USD10bn trade boosts Deutsche Bank's CLO hedging

10/11/2013

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.

HEDGING REGIME

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)



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