The new asset class of choice to back balance sheet collateralized debt obligations in Europe is debt owed by small- and medium-sized enterprises, according to panelists. Linda Lysell, senior associate in Barclays Capital's CDO group in London, says the trend is occurring as banks are selling balance sheet CDOs primarily for regulatory capital relief and to reduce the risk on their balance sheet. "SME loans offer excellent portfolio diversity and low idiosyncratic risk" to investors, says Lysell, who adds that the credits are all high-quality and "so far, there have been no downgrades." She says debt from SMEs is more attractive than unsecured debt from larger corporates for collateral because it is more granular and has not suffered the same rate of downgrades that corporates have.
The collateral is popular with investors, too. "We like CDOs of SMEs because they are easy to understand and offers us diversification," says Serge Crevecoeur, credit portfolio manager at ING Bank in Brussels, which also serves as a collateral manager.
Lambda 2003-1, a deal underwritten by Barclays in December, was the first such transaction to be done in the U.K. and was collateralized by cash flows from debt owed in more than 20,000 transactions by small- and medium-sized U.K. companies. Other busy areas include Germany and Spain, where a partial government guarantee on SME debt provides an additional layer of protection for CDO investors. The SMEs in Italy have not yet been securitized but the government is preparing legislation to make it possible.
"More and more traditional CLO buyers are getting into SME-backed CDOs, because they need the diversification," says Lysell. In the past, the investor base was mostly ABS investors and others familiar with structured transactions.
Triple-A SMEs tend to trade about 50 basis points behind similar ABS, for liquidity reasons, by Lysell notes that SME portfolios are very granular and actually offer less risk than some asset-backeds.