Opportunity in the Mittelstand, says Fitch

Privately-held mid-sized German companies may face a new paradigm with private equity and hedge funds stepping into the breach as banking relationships unravel, according to a new report from Fitch Ratings.

The ratings agency suggested that Mittelstand companies might turn to private equity as house bank relationships come under mounting pressure. This is due to profitability pressures on private banks, new commercial realities for public sector banks and greater supervision and transparency of all German banks due to implementation of Basel II and the EU capital adequacy regime.

“The clear preference for domestic market solutions that avoid straight equity and international capital market standards on disclosure and covenants risk leaving these companies under-prepared for an end to the historically close house bank relationships,” said Edward Eyerman, a senior director at Fitch and the author of the report.

The house bank relationship has traditionally provided German companies with long-term, patient financing at reduced expense. The arrangement also addressed borrowers’ principal concerns: maintaining economic and voting control, confidentiality of information and tax efficiency.

But the combination of pressures means that Mittelstand companies will find it more difficult and more expensive to obtain bank financing in future. More sophisticated risk measurement under Basel II is already prompting German banks to sell NPL portfolios to distressed investors. The pending capital adequacy regime will also increase the monitoring demands that house banks make on borrowers.

“Bank financing will become less attractive and this is a huge opportunity for private equity. We will be able to compete with bank debt in a way that has never been possible before,” said Wolfgang Alvano head of the German division at Granville Baird Capital Partners.

Another harbinger of change is the increasing role of hedge funds in debt facilities. Hedge and distressed debt investors have taken large positions recently in performing loans for retailer KarstadtQuelle and auto supplier Schefenacker, Fitch said.