The German Mittelstand

Coupons insufficient to assess real SME bond risk potential

In Germany, a 5 thousand million Euro volume, 10 year bond did not work well for its issuer.  With an median forecast yield of 1.64%, when the subscription period ended in mid-February, investors had only put up 4,3 thousand million. In the final analysis, only 3.8 million were assigned and the rest went into the reserves of the tax authorities for debt management. The procedure is not unheard of. The last transaction of this kind dates back to no more than 18 months ago.

Almost contemporaneously, the by-then 5 year SME bond issued on the Deutsche Börse in Frankfurt by Neue ZWL Zahnradwerk Leipzig was celebrating –earlier than expected–a vigorous launch in Entry Standard for bonds. The title, oversubscribed many times, was assigned no less than 10 days before the deadline. On the first day of trading, its quotation rose to102.70%. Investors who came away empty-handed from the subscription and wanted to purchase directly on the market had no option but to accept a 7% per annum slash in revenue.

In principle, a 25 million Euro SME bond ought not to be compared to a 5 thousand million Euro state bond. The ZWL launch, however, highlights how, just like at the time of the “New Economy”, investors are remarkably flippant in their approach to shares with a growth potential. The experts at one of the most important banks for issuing SME bonds, Close Bothers Seydler Bank AG, point out, however, that institutional investors tend to prefer a more diversified structure of lending conditions. In addition to the interest, they also set stock by specific terms inherent in the lending conditions that regulate certain guarantees of the obligors towards creditors during the life-time of  the bond.

What is of real interest to many investors, however, is the coupon. And the coupon should in reality be oriented similar to the bond’s rating. This is the regular bone of contention. There are known cases of bonds issued by MDax-listed companies assessed with a BBB investment grade that offer 3% interest while according to the coupons of SME bonds with a BBB rating, the interest  is 7%. It simply doesn’t square – either the rating or the coupon needs to be tweaked.

This is also the viewpoint of CAPMARCON – a consultancy company specialised in company financing. In its report, CAPMARCON spotlights the discrepancy in approach between that of a consolidated rating agency and that of an agency with a shorter history. The newer agencies with a shorter history tend to give much more practical evaluations. They assume that SMEs are comparable to major corporations, which leaves them open to the risk of giving insufficient weight to the risks inherent in SME bonds, notes CAPMARCON

Even though there are bonds that are clearly in difficulty, enthusiasm for SME bonds continues undiminished. It is highly likely that investors will grow to become more selective, but individual investors must quickly understand that on the capital market there is no such thing as a free lunch. For a proper risk assessment you need to look further than the coupon. A classic investment based on financial indices and the business model of the issuer is absolutely vital. Failing that, the man in the street will find himself – as so often happened after the collapse of the new market – on his uppers.