Another month, another three CLO-style deals backed by exposure to the German Mittelstand of small and medium-size companies. These have traditionally relied on lending from their house banks and have shied away from the equity markets to avoid ownership dilution and financial disclosure. But SME CLOs are seen as a solution for these borrowers, which might now face problems sourcing traditional loans from relationship lenders post-Basle II, when such lending will be 100% risk weighted.
The CLOs are primarily backed by hybrid capital or mezzanine private equity-like funding (Genussscheine). It is cheaper and more flexible than equity financing and can be treated as equity under German GAAP. It is also cheaper than traditional mezzanine borrowing – offering an overall cost of funds of 7% to 10% compared with 10% to 15% for traditional lending. Like the Trups and middle-market CDOs in the US, they tend to have low obligor counts ranging from the low 30s to the high 60s.
It is not surprising that Mittelstand companies have found these products attractive. But the flexibility they offer should be closely monitored by anyone buying into them. The hybrid “debtquity” loans typically have no financial covenants and there is little information on how much additional leverage these companies are taking on.
