A complex credit product that regulators are still trying to get their heads around is proving popular with some big institutional investors in Europe.
The product is a synthetic securitization, in which a bank pays an investor to take on the credit risk of a portfolio while keeping the actual loans on its balance sheet. The Basel Committee on Banking Supervision has warned such deals can hide a bank’s true risk, while Sweden’s regulator has said it’s planning new rules to keep up with the innovation behind the product.
ATP, Denmark’s biggest pension fund with about $113 billion in assets under management, says securitizations are a good way to generate an extra return if investors are willing to devote a lot of time to making sure they understand what they’re getting into.
ATP has done some “big” deals since first venturing into the synthetic market less than three years ago, and plans to do more, according to Kasper Ahrndt Lorenzen, chief investment officer at the fund.
The product “definitely has a better return” than index credit-default swaps and a diversified portfolio of corporate bonds, Lorenzen said. He also says he’d expect it to outperform those asset classes, given its complexity and maturity profile.
“The capital is locked up for a while, and there’s a lot of human capital used,” he said. “We spend a lot of time upfront to look at a deal, and there’s ongoing work in the life of the deal to make sure that we’re happy.”
In Scandinavia, the region’s biggest bank has already used securitizations to reduce its capital requirement. Nordea Bank AB said last year it will pay investors 30 million euros ($34 million) annually to take the credit risk on an 8.4 billion-euro portfolio of corporate loans. Doing so allowed Nordea to shave 30 basis points off its capital requirement.
Politicians are also warming to the products as a way to funnel more funding to small businesses. As part of the European Commission’s Investment Plan for Europe, the European Investment Bank and the European Investment Fund agreed earlier this month to guarantee the risk behind a portfolio of loans made by Spain’s Banco Bilbao Vizcaya Argentaria SA.
Given that these products can offer double-digit returns, it’s an attractive deal for investors hunting for yield in a world shaped by long-term negative rates. In Denmark, where ATP is based, central bank rates have been negative for half a decade.
ATP aims to have 20-25 percent of its credit investments in synthetic securitizations. It now holds around 15-20 percent, according to Lorenzen. He wouldn’t say whether the fund was among investors that bought Nordea’s risk.
“It’s not something that you can do every second week in small sizes,” he said. “These are complicated trades.”
Lorenzen says ATP spends a lot of time scrutinizing potential deals to avoid becoming a dumping ground for banks trying to offload their riskiest assets. He says he only takes on securitizations in which the bank selling the risk is as likely to suffer losses as the investor if the loans in the portfolio sour.
“We are very happy to take very illiquid exposure,” he said. But ‘‘we like to do a vertical slice, so there’s alignment of interests between us and the bank, and there are no asymmetries when it comes to first loss, there are no kinds of dangerous optionalities.”