By Owen Sanderson
LONDON, Oct 11 (IFR) - Deutsche Bank sold off the risk on
more than USD10bn of loans in CLO format at the end of
September, in a decisive shift of the bank's portfolio hedging
away from CDS and towards CLOs.
The German bank bought USD840m and EUR150m of protection,
representing the first 10% of losses on USD8.4bn and EUR1.5bn
books of corporate loans. This is by far the largest risk
transfer CLO since the onset of the financial crisis, with the
next largest deal being Papillon from Barclays, which referenced
EUR6bn of corporate risk. Deutsche's deals are called CRAFT
2013-1 and 2013-2.
Deutsche has a regular programme of CLO issuance to hedge
its loan book through the CRAFT shelf. There were, for example,
four deals from the programme in 2011.
These were previously used largely for hedging less liquid
names, with single name CDS used where these were widely traded.
As a result, CRAFT deals were typically small - CRAFT 2012-1,
for example, was just USD48.82m, though like the new deals, this
has a much larger reference portfolio.
Now, however, the bank's hedging team has decided to rely
much more heavily on CLOs. Deutsche's flow CDS business is
already being restricted by the leverage ratio and other
regulatory concerns, and plenty of single names cannot be
cleared, worsening their regulatory treatment.
Deutsche's investment bank is supported by the hedging team,
known as the Credit Portfolio Strategies Group, which has
responsibility for a range of loan portfolios, and is charged
with "actively managing the risk of these through implementation
of a structured hedging regime", according to the 2012 annual
report. This group was formerly known as the Loan Exposure
Management Group, and now includes responsibility for
counterparty risk management as well as the loan portfolio. It
is not a profit centre for the bank.
The group hedges loan exposures that go beyond bank-wide
credit limits for specific names. If a borrower wants a loan
beyond the bank's limits, Deutsche will still write the
business, but the cost of doing so will have to include the cost
of hedging this risk. The portfolios for CRAFT 2013-1 and 2 are
said to be mainly made up of undrawn high-grade loan exposures.
Deutsche will get some regulatory capital relief from doing
the deals but since the exposures are largely high-grade
corporates, this was not the main aim of the transaction.
This is a sharp contrast with other similar portfolio hedges
or risk transfer deals, which typically reference non-investment
exposures such as trade finance or SME lending and specifically
target regulatory capital relief. Commerzbank, for example,
issues SME deals under the CoSMO shelf and has recently closed
CoTrax II, a trade finance CLO, where it sold the EUR22m
mezzanine tranche of a EUR500m trade finance portfolio.
Deutsche will pay a coupon of three-month Euribor plus 9%
for the euro tranche and three-month Libor plus 9.25% for the US
dollar piece - further confirmation of the different quality of
the portfolio, since risk transfer deals are typically priced in
the teens where they reference non-investment grade obligations.
Banks targeting regulatory capital relief from their deals
also usually retain the "expected loss", the first 0.5%-1% of
losses, since this has to be provisioned for anyway, so the most
efficient capital relief comes from hedging "unexpected losses"
between the expected loss and senior risk.
The dollar tranche has a 6.5-year life and the euro tranche
a seven-year life. The deal was placed with between five and 15
investors, including some new to the CRAFT programme. It is
structured as an MTN from Deutsche's own name shelf, but this is
credit-linked to the underlying pool. The protection is fully
funded with cash.
(Reporting By Owen Sanderson, editing by Matthew Davies)