SG plans to securitise €1.9 billion of derivatives exposure

Société Générale (SG) is in the final stages of a rare securitisation of derivatives counterparty risk – known as credit valuation adjustment (CVA) – which would see the French bank buying protection on the first 5% of losses generated by a portfolio of around €1.9 billion in exposure, according to a number of credit investors that have seen the deal. None of those investors opted to buy the eight-year bonds, and two are critical of the terms of the transaction, which is said to see the bank paying around 11% over the Euribor rate.

Investors argue the coupon paid for first-loss exposure should be higher. "We didn't want to proceed with the deal because we thought it was too tight, too expensive. For an equity tranche you have to assume you will experience losses, and when you are capping your internal rate of return at 11%, that seems too skinny to me. The going rate for these deals should be around the low to mid-teens," says one structured credit investor.

One French source says similar returns to the SG deal could be earned with less risk – for example, by selling tranche protection on Markit's iTraxx Europe index of credit default swaps (CDSs), with attachment points of 3–6%, meaning the investor would be exposed to losses on the index between those points.

"It's really a very risky deal. Why would you take the 0–5% exposure for 11% with a bunch of really weak names, when you could do 3–6% on the iTraxx and earn much the same – it's a very, very clean index, all investment-grade names, and has seen one default since its inception, and that at 77% recoveries," he says.

The counterparties on which SG is buying protection are understood to include Air France – said to be the biggest component of the exposure, at 2% – cable operator Liberty Global, Italian carmaker Fiat, Danish wind power company Vestas Wind Systems, and Italian power company Sorgenia Power. According to Markit, five-year CDSs on Air France currently trade with a spread of 588 basis points, while those of Fiat have a 577bp spread.

For an equity tranche you have to assume you will experience losses, and when you are capping your internal rate of return at 11%, that seems too skinny to me

SG declined to comment, citing client confidentiality.

Large derivatives dealers are looking to CVA securitisations as a way to reduce capital requirements associated with counterparty exposure – primarily the new CVA charge contained in Basel III, which dramatically hikes the amount of capital banks need to hold against uncollateralised derivatives positions.

The capital relief that can be achieved by selling the equity tranche of a CVA securitisation is estimated to be in the region of 80–90%. And at least three investors that have seen the SG deal believe the bank is likely to be getting roughly one-to-one capital relief by selling the first loss – that should mean a saving of a little less than €100 million.

Despite the capital incentive, CVA securitisation deals in recent years have been few and far between, primarily because of their complexity and the difficulty in getting regulatory approval. Both UBS and Royal Bank of Scotland (RBS) are understood to have completed securitisations of derivatives counterparty credit risk since the collapse of Lehman Brothers in September 2008. Credit Suisse also transferred CVA exposure to 6,000 of the bank's senior employees as part of a deal known as the Partner Asset Facility 2, unveiled at the start of 2012.

But the idea of securitising derivatives counterparty credit risk is not new. The first deal, Alpine Partners, was issued in 2000 and referenced a $750 million portfolio of counterparty exposures in the interest rate swap trading book of UBS. The Swiss bank followed up with a second Alpine Partners transaction in 2003, a managed deal that drew on a $1.5 billion reference pool of 4,000 derivatives contracts with around 80 counterparties from the bank's interest rate, foreign exchange, equity and energy derivatives trading books.

Other deals have been launched by ABN Amro and Deutsche Bank. ABN Amro structured a €5 billion managed synthetic securitisation called Amstel with a reference pool that encompassed around 1,500 names, while Deutsche issued a €2.8 billion transaction called Eirles Four. Both were launched before the crisis.