors are largely passive, as there is no need to become involved in waiver or consent requests by the issuer.
Market data shows that issuance volumes are oscillating around roughly EUR 10 billion a year. While there is no steep increase in overall issuances (e.g. issuances in 2013 were considerably lower than in 2012), there seems to be an on-going and general interest in the instrument. While the bulk of issuers are German, the share of non-German issuances is rising. It remains to be seen whether or not this interest will continue and make the Schuldschein, along with the Pfandbrief, a staple of the international finance arena. At the moment, this may provide an interesting alternative.