The World Bank’s International Finance Corporation has agreed to guarantee part of a $2bn portfolio of emerging market loans owned by Crédit Agricole in the latest example of banks using complex financing to help lower their regulatory capital costs.
IFC is providing $90m worth of credit risk protection on a wide variety of emerging market loans, such as infrastructure lending in Egypt. It is the largest structured finance transaction ever created by IFC and officials there are hoping it will enable it to provide credit to developing countries in a more efficient way.
“We could have taken that $90m and lent it to companies or we could go to a bank and support $2bn worth of loans,” said an IFC official.
The deal is an example of a “synthetic securitisation” or “reg-cap trade,” which involve banks purchasing credit risk protection – typically from a hedge fund or insurer – on part of a portfolio of loans. Using the structures frees up a bank’s regulatory capital, enabling it to increase its lending while the providers of the credit protection can earn a hefty return.
Such deals have been a persistent – if contentious – part of the financial system since the invention of credit default swaps in the late 1990s.
Proponents of the securitisations say that sharing credit risk with private investors can be a useful tool to enable banks to lend amid higher capital charges. However, the deals have caught the attention of regulators in the US and in Europe who are worried that some of the transactions may conceal risk in the banking system rather than transfer it.
“The presumption here is that banks face a capital adequacy challenge,” said the IFC official. “This is a very efficient way for us to allow banks to do much more developing market business.”
Most reg-cap deals are being struck in Europe, where lenders are still scrambling to reduce their capital usage and where investors are also searching for higher-yielding transactions.
IFC said it expected a return in line with current market rates.
The transaction involves a revolving portfolio, meaning loans are of relatively short duration and will be replenished as they mature. IFC is guaranteeing losses on the middle or “mezzanine” portion of the portfolio.
The deal includes a relatively uncommon feature whereby Crédit Agricole will retain a vertical slice of the securitisation, in an effort to further align the interests of the French bank and IFC.
The transaction has been signed off by the local French regulator and the European Banking Authority, which are following new guidelines from the Basel committee of banking regulators, according to people familiar with the IFC deal.
IFC had initially planned to partner with New York-based hedge fund Christofferson Robb to invest in a reg-cap fund, but has since decided to undertake such transactions independently. It struck its first such deal – a similar, though smaller, synthetic securitisation with Standard Chartered – about four years ago.