With the German economy teetering on a technical recession, investors are beginning to take a more thorough look at the type of loans to be included in true sale structures going forward. There may be more than meets the eye, and in the long term, sources say, the German cash initiative may turn out to be more than just a funding opportunity.

"Investors will no doubt see the German market as a valuable diversification tool, but should keep in mind the motivation behind future cash deals," said one market source. Under the true sale initiative (see ASR 4/28), government-owned promotional bank Kreditanstalt fur Wiederaufbau (KfW) will assume the moderator role. KfW is not, however, expected to lend any explicit guarantee to transactions.

The German program is likely to function much like the Spain's FTPYME program, which also promotes true sale securitizations of loans made to small- and medium-sized enterprises. Unlike the German initiative, however, some of the tranches in the FTPYME do benefit from an explicit government guarantee.

Furthermore, although KfW announced late last month that its true sale initiative involving five of the larger German banks would not include non-performing loans, specific eligibility criteria have not been issued. The Spanish FTPYME provides detailed loan eligibility criteria dictating several conditions regarding obligor statue, loan duration and use of proceeds. Market sources warn that the danger lies in what turn currently well-performing loans may take if economic conditions in Germany worsen - particularly loans emerging from the problematic east.

The reunification of Germany prompted heavy rebuilding efforts in the east, which exerted pressure on banks to lend for commercial property building and the economic development of buy-to-let properties. Today, defaults are reaching historical highs, and according to commentary from ABN AMRO, the market is highly susceptible to variations in the interest rate environment.

"These mortgages may be performing well now, but historically the ABS market has been a longer term market," said one market source. "Who can vouch that banks won't look at it as an opportunity to unload what potentially may become problem paper from their books?"

Recently, a wave of Germans have been moving west, meaning that those with investments in the east may find it difficult to secure a rental base for buy-to-let properties, for example. "Right now they are paying down, but at some point we could see a surge in defaults," said the source. "Take the CLO market as an example: early transactions included grade-A names, but as the market developed, it stopped being just about capital arbitrage and became more about risk management."

Deutsche Bank noted last week, however, that if the initiative allowed for pfandbriefe-like underlying cashflows, where the liability structure was not required to match underlying cash flows, it could potentially open up the market to a larger investor pool.

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