Patrimonium has financed more than 100 mid-market companies in Germany over the past 10 years.
“When we started in 2005/2006 with our lending activities it was mainly through mezzanine loans as this was the only way you could position yourself as an alternative lender in the bank-dominated German financing landscape,” says Heine.
However, the 2008/2009 crisis has fundamentally changed this environment, with most of the traditional lenders struggling with tier 1 capital restrictions, amplified by tougher regulatory requirements resulting from Basel II/III accords. They were forced to retrench from lending to the lower rated range of mid-market corporates.
As a consequence German stock exchanges allowed Mittelstand companies to issue public bonds. The so-called German Mini Bond market was created and surged in the years 2011 to 2015 to a total issuance volume surpassing €10 billion.
“We are fundamentally convinced that we are at the beginning of a development where alternative lenders will fill the widening gap left behind by traditional lenders. Bank disintermediation in Germany will gradually change the German lending landscape to a more Anglo-Saxon type of structure where traditional lenders, public markets and institutional lending funds serve the credit demand of middle market corporates,” says Heine.
“Loan pricing trichotomy is the new normal in German Mittelstand lending,” he adds.
Today three loan pricing groups can be observed in Germany. The first group encompasses companies which have high bank internal rating results. In this group a highly competitive pricing battle between traditional lenders backed by ECB liquidity is raging. From a risk/ return perspective such low pricing is justified if traditional lenders manage to enhance returns with additional fees from cross-selling initiatives.
The second group are the companies with lower rating results which have issued public bonds in the German mini bond market. In this segment low loan pricing, covenant light, unsecured instruments and bullet maturities are commonly observed as these bonds are usually sold into the yield-starving and mostly unsophisticated German retail market. Due to the mispricing of these bonds, the market attracted a certain number of companies which should not have qualified to issue public instruments as credit metrics and credit quality were not sufficient.
The third group of companies is the group which due to increased Basel II/III regulatory requirements no longer qualifies for traditional bank lending solutions, but is seeking the flexibility of a bilateral relationship which can only be provided by a direct lending fund and not through public instruments. Such flexibility is rewarded with a superior risk-return profile, which typically stems from obtaining hard asset collateral as security supporting the loan. The risk-return profile is further improved with variable upside participation features attached to the loan instrument.
To be successful in the German direct lending market Patrimonium believes that three conditions must be met.
SHARED CREDIT CULTURE
The so-called German Mittelstand companies are often referred to as the backbone of the European economy. Many of these companies have been run by the same family for generations and are renowned for their high level of specialisation and their aspiration for quality. Numerous Mittelstand companies have become world market leaders in their product niches and are serving the markets with high precision tools, goods, components and machines. The corporate culture of these companies is not a private equity culture, but a culture where family tradition, sustainability, independence and the aim to pass on the business to the next generation are more important than short-term returns. This culture was historically also reflected in long-term lending relationships with traditional banks, where mutual trust played a major role and financial interest was fairly aligned. Such shared credit culture is a main characteristic of the German Mittelstand and new providers of credit will only be successful within this market if they equally live and share this culture.
Providing loans to mid-market companies requires speaking the local language, understanding local peculiarities and full command of the local law and lending experience of how it is applied. Such local understanding is only possible when working with a team of local origin with lending experience in recession periods, where recovery measures and insolvency scenarios become part of the daily work.
“Our experience is that only credit managers who have lived through downturn credit cycles are able to relate at eye level with battle-scarred Mittelstand company owners,” says Heine.
Sourcing of investments, loan underwriting and monitoring of investments requires a hands-on approach. This approach is needed when developing a sourcing network where personal relationships are important. It is necessary when it comes to loan underwriting. Understanding the needs and characteristics of mid-market companies on the one hand, and structuring tight and economically sound loan documentation on the other hand, is key to successful mid-market financing. By committing management to a financial plan and drafting sensible covenants and security packages around the loan documentation creates superior risk-return profiles for investors.
Last but not least, a hands-on approach is required when monitoring investments and timely action needs to be taken should investments deviate from budgets. Altogether such tight and strong loan documentation combined with flexibility when needed is highly appreciated by mid-market companies and justifies better pricing if compared to more standardised but less flexible public instruments.
“We think that direct lending funds must play a major role to bolster the negative effects of bank disintermediation for the German economy in general and for Mittelstand companies in particular,” concludes Heine.
Bond refinancing to German fastening maker, Joh. Friedrich Behrens
In March 2016, Patrimonium sourced and underwrote a €10.5 million secured loan financing of Joh. Friedrich Behrens. Founded more than 100 years ago, Behrens has emerged as one of Europe’s leading manufacturers and suppliers of high quality fastening systems with revenues of €106.2 million and an EBIT of €6.2 million in 2015 and a market share of approx. 25 percent, serving more than 20,000 customers globally.
Behrens employs 400 employees at its Ahrensburg site, close to Hamburg, and its foreign subsidiaries. Patrimonium ensured the repayment of the €30 million outstanding Behrens Mini-Bond which matured in March 2016. The Patrimonium loan enabled the timely refinancing of the bond and also improved the financial stability of the company. Given the operational strengths of Behrens the company is seeking to pay down the Patrimonium
loan within a few years, making use of possible early repayment features.
The investment is modeled to trade over its lifespan within a net-debt/EBITDA ratio of approx. 3.3. The loan is secured with all of Behrens 23.696 m2 property and plant at its Ahrensburg main production site. Key to the investment was structuring a reliable yet flexible financing instrument around the Mini-Bond refinancing transaction.
Tobias Fischer-Zernin, Behrens owner and CEO says: ”The successful collaboration leads to a new financing structure, which allows us to successfully and sustainably position ourselves in the market. We are convinced we have found the right financing partner in Patrimonium, in order to continue the business successfully and be self-determined in the future.”
Patrimonium Asset Management is a Swiss-owned independent alternative asset management company founded in 2006 and regulated by the FINMA. Its German private debt team has been operating since 2006 and has invested a total loan volume in excess of €700 million in German middle market companies. Today`s investments are typically senior secured loans in the range of €5 million to €30 million into sponsorless, mostly family-owned and managed middle market companies. The firm manages today approx. CHF2.5 billion and has around 40 employees.
Best European Direct Lending Fund 2016. Patrimonium won this distinction for its Middle Market Debt Fund at the 2016 Creditflux Manager Awards. It was already shortlisted as one of the top 3 Best European Direct Lending Funds in 2015. In 2016, 30 direct lending funds were analyzed which fulfilled the eligibility criteria. The Creditflux Manager Awards are based on fund performance to investors and portfolio credit metrics.
This article is sponsored by Patrimonium. It appeared in Private Debt Investor's Sponsorless Finance supplement, published June 2016.