PGGM has taken its credit-risk-sharing strategy a step further by forging a partnership with Sweden’s Alecta
- PGGM has run a credit risk sharing mandate since 2006
- Current mandate exposure is €5bn
- PGGM will partner with Sweden’s Alecta in new transactions with an envisaged 70/30 split
For a pension fund, the ability to deploy its own balance sheet prudently to obtain exposure to alternative forms of credit yield makes sense. It is certainly more appealing than the extremes of ultra-low and negative government bond yields, on the one hand, and costly specialist, if lucrative, credit hedge fund strategies on the other.
PGGM first started its credit-risk-sharing mandate in 2006 and invests on behalf of its pension fund client PFZW. The mandate takes first and second-loss positions in mezzanine or junior tranches of selected loan portfolios in return for an agreed fee from the originating bank.
The transactions involve ‘synthetic’ securitisation – rather than true-sale, where the exposure completely leaves the originator’s balance sheet – but on a ‘balance-sheet’ basis with the originating bank retaining an agreed exposure to the credit loss to ensure ‘skin in the game’. For PGGM, each originator must retain at least 20% of unhedged loss exposure on its own balance sheet’. Synthetic ‘arbitrage’ securitisation, as with the complex type of pre-2008 CDO structure, has disappeared from the market.
Under a synthetic balance sheet structure, the originator can free up its own capacity for further lending. The transactions, which for PGGM must be fully collateralised, are either structured as credit-linked notes or as credit derivatives, such as credit default swaps.
PGGM’s credit and insurance-linked investment department runs the credit-risk-sharing mandate and has built up diversified exposure over the years, involving different currencies, counterparties and types of lending. Credit Suisse, MUFG, Standard Chartered, BNP Paribas, Barclays and Santander are or have all been counterparties, with exposure variously to Swiss property and SMEs, loans to Asian and US companies, global trade finance, and green loans in Spain and Portugal.
According to Mascha Canio, head of credit and insurance-linked investment at PGGM, the strategy is slightly below target, with exposure of about €5bn at current valuations, an average ticket size presently of about €275bn and a typical four-year term. For PFZW, this equates to an allocation of 2.3% of the total portfolio, according to the pension scheme’s 2020 first-quarter results. The portfolio is valued using an externally-validated fair-market-value model, using actual market indicators such as CDS spreads.
The initial mandate targeted equity-like returns at lower risk; since inception returns have exceeded 10% on an annual basis. PFZW reported 2019 net performance of 8.5% for the strategy and 12.2% in 2018, with the credit risk strategy cited as one of the main drivers of performance that year. By contrast, net performance in 2017 was -4.5% and -2.5% in the first quarter of this year.
Canio says: “We’ve been growing the portfolio over the years, consistently maintaining the long-term risk-sharing partnerships that we have with the banks and occasionally adding a new risk-sharing bank to the portfolio, which we will continue to do.”
In May, PGGM and Sweden’s Alecta, the SEK893bn (€85bn) second-pillar pension fund, agreed a partnership whereby they will co-invest in future deals.
Tony Persson, head of fixed income and strategy at Alecta, says he was introduced to first-loss tranche credit deals many years ago but shied away from the market because they are resource-intensive to close and manage. He sees clear advantages of this form of co-investment over complex and more costly hedge fund or private equity-type structures.
All of Alecta’s first-loss securitisation activity will go through the partnership, with PFZW envisaged to take 70% of each transaction and Alecta 30%. Internal and direct costs will be shared between the two parties. Alecta will make its own decision whether or not to invest in each transaction and will take part in the due diligence analysis conducted by Canio’s team at PGGM.
Persson says the input and experience of PGGM is crucial: “If I hadn’t been able to work with the team at PGGM I wouldn’t have the resources to make these transactions. So to have these specialist resources available for our decision making is key.
“We will sit in the same position as PFZW, the client of PGGM. We will receive a proposal to make a transaction, and then we will make our own decision to participate or not.”
But the relationship will not be entirely one-sided. Canio explains: “There are relationships or exposures where I think Alecta can certainly contribute their view and experience. On the Alecta side, there are people with some really interesting and long standing experience.”
Canio says she is “not pessimistic” about the strategy in light of coronavirus, either in terms of the current book of closed transactions or the future potential pipeline. She says: “We’re very confident with our existing portfolio. Yes, there will be more losses. But we can cope with such losses, we feel, and still deliver a very decent return.” Regulators have also helped by increasing first-loss tranches, providing a bigger buffer to cushion losses.
Canio also sees potential amid the coronavirus crisis: “I do believe there are opportunities to do transactions. With that belief, we’re actually extremely busy seeing if we’re right, working on transactions with banks to see if we can come to an agreement that works for both parties.”
The EU has focused on securitisation as a means to boost lending as part of its flagship Capital Markets Union programme. In a May 2020 report, the European Banking Authority (EBA) recommended setting up a cross-sector framework purely for ‘simple, transparent and secure’ (STS) synthetic securitisations, limited to balance-sheet securitisations. This follows the publication of final STS guidelines for ‘traditional’ true-sale securitisation in 2018.
The new proposed rules follow the same principles as the 2018 guidelines but the EBA also recommends more favourable capital treatment for STS balance sheet synthetic securitisation, which would be likely to boost the overall market.
Partnerships like that of PGGM and Alecta could be an attractive mode of entry for some investors willing to work together. For Europe’s economy the prospect of boosting lending capacity, particularly in light of COVID-19, is a welcome prospect.
Credit: Investment grade credit markets in a pandemic
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