S ecuritis e This Jon Tindall Outline 1. Background 2. - - PowerPoint PPT Presentation

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

50 100 150 200 250 300 350 400 450 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

ROL index

Source: Guy Carpenter

• Alternative risk transfer

mechanisms become popular after spikes in RI premiums

• Generally follow shortages in

global reinsurance capital

• Acts to put downwards

pressure on RI premiums

Rate On Line (ROL) index

S ecuritis ation Markets

ILS Markets

$0 $2,000 $4,000 $6,000 $8,000 $10,000 $12,000 $14,000 $16,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Value (US$m)

5 10 15 20 25 30

Number of Transactions New Issues Outstanding @ year end number

• Market peaked

in 2007.

• New issuance

dropped by nearly 2/3 post GFC

• 2010 was 2nd

largest new issuance, behind 2007.

Source: Willis Capital Markets ILS Update - Q4 2010

ILS Markets

• High issuance in 2010

covering US risks.

• Primarily wind coverage,

some earthquake

• Australia – no recent

transactions. – Earthquake bonds, Australis, introduced by Swiss Re in 2006.

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

R ecapitilis ation

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Andrew September 11th Katrina et al Share of New Capital

Cat Bonds Sidecars Start Ups Recapitilisation

Alternative forms

• f capital have

become increasingly important in the recapitalisation of insurance markets following natural disasters.

Inves tor Mix

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1999 2009 Money Managers Hedge Funds CAT Funds Banks Insurers

• Specialist CAT and

hedge funds now dominate.

• Less than 10% now

retained within the insurance industry.

S tructuring S ecuritis ations

B as ic S tructure

Swap Counterparty Capital Markets SPV Originator Trust

Originator: The institution providing the securitised assets. 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. Trust: Generally set up as a charitable trust. Provides independence of the SPV. Swaps: TRS, credit risk, liquidity risk.

Cas h Flows – Financial Clos e

Swap Counterparty Capital Markets SPV Originator Trust

Securitised assets / liability Deposit / Obligation Setup Costs Capital Securities, bonds, equity Swap Obligation Swap fee

• SPV offers securities to 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

Cas h Flows – Operation

Swap Counterparty Capital Markets SPV Originator Trust

Premium Operating Costs BBSW + margin% Fixed rate Variable rate

• Originator pays ongoing premium

to SPV. Sometimes collateralised upfront.

• SPV pays BBSW + margin% in

accordance with securities offered.

• Swap arrangements – hedging,

liquidity payments.

• SPV generally pays for operation
• f the structure.

Cas h Flows – Maturity

Swap Counterparty Capital Markets SPV Originator Trust

Trigger payment Principal Break fee

• If not triggered – SPV returns the

principal to note holders.

• If trigger event then payment made

to Originator based on payment mechanism.

• Trigger event may or may not cause

maturity

• Swap and liquidity account break

fees are paid depending on term to maturity.

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 3rd

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

different quality securities to be issued.

• Margins can range from +20bps

to over +800bps

• Senior debt generally have largest

volumes

• Equity tranche – often purchased

by the sponsor

Tranche C Tranche B Tranche A Debt

AAA+ $250m

Equity SPV Funding

AA $80m BB+ $40m Preference Shares $10m

Pricing and R is k Management Applications

Pricing S ecuritis ations

Pricing of the offered securities: The spread can be broken into:

• 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.

% Spread % BBSW % Coupon + =

% in ProfitMarg % DefautRisk % CreditRisk % Spread + + =

Pricing S ecuritis ations

• Ultimate Loss:

Major drawback is that effective maturity can be very early on. No further upside possible

• Periodic Loss:

Loss of principal in one period doesn’t affect subsequent periods

∑

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Lehman’s Impact

$20 $30 $40 $50 $60 $70 $80 $90 $100 $110 30-Aug 14-Sep 29-Sep 14-Oct 29-Oct 13-Nov

Market Value

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

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

J apan E arthquake

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

• 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

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

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.

AXA Motor S ecuritis ation

Class A - AAA €91.5m Class B - A €220.0m Class C – BBB- €100.1m Equity - €24.2 AXA Capital Markets Loss ratio Class D - BB €39.2m

72.5% 69.0% 74.3% 78.9% 89.0% 93.2%

Probability

Equity Class A Class C Class D Class B

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?

AXA Motor S ecuritis ation

• Benefits to AXA include:

» 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

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

Thankyou

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