It’s a worrying time to be a big lender. Loan accounting rules will get a dramatic shake-up at the start of next year, ahead of a credit risk capital overhaul, with pessimists expecting the outcome to be a jump in the level and volatility of both loss reserves and prudential buffers.
Crédit Agricole Corporate and Investment Banking decided not to hang around. In a landmark $3 billion synthetic securitisation dubbed Acier, the bank’s credit portfolio management (CPM) team was able to protect its leading project and object finance business from a change in the capital framework – thought to be the first deal of its kind – while also gearing up for a future in which it believes synthetic transfer will be a key tool for managing accounting reserves.
“When we saw the credit risk capital proposals, we realised they would put a lot of pressure on our balance sheet, so, as a CPM team, we started looking for solutions,” says Olivier Jouy, global head of the bank’s asset and liability management and CPM execution group.
In the end, the answer was to sell a tranche of the risk to Mariner Investment Group in February this year – the bank’s fifth synthetic deal in the past three years – successfully transferring exposure on power, oil and gas, infrastructure, aviation, shipping and rail lending in a single deal.
Along the way, the transaction became more innovative. Working with Mariner, a green element was added to Acier – a commitment to use the freed-up capital to back $2 billion of new lending in renewable energy, public transportation and other sectors with a positive environmental impact.
Andrew Hohns, Philadelphia-based managing director with Mariner, says the bank’s track record of successful securitisations – which included a $2 billion trade finance deal in 2014 – has allowed the CPM team to build “a special competence” in this area.
“I think that was the foundation for the ability to do such a pioneering transaction; by far the largest synthetic securitisation of project finance assets ever, the most international, the most diverse in terms of sector – and then there’s also the incorporation of the novel green element,” says Hohns.
Pressure started building in March 2016, with the publication of draft credit risk capital rules by the Basel Committee on Banking Supervision, which barred the use of internal models for specialised lending – project finance, commodities finance, aircraft, shipping and certain real-estate loans. Instead, banks would have to use standardised calculations, or the so-called “slotting” approach – the latter applied to generate a more risk-sensitive ranking of exposures where banks are unable to meet regulatory requirements for the modelling of default probabilities.
When we saw the credit risk capital proposals, we realised they would put a lot of pressure on our balance sheet, so, as a CPM team, we started looking for solutionsOlivier Jouy, Crédit Agricole CIB
As one of the world’s biggest project and object finance lenders, Crédit Agricole CIB had more to lose than most. Under current rules, the Acier deal will cut more than $1 billion in risk-weighted assets for the bank – but the RWA total for the same portfolio would jump as much as threefold under standardised calculations, says Jouy.
The CPM team had not worked with Mariner before, but knew the firm had appetite for project and infrastructure investing. Conversations between the two parties began in early 2016, and concluded roughly a year later, with Mariner taking a “low mezzanine” slice of the credit risk on the portfolio via a guarantee. Crédit Agricole CIB declines to specify the attachment and detachment points, but retains a “thin” equity slice as well as the senior exposure.
The synthetic approach worked for the bank as it meant the assets could remain on balance sheet – preserving important client relationships. But it also complicated the management of the transaction. The bank had to track all assets that were part of the deal so it could provide regulatory reports on the proportion of its assets that are pledged, securitised or encumbered in some way, and to ensure they were not included in any future deal, or inadvertently double-hedged via credit default swaps.
This is where the bank’s experience came in. Crédit Agricole CIB uses an in-house tool called LoanTracker to monitor and manage each loan facility and each individual draw under that facility – a database that has been adapted so it also supports the bank’s risk transfer deals.
“If you’re distributing risk via synthetic securitisation, then you need to take into account the asset allocation rules to ensure there is no overlap in term of credit hedges, that the bank complies with its retention or confidentiality obligations, and more generally to validate proper usage of banking book assets. That’s why CPM carefully tracks the securitised assets and compliance with the rules – it’s ongoing, and quite burdensome,” says Pascale Olivié, head of structuring and asset allocation for asset and liability management (ALM) and CPM.
Each of the 200 facilities in Acier might have up to 50 separate draws, she says, with as many as 100 individual datapoints recorded for every draw.
A selection of the loan and risk information was shared with Mariner – but not the identities of the obligors. This required both sides to do some work, and resulted in a series of site visits as Mariner sought to understand not just what it was buying, but also how the bank thinks about its structured finance business.
We are convinced synthetic securitisation has an important role to play in maintaining – or even increasing – the rotation capacity of the loan portfolioOlivier Jouy, Crédit Agricole CIB
“Typically, as we have these discussions on a loan-by-loan basis, not only do we learn things about certain loans that lead us to either take them in or kick them out – we also develop a shared understanding of the bank’s origination strategy, while they develop an understanding of our objectives. In every deal we’ve completed, this has resulted in an enlarging of the prospective perimeter of the reference portfolio,” says Mariner’s Hohns.
This kind of experience will become more valuable to the bank following the arrival of the new accounting rules, Jouy believes. Under International Financial Reporting Standard 9, banks face tougher restrictions if they want to sell loans.
There are two ways to do it: if the business model involves frequent and significant loan sales, then the loans have to be classified as ‘hold-to-collect-and-sell’, but would then have to be carried at fair value, which is very challenging for the chunky, illiquid assets found in specialised lending. The alternative is the ‘hold-to-collect’ (HTC) business model, which means the loans can be accounted for at amortised cost, but any sales from these portfolios can only be infrequent and insignificant in value – terms that are not defined clearly.
Crédit Agricole CIB expects its use of synthetic transfer to increase as a result.
“Based on feedback from our auditors, we think the threshold amount that could be sold under an HTC model is only about 3–5% per year,” says Jouy.
Now, 75% of the portfolio references names with a rating equal to or below triple-B, and we have something like 30% referencing non-investment-grade namesFrancois-Edouard Hetier, Crédit Agricole CIB
Adding a green element to the deal was first suggested by Mariner, but the fund isn’t looking for the credit: “It’s not as though the idea was a lightning bolt, it’s more the case that the DNA of the two institutions progressively matched such that this idea was the natural result,” says Mariner’s Hohns.
One criticism of the structure is that it’s impossible to know whether Crédit Agricole CIB is making more green loans than it would otherwise have done – the $2 billion commitment isn’t backed by a separate, ring-fenced pot of capital – but in March this year, the bank also changed its internal pricing for green loans, giving such credits a lower liquidity cost, says Michel Robert, global head of ALM and CPM with the bank in Paris.
“All the financial management of the bank is done in one place, so this green focus is being supported by ALM through a bonus on the price of the scarce resources we allocate to a product line or coverage officer: basically, liquidity is cheaper for a green loan. And then, in parallel, on the CPM side, we are also trying to encourage this approach by having a transaction with a green component,” says Robert.
Mariner’s Hohns adds: “If we had not included this green feature then the bank could have used all the liberated capital to make more loans to buy gas turbines – but now they’ve agreed they’re going to devote it to green lending. The bank already had a strong bid for green lending, and this gives their frontline bankers even more firepower to address the demand there.”
The bank’s use of synthetic securitisation to manage capital has allowed it to start thinking about its CDS portfolio in a different way – over the past two years, Crédit Agricole CIB has been applying hedges to manage real credit risk, rather than to obtain RWA relief. The result has been a halving in the size of the book and a big shift in its focus.
“Now, 75% of the portfolio references names with a rating equal to or below triple-B, and we have something like 30% referencing non-investment-grade names. It’s a portfolio that is much more focused on the real credit risk in the banking book,” says Francois-Edouard Hetier, head of ALM and CPM liquidity and credit execution.
The focus on risk management – and particularly concentration risk – is also helping the bank win business. On two occasions this year, CDS hedges have been planned in advance as a way of increasing the bank’s capacity to take on jumbo deals.
Here, Hetier says exploring the hedge in advance has allowed the bank to expand its appetite by up to 20% for jumbo transactions, or new transactions on main exposures.
“Bit by bit, we are making these tools available to coverage officers, and it’s changing the way we behave,” he says.
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