Germany’s Mittelstand (mid-market) will lag other countries’ corporates in seeking alternative sources of debt funding, argues Standard & Poor’s, thanks to the strength of the company’s banking sector and the prudence shown by its corporates through the crisis.
The German banking system “remains a very liquid and competitive lender”, S&P said, “so the pace of distintermediation will likely be slower in Germany than in many other European markets.”
Growth in the Mittlestand’s European export markets will be more benign than in Germany over the next two years, S&P said, while the magnitude of growth in markets beyond the EU also may not meet previous expectations. “This will likely hold back the pace of the Mittlestand’s growth-oriented investments”, the report said.
German corporates also adopted a defensive approach to the financial crisis, stockpiling cash on their balance sheets and reducing total leverage. When investment activity does pick up, S&P expects companies to draw on this cash to finance growth projects rather than turning to debt capital markets or lenders.
Liquidity has not receded significantly for German mid-market companies, especially not for those with higher credit quality. Favourable interest rates also mean public and private funding markets are attractive, including the German Schuldschein and US private placement markets, the report found.
“We nevertheless believe smaller mid-market companies will encounter greater hurdles to accessing bank funding over time as the disintermediation process takes effect, making access to alternative lending more important,” S&P said.
“To support the development of new lending markets, investors will seek greater transparency about the credit risk of mid-market debt issuers. For example, while domestic investors may have a good understanding of a local company's credit risk, foreign investors or those without their own credit analysis capacities might have difficulty making investment decisions without further information. In general, we believe that increased transparency leads to better capital allocation and more accurate and efficient pricing, which in turn strengthens the trust of market participants to re-invest.”
The biggest obstacle to disintermediation in Germany is the strong cultural relationship between the Mittelstand and the country’s domestic banking community, which comprises commercial banks, Landesbanken (regional banks), Sparkassen (savings banks) and Volks-und Raiffeisenbanken (cooperative banks).
“Given the low current interest rate environment, the market will stay ‘overbanked’ and offer mid-market companies in general very attractive funding rates,” S&P said. “Consequently, bank debt will remain the most efficient and most widely used financing method for mid-market companies for the time being. We nevertheless believe that other sources of funding will increasingly play a role in mid-market financing.”
The direct lending market in Germany has a long way to go. Deloitte’s Alternative Deal Tracker found in May this year that there have been 22 direct lending deals in Germany since Q4 2012, compared to 93 in the UK and 50 in France over the same period.