Budgetary constraints have prompted the Spanish Treasury to further reduce guarantees provided to Spanish-styled SME CLOs called FTPYMES. In 2001, the Spanish government cut 15% from the guarantee coverage it offers on triple-B tranches, and this year it plans to move ahead with a 50% cut on the coverage provided for single-A tranches. Although it's the second cut in two years, market analysts say it's unlikely to stymie the growing popularity of the asset class.

The guarantee is largely regarded as reinforcement aimed to attract typical buyers of government debt. For true ABS investors, the absence of a guarantee provides an opportunity for cheaper participation in larger tranches of unguaranteed notes. According to Merrill Lynch, there have been 12 other transactions completed since the market's inception in 2000, and performance to date is excellent.

For deals that still require a stronger level of guarantee, the call to fill the gap is being answered by local regional governments. "As demand remains for these tranches it is expected that regional governments will step in the shoes of the Kingdom of Spain to provide partial coverage on their own as it occurred towards the end of 2002 with Ayt FTGENCAT 1, which was guaranteed by the region of Catalunya," reported analysts at Merrill. The municipality of Catalunya last year approved $540 million equivalent to back these loans.

The mere mention of the SME CLO asset class brings to mind the perils suffered by Spain's continental neighbor, Germany; market analysts have said, however, that the potential negative exposures for German SME CLOs are unlikely to be repeated by their Spanish counterparts. Spanish small business enterprises, or PYMES, typically include smaller businesses that do not depend on any one large customer, and are therefore less exposed to the sufferings of large corporates and tied more closely into the consumer local economy.

"On the other hand, German Mittelstand loan securitizations are often highly concentrated in manufacturing companies, which tend to be much larger than Spanish PYMES and often supply parts to larger companies," analysts said. This tie-in exposes German transactions to a higher correlation to the deterioration of heavy industries like the auto industry, and with the economic forecasts within such sectors weakening, these SME CLOs are likely to be negatively impacted in the future.

For Spain, however, it would take a double blow of sustained consumer economic weakness and a decrease in international tourism to affect the PYMES, said analysts. According to Merrill, the outlook for tourism still remains positive.

"In both jurisdictions, the incidence of default will likely increase over the next two years," said Merrill. "However, the German SME securitizations are likely to continue to see higher headline figures. The greater extent of underlying security present in the FTPYME transactions will result in significant loan recoveries, and cumulative net loss figures will be closer to Spanish residential mortgage transactions."

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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