European Structured Credit: SME CLOs Remain Resilient Despite Challenges to SMEs

DBRS Morningstar published a commentary providing an update on the recent developments in the European Small and Medium-Size Enterprises (SMEs) sector and the performance of SME collateralised loan obligation transactions (SME CLOs) rated by DRBS Morningstar across different European countries.

-- The Russia´s invasion of Ukraine in February 2022, the stark rise in inflation fuelled by higher energy prices, and the tightening of monetary policy by central banks have raised uncertainty in financial markets and increased stress on SMEs.

-- The changes in central bank monetary policies and interest rates have made access to affordable debt financing a prime concern for SMEs. SMEs are less able to withstand price fluctuations and to pass on increased production and/or capital cost, and this is weighing on profit margins and competitiveness.

-- New regulations for the EU-wide sustainability agenda could also adversely affect SME finance and operations. SMEs may experience secondary effects of legislative actions in their role as suppliers to larger firms which requires investments in green technology and exacerbates the difficulties in access to finance.

-- While loan default levels had been subdued during the pandemic because of government support measures, their gradual phase-out and the normalisation of business activity have elicited the predicted catch-up effect and bankruptcy levels have started to rise across EU member states.

-- Despite a worsening economic outlook and the deteriorating performance of the asset class in the short and medium term, SME CLOs rated and monitored by DBRS Morningstar have remained resilient.

“Overall, persisting geopolitical uncertainties, market dislocations, and a dramatically changed interest rate environment require SMEs to continue to navigate a very uncertain economic environment”, said Stephan Rompf, Vice President of European Structured Credit. “But SME CLOs typically are well diversified and exhibit low levels of borrower- or industry concentration. They also tend to deleverage quickly, which is beneficial to the build-up of additional credit enhancement. Overall, we currently see limited risk to the rated notes because of high diversification and ample cushions of credit enhancement to absorb losses”.