Of the around 100 bonds issued on the SME segments of the German stock market since 2010, some 16 were secured bonds. To date, secured bonds account for nearly €700 million as compared with total issuance of €5 billion for the SME bond market.

Issue volumes of secured corporate bonds are rising steadily. In 2010, they amounted to only €100 million. In 2011, the volume had risen to €150 million, and by 2012 it was €175 million. By September 2013, the amount of secured bonds issued to investors in the German SME market had already reached €250 million.

Recovery rate significantly higher for secured bonds 
Investors buying unsecured corporate bonds must rely on the issuers’ creditworthiness. If the issuer cannot meet its payment obligations, investors are grouped with other creditors and repaid out of the remaining assets, generally at a significant loss. With only one exception, in all insolvencies observed in the SME segment, the bonds were unsecured. The average recovery rate, i.e. the share of claims fully repaid to bondholders after liquidation of all assets, was less than 10%.
This contrasts with secured bonds. In the event of default, bondholders can exercise their secured claims and will be repaid before other creditors. To give an example, the recovery rate on high-yield, secured US bonds is around 60% (source: Deutsche Bank).

Recovery rate a key element of the bond rating 
When assessing corporate bond risks, rating agencies like Scope always look at the long-term intrinsic value and the liquidation value of an asset, and not just the probability of default. The bond rating thus reflects both the default probability and the expected recovery rate.

Low risk premiums on secured SME bonds
The significantly higher recovery rate on secured bonds reduces the risk of major losses for investors. The risk premiums are accordingly lower than on unsecured bonds. The average premium on the risk-free rate for all secured SME issues was 6.1 percentage points at the time of issue. For unsecured bonds, it was 6.5 percentage points. The average maturity of SME bonds is five years, which is why Scope uses 5-year Bunds as its risk-free rate benchmark.

Secured bonds particularly attractive for smaller companies with less financial resources
Issuers with a high credit risk profile are able to reduce their coupon payments by pledging substantial, high-value collateral. This is particularly true for smaller companies, which tend to have a higher risk profile than large companies with diversified business models. In 2012, the total assets of German SME issuers of secured bonds amounted to an average €110 million, well below the €320 million of SME issuers of unsecured bonds.

Mortgages frequently used as collateral 
There are many types of collateral, specifically adapted to each corporate bond. In practice, collateral often takes the form of rights to assets such as property, movable fixed assets, equity investments and other securities, but also sureties or third-party guarantees. The SME bonds issued to date are secured primarily by mortgages, which represented over half of the collateral used. Pledged assets and third-party guarantees play a major role as well.

Scope foresees an increase in secured bond issues 
Scope notes that SME market investors are becoming increasingly risk averse, as evidenced by the rise in risk premiums (see Scope’s analytical commentary of July 17, 2013). This trend is driven in particular by the recent spate of corporate insolvencies. As a result, Scope expects to see the number and volume of secured bonds increase significantly in 2014. This development will be boosted by the trend towards smaller issuers (see Scope commentary of 7 August, 2013).