European securitization of SME financing has experienced strong growth since 1999. SME transactions reached 5.3% of total European ABS issuance in 2005; and in 2006 have represented 2.5% of euro asset-backed volume year-to-date. In a report last week, Sarah Barton at Morgan Stanley said that further growth is anticipated within this asset class going forward, particularly in Germany, aided by government sponsorship, cash transactions and securitization of mezzanine products.
The largest asset-backed SME markets in terms of issuance and risk transferred are Germany and Spain. Smaller volumes have been issued from Holland - 13.8 billion ($17.51 billion) is the total risk transferred - Italy (0.5 billion), Switzerland (3.4 billion) and Austria (1.0 billion). Italy and Portugal are relative newcomers - both brought their first SME transactions in 2004.
The case of Spain
Despite a reduction in government support, Spain had the greatest issuance numbers in 2005. Spanish SME volume in 2006 is now around $2.1 billion. Despite lower levels of issuance in 2005, Germany has a high amount of outstanding SME secured bonds.
According to Morgan Stanley, the market has seen $6.6 billion issued year to date, of which $3.8 billion is German paper.
The latest transaction to come to market was RCL Securitization GmbH, a 2.9 billion cash transaction, which priced last April, and had 1.9 billion privately placed. Barton said that German Participation Rights are also increasing in popularity with $800 million of issuance year to date.
The Fitch report
According to Fitch Ratings, the German SME CLO market is becoming more diverse in securitized instruments as well as transaction structures. Over the last eight years, this market segment has traditionally been dominated by synthetic balance sheet CLOs. But during 2005 and 2006, the true sale segment of the German SME CLO market has gained significant momentum, Fitch analysts said.
"The trade tax exemption for bank loan securitizations, the interest of True Sale International members to execute transactions under the TSI label and the historically low spread environment have been the driving forces behind this development," said Stefan Bund, managing director in Fitch's European structured finance group.
There are now three main different transaction types evident in the German CLO market: balance sheet CLOs (cash and synthetic); mezzanine CLOs and Schuldschein CLOs. The report discusses the key features of the main transaction types and highlights specific rating features of each of the types.
"The emergence of new product types for SME lending such as mezzanine instruments and the introduction of fungible Schuldscheindarlehen with standardised terms have led to new asset types being securitised," said Susanne Matern, director in Fitch's Frankfurt based structured finance team.
Morgan Stanley's Barton said that the implementation of Basel II should provide additional incentive to get these transactions financed via the securitization market. SMEs typically rely on bank loans, although alternative sources of finance, such as leasing and factoring (where the company sells its accounts receivable at a discount), are gaining in popularity.
"However, we do not see either as able to displace bank loans as the primary source of capital for these borrowers," Barton said. "Securitization offers banks attractive funding, capital management and the ability to transfer risk. We view this as a growing market."
SME loans under Basel
A study conducted by the European Commission found that only 1% to 2% of securitizable SME claims on banks' balance sheets have been securitized so far. SME securitization under Basel II would offer banks relatively efficient capital relief because the relative capital charge for banks' SME lending remains high when compared with other asset classes. Under Basel II, the credit quality of the borrower becomes the primary determinant of regulatory capital held against the credit exposure.
"For SME loans in particular, this leads to a higher cost of bank finance than for many assets, particularly since the borrowers are unlikely to be investment grade," Morgan Stanley's Barton said. "Not only will banks still be encouraged to transfer the credit risk to the capital markets and achieve capital relief, but they can also free capacity for further SME lending."
Barton calculated in her report that those banks adopting the Foundation Internal Ratings Based approach will see the risk weight for a corporate SME fall to 85% from 100% under Basel I.
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