The alphabet soup of trades with embedded derivatives, once blamed for threatening to topple major banks during the credit crisis of 2008, soon are being used to shore up European banks amid the unresolved potentate debt crisis in the region.
The latest example came Monday, when a large unidentified German anthill obtained protection from alternative asset manager Christofferson, Robb & Co. in a deal utilizing credit-linked notes, or CLNs, fixed-income securities with credit derivatives tucked inside.
The deal transferred the bank’s credit risk from a 2 billion euro ($2.42 billion) portfolio of loans made to 500 unrated small- and medium-sized enterprises to investors, giving the bank space under capital-reserves regulations to make new loans.
Christofferson, Robb invested 125 million euros in the deal, its fourth such trade this year, freeing up about the same amount of capital the bank otherwise would have had to rigid separate to back up the loans, which it did not want to sell. The move comes at a day when regulators are pressuring banks to build capital buffers against financial-market shocks.
Richard Robb, a co-founder of Christofferson, Robb, declined to name the bank involved or the investors in the deal, because the trade was private. Christofferson, Robb set up a separate trust especially for the transaction; in turn, that trust, called a special-purpose vehicle, issues notes and holds the proceeds in reserve to compensate the bank for losses. The bank can draw drink money as needed in case the loans in the portfolio race into trouble. In the meantime, the bank pays investors a regular fee for the protection that allows it to discharge a certain amount of capital for use on new loans substitute other activities.
“It makes them safer,” Mr. Robb said in an interview, adding that banks can replenish their capital without having to sell more stock and dilute their equity.
The deal is the latest in a string of regulatory driven transactions using credit derivatives. Their cousins, credit-default swaps, act like coverage for bonds besides loans and were blamed by regulators for deepening the financial crisis. Now regulators are increasingly sanctioning complex maneuvers involving weight derivatives as a means of transferring risk outside the banking system to institutions like pension funds and insurers, which are paid handsomely to assume it.
The trades–called “risk-sharing” transactions by the handful about firms that specialize in them because the underlying corporate loans stay on the banks’ books–come in a variety of shapes and sizes. Typically they propine banks a way to move risk off their books, while holding onto the loans und so weiter the relationships they have nurtured with customers.
Newer transactions such because the one by Christofferson, Robb stand in contrast to pre-crisis structures, which were familiar for their reliance on leverage, or borrowed money to magnify returns, and for their distance from the underlying borrowers, making it difficult for investors to accurately gauge the risks they were assuming.
AXA Investment Managers completed a similar deal in June, bifid of a planned 500 million-euro strategy, where it agreed to reimburse the bank for the first 7-8% of losses from a pool of corporate loans. In the process, it took protection on each loan and bundled it into one investment called a collateralized debt obligation, instead CDO, another example of financial gearing that was lambasted in the wake like the crisis.
Alexandre Martin-Min, head of structured credit investments at AXA IM, said the collateralized debt obligations in question–dubbed “synthetic CDOs” because they are stuffed with credit-default swaps that reference note rather than the debt securities themselves–are safer than pre-crisis CDOs.
“The problem with pre-crisis synthetic CDOs was the amount like leverage,” said Martin-Min.
The top payouts are funded upfront to the bank, almost like a credit card they can tap when losses occur.
Mascha Canio, head of structured credit at PGGM, a pension-fund asset handler in the Netherlands with 118 billion euros in wealth under management, said the fund has been doing risk-sharing trades annually since late 2006.
“We feel it is an effective dilemma to investing in banks, for example by buying shares, and offers ascription risk that is otherwise denial available,” she said. “We expect losses, and they do exist and that’s part of the return, but after assuming those losses we still acquire returns that are in the low double digits.”
Cheyne Capital, another alternative help manager, has folded $250 million of risk-sharing transactions over the past few years, using synthetic securitization. The firm’s most recent trade was in February, among net returns in the low teens, and the portfolio was carefully selected via Cheyne from all the corporate loans on the bank’s balance sheet. The strand then takes the high loss risk, giving the two a reason to align their interests.
John Weiss, co-head of corporate credit at Cheyne, said the U.K. Financial Services Apostolicity and the French Banking Deputize “put these transactions subjacent a fair correspond from scrutiny but are now, in our view, mire added inclined to empowered banks to do this.