Corporate bonds versus bonded loans - two financing tools in the focus of German companies

May 2013 | EXPERT BRIEFING | BANKING & FINANCE

financierworldwide.com

Corporate bonds have become popular among German companies in the past few years as an alternative financing instrument to the traditional bank loan. This is particularly true for small and mid cap companies which suffered most from the restrictive lending policy of banks, due to the altered regulatory regime of Basel II and the worldwide financial crisis. Upcoming revisions of the regulatory environment for banks under Basel III have not improved the willingness or ability of banks to lend money via traditional bank loans. To the contrary, banks have instead engaged in activities to reduce their risk weighted assets, including bank loans which absorb a high percentage of their own funds. Small and mid cap companies have started to review their balance sheets and diversify their funding sources. For many companies, the corporate bond was a suitable substitute for bank loan financing, at least in part, through the capital markets. The corporate bonds of small and mid cap companies have been well received by investors due to their attractive coupon in a low interest rate environment driven by the monetary policy of the European Central Bank. German exchanges began to offer particular market segments for small and mid cap companies’ corporate bonds, and now there is a variety of such segments, including Bondm (Stuttgart), Entry Standard (Frankfurt), Mittelstandsmarkt (Düsseldorf), m:access (Munich) and Mittelstandsbörse Deutschland.

Although the acceptance of corporate bonds is unchanged, other financing tools have entered the landscape of small and mid cap companies. Among those is the bonded loan which has become increasingly popular as a financing tool over the past few years. The transaction volume of the German bonded loan market exceeded €10bn in 2012. The bonded loan is legally a loan and not a security like the corporate bond, but it combines the economic advantages of capital markets instruments with the favourable legal requirements of loans.

The bonded loan allows use of the capital markets, since typically institutional investors like insurance companies, pension funds, public bodies and credit institutions seek investments in this instrument. Often the transaction volume for a bonded loan is comparable to a corporate bond. Bonded loans have a relatively short and standardised documentation with a promissory note attached. The promissory note is not a security but provides evidence that the loan has been paid out. Comparable to securities, the promissory note is handed over when the bonded loan is transferred to a new investor. Together with the lean loan documentation, this makes it comfortable to trade the bonded loan.

In addition, the legal requirements for bonded loans are less restrictive than for corporate bonds. German securities laws require for corporate bonds, offered to the public or listed on a regulated market, the publication of a securities prospectus. The preparation of this document is a costly, complex and time-consuming process, because it has to disclose any material facts about the company and the securities which are necessary to enable potential investors to make an informed investment decision. The issuer is liable for the correctness and completeness of the prospectus and, following listing of the corporate bond, must comply with ongoing disclosure requirements, such as the publication of financial statements and any material facts which may have an impact on the market price of the bond. Since the bonded loan is not a security, these legal requirements do not apply. Most market segments for small and mid cap bonds also require an external rating which is in general not required for a bonded loan transaction. Overall transaction costs for a bonded loan are much lower than for a corporate bond.

This does not mean, however, that the bonded loan is in all cases more attractive than the corporate bond. Corporate bonds have their own advantages, such as the opportunity for a widespread placement with private and institutional investors, reputational gain, a lower coupon than bonded loan, and the opportunity to shape the terms and conditions of the bond in line with the company’s needs. Companies are well advised, however, to consider the bonded loan as an alternative by reflecting on their particular situation and circumstances and weighing this against the advantages of each instrument.

A typical bonded loan transaction is arranged by a bank which structures the bonded loan and places it on a best effort basis with interested institutional investors. The structuring includes the agreement on the terms of the loan. A typical bonded loan has a term between three and 10 years, is repayable in one amount at the end of its term, is unsecured and is transferrable for the investor. The coupon may be fixed or variable and in some cases structured. It is also not uncommon to split the bonded loan into several tranches with different terms and coupons. The documentation is lean but derived from large syndicated loan documents. The initial lender is the arranging bank but the investor is identified beforehand and the bonded loan is transferred to them immediately after signing and once the respective funds have been provided by the investor.

In summary, the bonded loan is an interesting alternative to the corporate bond which companies should consider when structuring financing solutions.

Ingo Wallenborn, LL.M. is a senior manager at BDO Legal. He can be contacted on +49 211 1371 305 or by email: ingo.wallenborn@bdolegal.de.

Ingo Wallenborn

BDO Legal