S ecuritis e This. Jon Tindall

Transcription

1 S ecuritis e This Jon Tindall

2 Outline 1. Background 2. Securitisation Markets 3. Structuring Securitisations 4. Pricing Securitisations 5. Lehman Brothers 6. AXA Motor Securitisation 7. What next?

3 B ackground

4 Market B ackground First securitisations early 1970 s in US mortgage markets» Funding shortfalls in residential mortgage markets.» State backed lenders. Government National Mortgage Association (GNMA) Ginnie Mae (1970), Freddie Mac (1970), Fannie Mae (1981). First Asset Backed Securities (ABS) 1985 Computer loans ILS Markets took first big steps after series of catastrophes in early 1990 s»hurricane Andrew»Northbridge earthquake

5 What is S ecuritis ation? Some common features of securitisations:» The consolidation of cash flows into a single, tradeable asset;» The transfer of risk between parties.» The creation of a Special Purpose Vehicle (SPV) to act between the parties involved in the transaction.» A tax-beneficial structure.

6 Ins urance S ecuritis ation Similar in structure with one major distinction: Cedant generally remains liable to the policyholder Convergence of capital and insurance markets» Financial institutions seeking to diversify risk profiles;» Capacity constraints of traditional insurance markets;» Requirement for an integrated approach to risk and ERM practices.

7 Why S ecuritis e? Range of reasons why an Originator would securitise:» Lower cost of capital» Locking in profits from a block of business» Transferring unwanted risks to wider capital markets Increased hedging opportunities Provides flexibility in new business and M&A activities

8 Alternative risk transfer mechanisms become popular after spikes in RI premiums AR T vs Traditional R eins urance Generally follow shortages in global reinsurance capital Acts to put downwards pressure on RI premiums ROL index Rate On Line (ROL) index Source: Guy Carpenter

9 S ecuritis ation Markets

10 IL S Markets Market peaked in New issuance dropped by nearly 2/3 post GFC 2010 was 2 nd largest new issuance, behind Value (US$m) $16,000 $14,000 $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 New Issues year end number Number of Transactions $ Source: Willis Capital Markets ILS Update - Q

11 High issuance in 2010 covering US risks. Primarily wind coverage, some earthquake Australia no recent transactions. Earthquake bonds, Australis, introduced by Swiss Re in IL S Markets Transaction Size Sponsor Perils Trigger Maturity Johnston Re $305m Munich Re US Wind Indemnity May-13 Lodestone Re $420m National Union Fire US Wind, US Earthquake PCS May-13 Merna Reinsurance $350m State Farm US Earthquake Midwest Indemnity Apr-13 Foundation Re $180m Hartford US Wind PCS Feb-14 Successor $90m Swiss Re US Wind, Japan Earthquake, Europe Wind Hybrid Apr-13 Green Valley $134m Swiss Re Europe Wind Parametric Jan-12 Blue Fin $150m Allianz US Wind, US Earthquake Modelled Loss May-13 Ibis Re $150m Assurant US Wind PCS Apr-13

12 R ecapitilis ation Share of New Capital 100% 90% 80% 70% 60% 50% 40% 30% 20% Cat Bonds Sidecars Start Ups Recapitilisation Alternative forms of capital have become increasingly important in the recapitalisation of insurance markets following natural disasters. 10% 0% Andrew September 11th Katrina et al

13 Investor Mix Specialist CAT and hedge funds now dominate. Less than 10% now retained within the insurance industry. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% Money Managers Hedge Funds CAT Funds Banks Insurers 0%

14 S tructuring S ecuritis ations

15 Originator: The institution providing the securitised assets. B as ic S tructure Trust SPV: The vehicle that issues securities to the capital markets and provides coverage to the originator. Capital Markets: The purchasers of securities offered by the SPV. Originator SPV Capital Markets Trust: Generally set up as a charitable trust. Provides independence of the SPV. Swap Counterparty Swaps: TRS, credit risk, liquidity risk.

16 Cash Flows Financial Clos e Trust SPV offers securities to capital markets. Originator Deposit / Obligation Securitised assets / liability Swap Obligation SPV Setup Costs Swap fee Capital Securities, bonds, equity Capital Markets Proceeds held within the SPV and invested via a mandate. Deposit / Obligation is provided to the Originator by the SPV Swaps are entered into Swap Counterparty

17 Cash Flows Operation Originator pays ongoing premium to SPV. Sometimes collateralised upfront. SPV pays BBSW + margin% in accordance with securities offered. Originator Trust SPV Operating Costs Capital Markets Swap arrangements hedging, liquidity payments. SPV generally pays for operation of the structure. Premium Fixed rate Variable rate Swap Counterparty BBSW + margin%

18 Cash Flows Maturity Trust If not triggered SPV returns the principal to note holders. Originator Trigger payment SPV Principal Capital Markets If trigger event then payment made to Originator based on payment mechanism. Trigger event may or may not cause maturity Break fee Swap Counterparty Swap and liquidity account break fees are paid depending on term to maturity.

19 Trigger Types The trigger defines the payment mechanism for the securitisation transaction. The type of trigger determines where the structure sits on the basisrisk / moral-hazard spectrum.» Matching the payout of the derivative to the incurred losses» Moral hazard can increase at claims approach attachment level Multiple peril triggers are popular especially post GFC

20 Types of common triggers: Trigger Types» Indemnity: Based on the actual losses incurred by the insurer. Contains no basis risk but high moral risk.» Modelled Loss: Combination of indemnity and parametric triggers. Insurers exposure + Loss model maintained by 3 rd party.» Industry Loss: Based on total loss to the industry.» Parametric: Payments based on reference to some index. Eliminates moral risk but contains the largest basis risk.

21 S tructural E nhancements Subordination: SPV issues a variety of securities of varying credit qualities via a series of tranches. Spread accounts: more recent transactions use credit derivatives to achieve this and to transfer the credit exposure to wider capital markets. Collateralised accounts: Feature of most insurance transactions. Percentage (often 100%) of the outstanding liability is collateralised in cash (or equivalent) within the SPV. Over collateralisation: Placing more capital in the SPV than is required to back the liabilities. Liquidity account: Added to provide security around the timely payment of dividends.

22 Tranching of liabilities allows different quality securities to be issued. Tranching Margins can range from +20bps to over +800bps Senior debt generally have largest volumes Equity tranche often purchased by the sponsor Tranche A Tranche B Tranche C SPV Funding AAA+ $250m AA $80m BB+ $40m Preference Shares $10m Debt Equity

23 Pricing and R isk Management Applications

24 Pricing S ecuritis ations Pricing of the offered securities: Coupon % = BBSW % + Spread % The spread can be broken into: Spread % = CreditRisk % + DefautRisk % + ProfitMargin % Credit risk priced via traditional means. Default risk is the risk due to the securitised asset / liability i.e. the catastrophe in a CAT bond. Determined by integrated CAT models.

25 Pricing S ecuritis ations Ultimate Loss: S = N i= 1 X i. e Major drawback is that effective maturity can be very early on. No further upside possible ( rt) Periodic Loss: l t 1, t = L P t 1, t t 1, t Loss of principal in one period doesn t affect subsequent periods

26 Lehman s Impact Market Value $110 $100 $90 $80 $70 $60 $50 $40 $30 Ajax Carillion A-1 New ton Re 2008 Willow Re Lehman Brothers was the counterparty in 4 Total Return Swaps (TRS) for CAT bond at the time of their collapse Returns to note holders could no longer be guaranteed $20 30-Aug 14-Sep 29-Sep 14-Oct 29-Oct 13-Nov

27 QLD Floods Massive uninsured infrastructure losses. Who should pay for these costs? Flood levy? QLD? Australia? Or offload the risk to broader capital markets» Independent MP, Nick Xenophon» Swiss Re call for use of CAT bonds

28 J apan Earthquake Exposures to the earthquake are still being evaluated. Insured losses ~ US$35 billion Total cost ~ US$310 billion A range of CAT bonds involved. Several triggers will be breached Montana Re Topiary Capital Issue Size (US$) Sponsor Trigger Montana Re $250m Flagstone Re Parametric Vega $106m Swiss Re Parametric Atlas Capital VI $50m SCOR Parametric Successor X $120m Swiss Re Parametric Atlas Capital VI $50m SCOR Parametric Topiary Capital $200m Platinum Underwriters Parametric Vega $150m Swiss Re Modelled Loss Valais Re $104m Flagstone Re Indemnity Muteki $300m Munich Re Parametric Midori $260m Munich Re Parametric

29 QLD Floods Massive uninsured infrastructure losses. Who should pay for these costs? Flood levy? QLD? Australia? Or offload the risk to broader capital markets» Independent MP, Nick Xenophon» Swiss Re call for use of CAT bonds

30 AXA Motor S ecuritis ation First Securitisation of a retail GI portfolio 200m of bonds issued in 2006» Approximately 3 million French vehicles.» Around 1 billion in premiums 475m in 2007.

31 AXA Motor S ecuritis ation Class A - AAA 91.5m Probability Equity Class D Class C Class B Class A Class B - A 220.0m Class C BBB m Capital Markets Class D - BB 39.2m 69.0% 72.5% 74.3% 78.9% 89.0% 93.2% Loss ratio Equity AXA

32 AXA Motor S ecuritis ation We don t know what the equity attachment level was in first issue, x% Class C notes rated BBB which is around a one in 200 year event. Raises a few questions:» So how muck risk was actually being transferred?» Would AXA have sought traditional reinsurance coverage this far in the tail?

33 Benefits to AXA include: AXA Motor S ecuritis ation» Attractive pricing (15, 37, 59 bps over EURIBOR)» Elimination of credit risk from the protection» Pricing pressure on traditional reinsurance providers Benefits to investors:» A wide range of securities in terms of risk/return profile.» An asset with very low correlation to other securities

34 Where to from here? Market is bouncing back from post GFC» Structural enhancements» Increased transparency 2010 second largest new issuance for ILS Significant opportunities in Australia given exposure to natural perils» Flood, Earthquake, Cyclone, Terrorism Securitisation of non-cat risks

35 Thankyou J on Tindall jon.tindall@ finity.com.au