S ecuritis e This Jon Tindall
Outline 1. Background 2. Securitisation Markets 3. Structuring Securitisations 4. Pricing Securitisations 5. Lehman Brothers 6. AXA Motor Securitisation 7. What next?
B ackground
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
What is S ecuritis ation? • Some common features of securitisations: » The consolidation of cash flows into a single, trade- able 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.
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.
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
AR T vs Traditional R eins urance Rate On Line (ROL) • Alternative risk transfer 450 index mechanisms become popular 400 after spikes in RI premiums 350 300 • Generally follow shortages in ROL index 250 global reinsurance capital 200 • Acts to put downwards 150 pressure on RI premiums 100 50 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: Guy Carpenter
S ecuritis ation Markets
ILS Markets • Market peaked $16,000 30 in 2007. $14,000 25 • New issuance New Issues $12,000 Outstanding @ year end dropped by nearly number 20 Number of Transactions $10,000 Value (US$m) 2/3 post GFC $8,000 15 • 2010 was 2 nd $6,000 10 largest new $4,000 issuance, behind 5 2007. $2,000 $0 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Willis Capital Markets ILS Update - Q4 2010
ILS Markets • High issuance in 2010 covering US risks. Transaction Size Sponsor Perils Trigger Maturity • Primarily wind coverage, Johnston Re $305m Munich Re US Wind Indemnity May-13 Lodestone Re $420m National Union Fire US Wind, US Earthquake PCS May-13 some earthquake Merna Reinsurance $350m State Farm US Earthquake Midwest Indemnity Apr-13 Foundation Re $180m Hartford US Wind PCS Feb-14 • Australia – no recent US Wind, Japan Earthquake, Europe Successor $90m Swiss Re Wind Hybrid Apr-13 transactions. Green Valley $134m Swiss Re Europe Wind Parametric Jan-12 – Earthquake bonds, Blue Fin $150m Allianz US Wind, US Earthquake Modelled Loss May-13 Australis , introduced by Ibis Re $150m Assurant US Wind PCS Apr-13 Swiss Re in 2006.
R ecapitilis ation Alternative forms 100% of capital have 90% become 80% increasingly 70% Share of New Capital important in the 60% Cat Bonds recapitalisation of Sidecars 50% Start Ups insurance markets Recapitilisation 40% following natural 30% disasters. 20% 10% 0% Andrew September 11th Katrina et al
Inves tor Mix • Specialist CAT and 100% hedge funds now 90% dominate. 80% Money Managers 70% Hedge Funds 60% CAT Funds Banks • Less than 10% now 50% Insurers retained within the 40% insurance industry. 30% 20% 10% 0% 1999 2009
S tructuring S ecuritis ations
B as ic S tructure Originator : The institution providing Trust the securitised assets. SPV: The vehicle that issues securities to the capital markets and provides coverage to the originator. Capital Originator SPV Markets Capital Markets: The purchasers of securities offered by the SPV. Trust: Generally set up as a charitable trust. Provides Swap Counterparty independence of the SPV. Swaps: TRS, credit risk, liquidity risk.
Cas h Flows – Financial Clos e • SPV offers securities to capital Trust markets. • Proceeds held within the SPV Setup Costs Deposit / and invested via a mandate. Obligation Capital Capital Originator Markets • Deposit / Obligation is provided SPV to the Originator by the SPV Securities, Securitised bonds, equity assets / • Swaps are entered into liability Swap Swap Obligation fee Swap Counterparty
Cas h Flows – Operation • Originator pays ongoing premium Trust to SPV. Sometimes collateralised upfront. Operating Costs • SPV pays BBSW + margin% in Capital accordance with securities offered. Originator Markets SPV • Swap arrangements – hedging, BBSW + Premium margin% liquidity payments. Fixed Variable rate rate • SPV generally pays for operation of the structure. Swap Counterparty
Cas h Flows – Maturity • If not triggered – SPV returns the Trust principal to note holders. • If trigger event then payment made Trigger to Originator based on payment payment Capital mechanism. Originator Markets SPV • Trigger event may or may not cause Principal maturity Break • Swap and liquidity account break fee fees are paid depending on term to Swap maturity. Counterparty
Trigger Types • The trigger defines the payment mechanism for the securitisation transaction. • The type of trigger determines where the structure sits on the basis- risk / 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
Trigger Types • Types of common triggers: » 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.
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.
‘Tranching’ • ‘Tranching’ of liabilities allows SPV Funding different quality securities to be issued. AAA+ $250m Tranche A Margins can range from +20bps to over +800bps Debt AA $80m Tranche B • Senior debt generally have largest volumes BB+ Tranche C $40m • Equity tranche – often purchased by the sponsor Preference Shares Equity $10m
Pricing and R is k Management Applications
Pricing S ecuritis ations Pricing of the offered securities: = + Coupon % BBSW % Spread % The spread can be broken into: = + + Spread % CreditRisk % DefautRisk % ProfitMarg in % • 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.
Pricing S ecuritis ations • Ultimate Loss: N ∑ = − ( rt ) S X i e . = i 1 Major drawback is that effective maturity can be very early on. No further upside possible • Periodic Loss: L − = t 1 , t l − t 1 , t P − t 1 , t Loss of principal in one period doesn’t affect subsequent periods
Lehman’s Impact $110 • Lehman Brothers was the $100 Ajax Carillion A-1 counterparty in 4 Total $90 New ton Re 2008 Return Swaps (TRS) for Willow Re $80 Market Value CAT bond at the time of their $70 collapse $60 • Returns to note holders $50 could no longer be $40 guaranteed $30 $20 30-Aug 14-Sep 29-Sep 14-Oct 29-Oct 13-Nov
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
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