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In a world of rock-bottom interest rates and negative bond yields, maybe it was bound to happen.
Products synonymous with the credit crisis such as "collateralized debt obligations" and "synthetic securitization" are returning as investors take on more risk while banks are forced by regulators to reduce it.
One of Europe's largest pension funds put itself first in line for losses on an €8.4-billion ($12.4-billion) portfolio of corporate loans in exchange for a likely double-digit return, according to two people familiar with the matter.
While the Dutch fund involved, PGGM NV, describes itself as an expert in this kind of investment, it's the latest example of investors clamouring for higher yields from complex products that were popular during the last credit boom. They amplified losses when markets seized up, sinking Lehman Brothers eight years ago this month. Echoing that era in the United States, Anchorage Capital Group packaged junk-rated corporate bonds and loans into a security that was then rated triple-A and sold in the market in July.
"The yield chase certainly encourages the creation of those instruments that helped cause the financial crisis," said Tracy Chen, a Philadelphia-based money manager and head of structured credit at Brandywine Global Investment Management, which oversees $70-billion (U.S.). "It will end ugly."
PGGM manages about €200-billion, the retirement savings of nurses and social workers in the Netherlands. It acquired the risk on the loans through a synthetic securitization, a bespoke product designed specifically for the transaction with Nordea Bank AB, according to the people familiar with the deal. They asked not to be identified because they aren't authorized to speak about it.
The Scandinavian lender packaged credit-default swaps, instruments that effectively act as insurance policies against borrowers failing to repay the loans. A spokesman said the deal was purchased by a syndicate, without identifying investors. He declined to comment on what loans are included or what coupon it's paying, beyond noting the range is 10 per cent to 12 per cent for similar instruments in Europe. Rodney Alfven, head of investor relations at Nordea, said last month there are "no hidden risks" in such transactions.
PGGM spokesman Maurice Wilbrink declined to comment specifically on Nordea, though said his company looks at "all risk characteristics" of the debt underpinning an investment. It agrees on the composition of any loan package with the bank involved, he said.
The fund invested in comparable products offered by Banco Santander SA in December and Rabobank in 2014. Similar transactions have returned more than 10 per cent on average over the past decade, Mr. Wilbrink said recently.
"We invest enormously in research on the quality of banks' deal teams as well as their track record in certain sectors," he said. "We strive for a well diversified portfolio, across individual borrowers, industry sectors, countries, etc. That is part of the negotiations."
Nordea is planning to do more deals to transfer risk from its balance sheet and improve its capital ratio, a key requirement by regulators in the aftermath of the financial crisis. The bank's asset quality is "sound," but weaker than other Swedish lenders because of its exposure to bad loans in Denmark, Fitch Ratings Ltd. said in May.
The question is how prevalent the transactions are elsewhere. They tend to be private and therefore harder to track. A mix of about 35 pension funds, insurers and hedge funds buy synthetic securitizations in Europe, according to James King, a fund manager at M&G in London. His company is among them, though it turns down a large number of sales.
"There are some deals where we can't get comfortable with the risk: maybe it's too leveraged, or there's not enough information on the underlying loans, or we're not convinced that it's not going to show a much higher default rate," King said.
While it's difficult to gauge the size of the market, recent deals from Standard Chartered PLC and Spanish bank Santander suggest it's growing, said Ruben van Leeuwen, an analyst at Rabobank in Utrecht. "I'd be concerned if less sophisticated investors started investing in these first-loss tranches," he said.
No less sophisticated an investor than Warren Buffett's Berkshire Hathaway Inc. had to pay out hundreds of millions of dollars on similar products during the financial crisis, when bankruptcies hit records. American International Group Inc., once the world's largest insurer, was undone by its credit derivative bets because the company couldn't meet collateral demands from trading partners after prices on the underlying debt plunged.
A chorus of global financial leaders from BlackRock Inc.'s Larry Fink to Janus Capital Group Inc.'s Bill Gross have warned that negative interest rates are punishing savers and pushing investors into assets with lower liquidity and higher risk.
Anchorage Capital's $433-million collateralized debt obligation backed by mostly junk-rated corporate bonds and loans is another recent example and its third such deal in just over a year. While 71.5 per cent of the underlying securities were rated at least five levels below investment-grade, $208-million of senior notes received a top rating from Moody's Investors Service. The notes pay 3.85 per cent, which is less than 4.3 per cent offered to investors on its previous deal in December.
While similar instruments called collateralized loan obligations have been around for years, they represent a new variation of them with potentially more risk. A spokesman for Anchorage declined to comment.
"Investors are making relative-value decisions in contrast to what else is available in the market," said Katherine Frey, a managing director for structured finance at Moody's in London. "Are they being paid for the risk? That's a very hard question to answer."