With a year of credit mishaps behind, the nascent mezzanine German SME CLO sector is seeing the first deal marketing in 2007 via HSBC Trinkaus & Burkhardt's HEAT Mezzanine -1 2007. Where the deal prices will tell the tale of where current investor sentiment is after last year's default debacle that placed a couple of structures in the firing zone.
"The degree of overlap is high within these structures," said Ganesh Rajendra, managing director and head of securitization research of Europe and Asia at Deutsche Bank. "It will be interesting to see if that is going to be priced in."
If appetite is any indication of where investor sentiment lies, then so far, so good, said Michael Auracher, managing director and head of structured solutions group at HSBC Trikhaus. According to Auracher, the deal - which is backed by subordinated loan agreements made to German small and medium sized companies - has been well received and went subject in two hours, a feat unheard of for these structures until last week. The triple-A tranche of the 330 million ($432 million) HEAT transaction was 2.5 times oversubscribed, the single-A tranche seven times and, even more unusual, the equity tranche saw itself two and half times oversubscribed. "Equity is hard to sell in Germany and is typically geared toward a specific market segment," Auracher said. "This time we had a straight marketing process covering some additional countries in Europe and also the U.S. and Japan - new investors in our book."
At press time, price guidance on the triple-A floating rated, 6.9-year Class A notes of HEAT Mezzanine-1 2007 were suggested at a spread of 35 to 37 basis points over Euribor. The Class B, single-A rated notes were talked at the 85 basis points area and the triple-B, Class C tranche was talked at the 200 basis point area.
SME CLOs typically have a much less granular asset pool, with the number of borrowers ranging between tens to low triple digit numbers. The less granular a pool, the higher the impact of a single default can be. Investors must surely remember that the two company defaults seen in 2006 - Nici AG and Hucke AG - affected five of these transactions. "The Nici debacle also unmasks the degree of (and risk related to) obligor overlap in this young SME sector," Deutsche's Rajendra said.
And even though the HEAT deal currently marketing is the biggest mezzanine SME CLO to date - counting 60 companies as underlying - it is still much less granular when compared to SME securitizations of balance sheet exposures that can have pool sizes of up to several standard borrowers. So does this appetite for the new HEAT deal mean that investors turned a blind eye to last year's defaults (ASR, 05/29/06)?
Auracher believes that investors now have a better understanding of how the product has evolved. "Compared to the number of companies financed by these loans throughout all platforms, the default rates are still below statistics," Auracher said. "And I think the market is growing accustomed to an expected rate of default and due to the fact that we have learned our lessons and improved selection and monitoring process."
Deutsche's Rajendra added that these defaults have a minimal impact on ratings - none of the deals were affected in that aspect by last year's events. According to Fitch Ratings, such early defaults are covered with the rating agency's analysis, which includes the testing of different default timings. Standard & Poor's analysts said that the performance of these deals remains stable because of the strict eligibility criteria imposed on the loans that are securitized and their collateralization levels.
Besides, the need to get these deals done is far greater than the ripples caused by last year's defaults. The rapid development of the market for mezzanine and equity financing has arguably driven up the aggregate equity capitalization of SMEs. According to Deutsche Bank, SME equity ratio has increased to an average of 13.6% in 2004 from 7.4% in 2000. The eight largest German mezzanine SME programs have outstanding balance sheet assets that topple the 4 billion mark, of which four have tapped the securitization market for funding and risk management purposes. The names included among those banks are the SBC Trinkaus transactions, Deutsche Bank-IKB joint venture equiNotes (FORCE CLO series), HVB's Capital Efficiency Group (PREPS), and Commerzbank (CB MezzCAP).
The German SMEs will continue to need this type of financing, Auracher said, and there is enough investor appetite to support further growth in this market segment.
It is likely that other countries will begin to use this technique as well, Auracher said. HSBC is currently looking at the U.K. and France but he emphasized that it is important not to mix these books because of the varying insolvency legislations in Europe.
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