IFR-Risk transfer funds gain momentum

By William Thornhill

LONDON, Oct 25 (IFR) – The host of new regulations, which
will make it much more expensive for banks to hold
risk-weighted assets on their balance sheets, has given added
impetus to the funds and investors that are hoping to use risk
transfer mechanisms to buy into those assets.

“After years of holding these loans, they [the banks] now
realise that some are distressed and are beginning to write
some of them down, resulting in increased capital charges and
thus creating an incentive to sell,” said one market specialist
last week.

In addition to bilateral trades between banks on one hand
and pension funds and asset managers on the other, a number of
intermediaries have sprung up offering risk valuation and
transfer solutions.

Christofferson, Robb & Co has been successfully operating
in this space for years, but other names have joined the fray
more recently. Axa already operates a fund dedicated to the
area, while Cheyne and Aladdin Capital are also putting similar
funds together.

A year ago Channel Capital Advisors was on the road trying
to raise seed capital, but struggled to find investors willing
to face long lock-up periods and potential liquidity traps.
More recently, Prytania Investment Advisors has said it is
poised to secure 50 million euros of seed capital for such a
fund.

The idea behind all these funds is simple, but the
execution is far from straightforward. Third-party, non-bank
intermediaries are invited to value a bank or insurer’s
portfolio with a view to potentially transferring some of the
risk. Such entities are in a strong position to be viewed as
independent and impartial arbiters of value, in contrast to the
often conflicting interests of other competing investment banks
which vie for the same business.

Under the Advanced IRB approach, banks that fail to
adequately value their assets could find that their local
regulator slaps a 1,250 percent risk-weighting on the affected
assets. It is therefore possible that an accurate valuation
alone might reduce their capital consumption.

But valuation services often also extend to actual sales,
in which risk is synthetically swapped. The target assets for
sale are typically high risk-weighted equity to junior
mezzanine portions of a given portfolio, as they attract the
most capital. The fund aims to construct as diverse a portfolio
as possible in the hope of reducing correlation and overall
risk.

In much the same way as for the construction of ABS-CDOs,
the next task is to make the arbitrage between assets and
liabilities economically viable. Prytania hopes to offer an IRR
of 13 percent, which could mean it would need to earn a gross
margin in the high teens, once defaults and fees are
subtracted.

But given that spreads have already tightened a lot, “it’s
not obvious a bank would be willing to pay these fees, in
particular for investment-grade credits,” said Olivier Renault,
head of structuring and advisory at StormHarbour Securities.

That may be true for some banks, but possibly not all.
Smaller banks typically follow the Standardised IRB approach,
but would benefit from a switch to Advanced IRB, which is more
finely tuned to risk and generally results in a lower capital
charge.

That would give banks the incentive to switch, but most
lack the necessary expertise to internally rate their assets.
It is here that Prytania sees the opportunity.

“For smaller institutions that may not have the expertise
to switch to Advanced IRB, we could provide the whole
solution,” said Mark Hale, chief investment officer at
Prytania. This would mean not just valuing the assets, but
potentially buying into them as well.

(Reporting by William Thornhill)

IFR-Risk transfer funds gain momentum