With a recent spate of German corporations filing for insolvency, CLOs backed by loans to German companies may be at risk, analysts say.

In the space of just a few weeks there have been a number of high profile German insolvencies: one for KirchMedia, the latest insolvency; the construction company Phillip Holzmann; stationary firm Herlitz; jet maker Fairchild Dornier; and clothing company Wuensche.

According to Dresdner Kleinwort Wasserstein, "The obligors in these deals are typically small and medium-sized enterprises ("SMEs") so there is the possibility that some of these transactions may have exposure to the companies [that have recently filed]."

A growing trend

According to tables provided by Creditreform and Dresdner Economics, in 2001 European insolvencies increased by 5.9% from figures reported the previous year. Data indicated that small and medium-sized companies were those principally affected and highlighted Germany as posting significant increases.

Over the past two years German insolvencies have risen by 20% and typically, very small companies show the highest probability of becoming insolvent. Nonetheless, the German CLO market has demonstrated its resilience, posting low delinquencies and very few defaults.

Forecasts provided by Creditreform in March indicated that that insolvencies would continue to grow throughout this year and future monitoring of these deals would rely on where the pools are concentrated, the concentration of the industry, the size of the individual obligor and the seasoning of the pool.

What deals might be exposed?

As Kirchmedia's largest creditor, Deutcshe Bank's German CLOs contain direct exposure to the insolvencies. According to figures reported by Dresdner the bank's exposure is estimated at EURO700 million. "The sheer diversity of these pools means they are a microcosm of the Deutsche loan book, so there is perhaps more of a chance that loans to some of [the insolvent companies] might be included," said analysts.

Further, the pools for Deutsche's outstanding SME CLOs - CAST and CORE - consist of non-promotional loans, meaning there is no limit in terms of the size of the company. This is contrary to the pools behind Kfw's Promise series, which includes promotional loans made to SMEs with an annual turnover of less than EURO500 million. Of the companies that recently filed for insolvency, only Wuensche meets such a requirement.

However, because the pools in these CLOs are blind, it is difficult to accurately gauge what type of exposure the deal might have to the recent insolvencies. S&P used the "actuarial" approach to rate the well-diversified pools of CAST, CORE, Promise and Geldilux. Based on this ratings approach and performance of these deals to date, S&P determined that the insolvencies of a few obligors should not affect these deals.

Paul Stanwix, a credit analyst in S&P's structured finance surveillance team, said that the performance of these deals has been satisfactory, with Geldilux 99-2 Ltd's C, D and E notes being upgraded by S&P in Jan. 2002.

In respect to the CAST series, for example, the bulky pool with larger loan and obligor concentration means there is a larger number of SMEs included, making the pool highly diversified, added one analyst.

While it appears that there is relatively little threat of direct exposure to the insolvencies, analysts said that German SME CLOs should still be wary of any indirect exposures that exist through contagion. Dresdner explained: "For example, companies that are suppliers to Phillip Holzman could come under pressure, particularly given that the German construction sector is already weak."

Analysts added that if deals had some exposure to the companies directly affected by the Phillip Holzman insolvency, there could be a problem, as there may be sigificant enough exposure to such companies to adversely affect the deal. In the meantime, such a scenario of contagion is quelled by the recent announcement by the German government that it expects to provide liquidity to SMEs affected by the Philip Holzman insolvency by providing low-interest loans to them.

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