In Search for Yield, Asset Owners Take on Bank Risks

For years, institutional investors have allocated to hedge
funds that profited from a complex European bank trade tied to
post-financial crisis regulation. Now, some large investors are
bypassing the middle man and making those trades

Pensions, endowments and other institutions are increasingly
dealing directly with banks to invest in customized regulatory
capital relief trades. The trades took off as a result of
increased regulations in Europe, including hefty charges for
holding complex securities, such as syndicated loans, on their
balance sheets. Banks have been shifting some of these risks to
outside investors to meet the European Commission’s
stricter capital requirements while also continuing to lend to
corporations. Barclays and other European banks are among the
most active participants in these trades.

Big institutions get fatter returns by dealing directly with
banks, rather than investing through a hedge fund or private
equity fund. Not only do they get the returns on the security
itself, but they don’t pay management and incentive fees
to third-party managers, which effectively decrease the yield
on the fund.

PGGM, a pension service provider in the
Netherlands that manages €181 billion ($203 billion) for a
number of Dutch pension funds — including PFZW, the
€161 billion pension plan for healthcare, nursing home and
other workers — is a big investor in what it likes to call
risk-sharing transactions. The PGGM structured credit team has
invested close to €6 billion in risk-sharing transactions
and now manages 22 transactions.

Mascha Canio, head of structured credit at PGGM, has been
investing in risk-sharing transactions for ten years, long
before increased regulation made it even more attractive for
banks to engage in the deals, and has seen significant growth
in the market — as well as in the complexity of
transactions. PGGM initially targeted these types of
investments because they offered access to products that
couldn’t be found in public markets. PGGM is now investing
up to 2.5 percent of PFZW’s portfolio, the second-largest
pension fund in the Netherlands, in balance sheet

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Canio explains that in a synthetic securitization, a bank
buys credit protection on a portfolio of loans from an
investor. When a loan in the portfolio defaults, the investor
reimburses the bank for the loss up to a maximum, which is the
amount invested. The transaction is synthetic because the loans
remain on the bank’s balance sheet. The bank is able to
reduce credit risk on the securitized loans while continuing to
manage the loans and the relationship with its client.

Canio emphasizes that the risk-sharing transactions help the
banking sector manage its credit risk and thus reduce overall
systemic risks as well. That fits with PGGM’s responsible
investment philosophy, she adds.

“We keep the transactions simple and try to avoid using
additional structural features that are not essential. We
don’t want to make it more complicated,” she

Canio adds that PGGM wants to work with only the top banks
and wants them to also share in the risk. “These risk
sharing transactions are truly about sharing,” she says.
“The bank is transferring a substantial amount of credit
risk, and we want them to keep at least 20 percent on their
balance sheet. We don’t like banks to solely originate to
distribute. Banks should originate credit risk that they are
happy to keep a good part of as well.”

According to a report from Deutsche Bank published in the
first quarter of 2017, synthetic deals have surged, reaching an
issuance volume of €94 billion in 2016. “Long-term
institutional investors are major buyers,” wrote the
report’s authors.

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The Deutsche Bank report says these types of transactions
serve as a way to re-start lending, as most of these complex
trades are made up of loans. Although the transactions are
complicated and involve transferring risk outside the bank,
regulators think they benefit the economy.

“Consequently, the European Commission has named
restarting high-quality securitisation as one of the main
objectives of its Capital Markets Union project,” wrote
the authors of the report. The Basel Committee on Banking
Supervision and the International Organisation of Securities
Commissions are jointly leading the project.

Institutions that go direct need to be large. On average,
pensions invest about $200 to $300 million in transactions from
Barclays, which provides reporting and customizes trades around
features like loan quality.