Secured Promissory Note Loans
A promissory note loan is a bilateral or syndicated loan instrument governed by German law and documented in accordance with Section 488 of the German Civil Code (BGB). It is not a security, but a loan securitised by a promissory note.
A collateralised promissory note is a variant in which the lender benefits from special security or credit protection mechanisms instead of relying solely on the general creditworthiness of the borrower.
A promissory note loan is a medium to long-term loan under German law (§ 488 BGB) in which a borrower receives funds from one or more investors and confirms the obligation by means of a written acknowledgement of debt (promissory note).
In contrast to a bond, a promissory note loan:
- is legally a loan and not a security
- is usually issued as a private placement and is not publicly traded
- is usually subscribed by institutional investors such as banks, insurance companies and pension funds
- Can be structured with fixed or variable interest rates and different maturities
The instrument combines features of traditional bank loans and capital market debt:
- From a legal perspective, it is a bilateral or syndicated loan agreement.
- From an economic point of view, it is long-term financing with capital market-like characteristics.
Promissory note loans are widely used in Germany and increasingly also on international markets, as they offer borrowers the following advantages
- Lower documentation requirements compared to bonds
- Flexible structuring options
- Access to a diversified investor base
The introduction of Solvency II on 1 January 2016 created a new supervisory regime for insurance companies that differs fundamentally from Solvency I, which was based on the Investment Ordinance (AnlV) and strict quantitative and qualitative investment rules for protection assets.
While Solvency II insurers enjoy extensive investment freedom under the prudent person principle, the AnlV, the Pension Fund Supervision Ordinance (PFAV) and the BaFin's investment circular continue to apply to smaller insurers, death benefit funds, pension funds and pension funds.
Due to these fundamentally different regulatory systems, the German Insurance Association (GDV) has developed two separate credit guidelines:
- One for Solvency I insurers and institutions for occupational retirement provision (IORPs), which will be updated in December 2019.
- A separate, stand-alone guideline for Solvency II insurers, published in August 2018.
The Solvency I Directive defines the conditions under which corporate loans (mainly promissory note loans) qualify as eligible investments for the insurer's cover assets. These loans must fulfil the requirements of Section 2(1) No. 4a AnlV, including
- The borrower must have an investment grade credit rating.
- The loan must be sufficiently collateralised, either by:
-
- First ranking real estate collateral,
- pledging or assignment of receivables and securities, or
- a negative pledge.
Loans that are only collateralised by a negative pledge must meet particularly high creditworthiness requirements, which generally correspond to at least A- / A3. BaFin continues to refer to the GDV guidelines when assessing borrower creditworthiness for such loans.
If a loan does not fulfil these criteria in full, it may still fall under Section 2 (1) No. 4c AnlV (e.g. infrastructure or high-yield loans), but these are limited to 5% of the insurer's cover pool and require at least a speculative grade rating (BB to B-).
The guideline also explains that due to the strong borrowing power of high-quality issuers, not all borrowers are prepared to contractually commit to maintaining financial ratios over the entire term of the loan. This has increased the practical relevance of the 5% ratio in accordance with Section 2(1) No. 4c AnlV.
In addition, the scope and strictness of the contractual covenants follow a risk-based "waterfall principle":
Weaker creditworthiness typically leads to more and stricter covenants, but more covenants do not automatically mean better protection. Each insurer must decide what level of covenant is appropriate based on its own risk appetite and the specific transaction.
From a legal perspective, promissory note loans:
- Are subject to German law (§ 488 BGB),
- are not securities, but acknowledgements of debt,
- allow each investor to act independently (no community of debtors),
- give the lender a statutory right of cancellation after 10 years (§ 489 BGB),
- are generally subject to German jurisdiction.
Connect with Our Experts
Contact SH Schweizer Hypotheken AG at Feldstrasse 22, Schaffhausen for Promissory Note Loan inquiries.
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