The Funding Alternatives for Germany’s Mittelstand
by Dr Mark Währisch, Director, Corporate Ratings, Alexandra Krief, Director, and Claire Mauduit-Le Clercq, Associate Director, Standard & Poor’s Ratings Services
Banking disintermediation is happening more slowly in Germany than elsewhere. Even so, Germany’s mid-market, or Mittelstand, will slowly begin to access new sources of funding to finance growth.
Held in envy around the world, Germany’s mid-market firms – known as Mittelstand businesses – are vital to its economy, contributing about one-third of total GDP. Like similarly-sized businesses throughout Europe, they are beginning to look for new funding sources to finance growth. However, the development of these alternative funding markets will likely be slower in Germany than elsewhere because its banking system remains, at present, a highly liquid and competitive lender.
That said, smaller mid-market firms will inevitably find bank funding harder or more expensive to access as the disintermediation process takes hold – in turn, increasing the importance of new sources of funding. For their part, private investors will look for greater transparency into the credit risk of mid-market debt issuers before investing. But we believe that increased transparency in this respect will lead to better capital allocation as well as more accurate and efficient pricing. As a track record of investment is built up, investors and mid-market firms will generate increased trust and, ultimately, more investment.
Mid-market shielded in challenging economy
Despite difficult conditions in the wider German economy at present, the mid-market corporate sector is somewhat shielded by its focus on exports. Indeed, around 65% of mid-market firms in Germany have links to international markets. Meanwhile, many operate conservative financial policies, as the increase in German companies’ equity to total assets since 2007 indicates. And EBIT margins since 2007 show that German mid-market firms have lower – but less volatile – profitability than larger peers.
Smaller mid-market companies in Germany, however, tend to be more affected by cyclicality and volatility than their larger counterparts. In particular, this can be ascribed to the fact that their activities are less diversified and their operating margins are more volatile.
But among this demographic there are market leaders in their respective industries – these ‘hidden champions’ profit from strong competitive advantages and good margins because they operate in niches and hold dominant market positions.
Funding options for the Mittelstand
This generally solid creditworthiness should put German mid-market companies in a strong position when seeking funding in new markets. Indeed, the number of mid-market businesses looking at alternative markets – including the well-established US private placement (USPP) market and the Schuldschein market in Germany – is rising.
Widely used by banks and corporates in Germany, the Schuldschein is a longstanding private placement market with a total estimated size of about €12bn for managed and arranged corporate deals in 2014 (up from €8bn in 2013). Mid-market firms – tending towards the larger end of the category – make up approximately 40% of the market.
Similarly, the USPP is a well-established market often used by mid-market firms to access funding. In fact it is the most important private placement market for European companies by volume size, although its share declined slightly after a peak in 2012.
Direct lending and mid-market bond financing could also improve the financial flexibility of mid-market firms should bank disintermediation begin to limit bank lending. Direct lending, for instance, can be attractive for German issuers in distressed circumstances or in certain refinancing situations – such as M&As – that require speedy execution and incremental leverage above standard bank leverage targets.