Académique Documents
Professionnel Documents
Culture Documents
By Thomas Duffy
04-22-2009
1. What is A) ''a Non‐Recourse Loan’’; B) ''a Perfected Interest''; C) ''a Bookable Event''?.
A) A "non‐recourse loan" is a loan whereby the lender, in this case the re‐insurance company, can only
look to the collateralized asset (the stocks or bonds) for repayment of the underlying debt. That means
if the collateral decreases in value below the level of the loan principal, the lender cannot look to the
borrower for repayment of the difference between the value of the collateral and the balance of the
loan outstanding.
B) A "perfected interest" is the legal term used by insurance regulators to acknowledge that the re‐
insurance company has the legal "use" of the collateral, but not legal ownership of the underlying
collateral. The best analogy I can draw is that of a rental property, whereby when you rent the office
space, you have a "perfected interest" in the use of the office, but not legal ownership of the underlying
building.
C) A "bookable event" is the accounting term used by insurance company regulators to acknowledge
the actual timing of the event. That is the "snap‐shot" or valuation date whereby the value of the
collateral is considered statutory capital for regulatory purposes. As the transaction is not valued
"market‐to‐market", the insurance company looks to the date of the transaction (signed pledge & loan
agreement) as the bookable event for asset valuation purposes.
2. can the re‐insurance company really use the pledged assets for their capital adequacy ratios with
the SEC/ FSA etc, yet still not have any rights over them if they fail ?, ie. Are you actually putting them
at risk?
Yes, the re‐insurance company has the right to use the assets as "statutory capital" during the term of
the agreement. This is very similar to how banks "use" your cash deposits as statutory capital to
transaction make commercial loans although they do not "own" the underlying deposits, or how broker‐
dealers "use" securities deposited at their institutions to make secondary markets for those securities,
although they too do no "own" the actual securities. Thus, much like the brokerage accounts at Merrill,
Lehman, and Bear Sterns or bank accounts at Wachovia, Countrywide and Citi the client's accounts are
separate from that of the institution and are not "at risk" as to the client.
3. what would be the min & max of deal size that the re‐insurance co would consider.
AmRe is the reinsurance company used here domestically in the United States. AmRe is the 100%
owned subsidiary of Munich Reinsurance, the largest reinsurance company in Germany (please see links
below). Munich Re has over $1.2 Trillion in statutory capital currently under its statutory regulatory
control. Therefore the size of the typical transaction can range from $1.0M to $1.0B, Dauphin Finance
has closed a transaction earlier this year for over $500M and in that transaction used four different
reinsurance companies around the globe to hedge the risk of the asset.
4. what happens if a 75% loan is made, but then the assets fall in value by say half, so now the loan is
150% of the assets, does this cause a kind of margin call or something else to trigger?, seems like NO is
the answer, but its hard to believe, sounds too good to be true ?
The answer is "NO" there is no margin call as the loan is "non‐recourse" and if you understand the
economics of the transaction from the insurance company side you will see why it is still profitable to
them and makes business sense. First, in your example, the insurance company has only extended a
75% LTV and thus has a built in cushion of 25% decrease in value before they are under‐water. Second,
in the insurance industry their "statutory capital" rate maybe something like 30%, thus they need to
have statutory capital reserves in the amount of 30% of their total outstanding policies. So, in your case,
if the client pledged $1.0M in assets, the reinsurance company can write $3.0M in new policies. Based
on accounting ruled, the insurance company can realized as current income the present value of that
policy over the term of the policy. Say the present value of that policy is 10% of the value of the
coverage, thus the reinsurance company may realize $300,000 in income currently. Now they have
extended the client $750,000 in the form of a "non‐recourse loan" less the $300,000 in realized income,
means the underlying asset would have to drop below $450,000 in value, or over 55% from the initial
value, before the reinsurance company stands to actually "lose" money. However, before the value of
the assets drops to this level, the reinsurance company would have contacted the client to see if they
want to continue making interest maintenance payments on a loan that they owe $750,000 in principal
while the asset they will receive in return is only worth $500,000. Nine times out of ten the client is just
going to walk away or "put" the asset to the insurance company once the economic benefit no longer
makes sense to keep making the interest payments.
5. I wonder, since the re‐insurance co is passing on the loan at institutional rates, and don't really care
about the loan, would they pay a fee for the pledged assets?. So in this case if the consumer did not
need a loan at present, they could just get a small income by pledging the assets?
No, they are not going to pay a fee to the prospective client to pledge their assets. This essentially
would be "double‐dipping" on the part of the client in that they are receiving a non‐recourse loan while
also receiving a fee. Now, with that said, you can structure the terms of the loan however you wish
(money is fungible). Meaning in your example, the 75% LTV can be a 70% loan with a 5% fee. Or, a
better way to understand this is that for regulatory statutory capital purposes the loan extended by the
reinsurance company is considered "fair and adequate" consideration of the pledging of the underlying
assets. This is a legal nuance in legal terminology, but gives the reinsurance company the regulatory
right to use the asset as statutory capital. In the case where the client did not need the loan, they still
have two alternatives. First, they can take out the loan at institutional rates (approximately 2%) and
reinvest the loan proceeds in an investment that earns over 2% such as bonds or annuities that earn as
5% thus creating a positive interest rate arbitrage of 3% per annum. Second, they can pledge their
assets to the reinsurance company, and not take a loan. In that instance the reinsurance company will
provide them with a "synthetic put" essentially guaranteeing the value of the pledged asset will never
drop below the 75% level (as used in your example) and if so the insurance company will make the client
whole. Without the need to purchase a costly put or incur in annual cost of the carried interest
expense.
6. the consumer would have to know that he/ she did not want to sell the assets for 3 year term of the
loan, which is a long time, unless it’s a family business or some such thing?.
No, the client has TOTAL control over the asset during the 3‐year term. They can continue to manage
the account, buy/sell securities held in the account, re‐balance the portfolio, sell call, even payoff the
loan early without pre‐payment penalty or other costs. If the client wanted to sell their asset for cash
they can do so and merely leave the cash in the account or use the sale proceeds to payback the loan
principal and receive the net cash.
7. does the consumer have the rights to change the assets, eg sell GE shares and replace with X shares
or does the portfolio have to remain static.
Yes, see above, the client retains full right to manage the account and even exchange assets. That is to
take a distribution of $1.0M in GE and put in $1.0 in IBM, so long as the value of the assets exchange are
of equal value or greater. Otherwise the loan principal must be paid down.