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 themselves.

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 securitizations.

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 says.

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.

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.