Banks unload risk into blind pools
In recent weeks about 2,500 companies that borrowed more than €11bn from the German bank Nord/LB have had the main risk of their loans transferred to a hedge fund based on New York’s Fifth Avenue.
None of these companies, which include small and medium-sized German enterprises, airlines, renewable energy providers and commercial property owners, know this has happened. Neither do the staff directly overseeing the loans, which make up more than a tenth of Nord/LB’s total loan book.
The only people fully in the loop are the top executives at Nord/LB and its regulator BaFin. Even Christofferson Robb, the US hedge fund, does not know which companies it is exposed to. “This is a blind pool transaction – European privacy law prevents us from seeing the identity of customers,” said Richard Robb, co-founder of Christofferson Robb.
The transaction illustrates how banks are responding to pressure from regulators to strengthen their balance sheets by shifting their risk into the so-called “shadow banking” sector, which includes hedge funds, private equity groups and insurers.
After paying a hedge fund to take a big chunk of the losses should the 5,000 loans start to default, Nord/LB has been able to persuade regulators that it should hold less capital against them even though, as far as the companies are concerned, they still owe money to the bank.
Nord/LB has kept exposure to the first €80m of losses on the 5,000 loans. Christofferson Robb will cover the next €450m of losses, before the state-owned bank is back on the hook.
The 10-year arrangement cut about €4bn off Nord/LB’s €68bn risk-weighted assets at the end of December and freed about €350m-€400m of equity.
“This is more attractive for us than raising equity in terms of cost per equity relief,” said Michael Schwabla, head of structured solutions and products at Nord/LB.
However, such deals are controversial among regulators because they have historically involved special purpose vehicles and credit default swaps – structures that played a big role in the 2008 financial crisis. The US Federal Reserve and the Basel Committee on Banking Supervision both attempted to clamp down on this type of activity last year.
Regulators worry that banks may transfer risk to entities that cannot absorb the losses in case of another crisis. They also suspect that, in some cases, the risk is never truly transferred because the bank pays such high fees that it covers the cost of any potential loss.
Analysts say the UK regulator has tightened the rules for such trades after Barclays moved $12bn of toxic assets off its balance sheet in 2009 to a vehicle called Protium, which was run by its former employees and funded with loans from the bank.
Mr Robb dismissed regulators’ concerns, saying his hedge fund had put collateral equal to the potential losses into an escrow account at Nord/LB.
Since the financial crisis there have been about €30bn of such regulatory capital trades on portfolios of loans worth hundreds of billions of euros, mostly done by European banks, according to Mr Robb.
“We’ve been doing this since 2007, before it was cool,” he said. “Now it is cool. Soon it won’t be cool. But we’ll keep doing it.”
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