German insurers, which came through the subprime mortgage crisis largely unscathed, are seeking to boost investment returns by buying junk loans to corporate borrowers.
Senior secured loans, which are repaid first in a default, are originated by banks for borrowers considered high yield or high risk as they usually have a significant level of debt relative to equity. The loans are then are sold on to investors.
Those loans, with interest margins of as much as 700 basis points above benchmark lending rates, are attracting German insurers struggling to improve investment returns amid the low interest-rate environment. For Gothaer Finanzholding AG and Versicherungskammer Bayern, the risks are outweighed by the interest paid by borrowers typically rated below investment grade by Moody’s Investors Service and Standard & Poor’s.
“Against the backdrop of low interest rates and historically low corporate default rates, we consider leveraged loans as an attractive and well diversified asset class and would be ready to invest more,” said Klaus-Michael Menz, head of credit investments at Gothaer. “As long as there is no global recession, we don’t see major risks in this asset class.”
Yields are currently 450 to 700 basis points above the London interbank offered rate, or Libor, said Menz, adding that the Cologne-based insurer has invested about 100 million euros ($126 million) in the asset class over the past three years. The portfolio is managed by Pramerica Financial, the asset management unit of Prudential Financial Inc., and focuses on U.S. issuers. A basis point is one hundredth of a percentage point.
The trailing 12-month global speculative-grade default rate, which includes bonds and loans, fell to 2.8 percent in July from a revised 2.9 percent in June, according to a Moody’s report on Aug. 7. Moody’s expects the rate to rise to 3.1 percent by the end of the year. The historical average was 4.8 percent since 1983, Moody’s said in July.
“We are receiving a lot of interest from other insurers as the investment appeals by being secured by the borrower’s assets and by offering a hedge against rising interest rates” because the coupon adjust to changes in the benchmark rate, said Jeffrey Bakalar, co-head of ING Investment Management’s senior loan group, which received a mandate from Munich-based insurer Versicherungskammer Bayern to manage 100 million euros of this debt.
Versicherungskammer Bayern, Germany’s biggest public-sector insurer, holds its senior loans as part of a fund set up by Munich-based BayernInvest, the asset manager owned by Bayerische Landesbank. The fund is allowed to invest as much as 30 percent of its assets in senior secured loans, which include financing used to back private equity firms’ leveraged buyouts.
“We like senior loans as they are an asset class that’s between lower-risk, lower-return investment grade loans and high-risk, high-return high-yield bonds,” said Anja Leibold, a fixed-income portfolio manager at Versicherungskammer Bayern, which has more than 40 billion euros in investments.
The insurer would consider increasing its investments to a “mid-three digit million-euro amount,” Leibold said, adding that the portfolio returned about 6 percent between the beginning of this year and mid-August.
Munich Re, the world’s biggest reinsurer and owner of Germany’s second-biggest insurer Ergo Versicherungsgruppe, doesn’t buy leveraged loans “as we clearly prefer their twin sister, high yield corporate bonds,” said Alexander Frey, a portfolio manager at Munich Re’s MEAG asset management unit, adding that bond returns are more predictable.
MEAG has invested about 1 billion euros in high-yield corporate bonds since 2006 and is seeing an increasing number of issuers as part of a general “loan to bond shift in Europe as banks deleverage and companies seek to reduce their dependence on bank financing,” Frey said.
Munich-based Allianz SE, Europe’s biggest insurer, is “only active in loans related to the German medium-sized company universe,” said Nikhil Srinivasan, chief investment officer at Allianz Investment Management.
“We are actively looking to increase our exposure to loans backed by commercial real estate and have also recently funded a team to invest in infrastructure debt,” he said.
Leveraged loan prices plunged to 59.2 cents on the dollar in mid-December 2008 as investors dumped risky debt two months after the collapse of Lehman Brothers Holdings Inc. They averaged 95.12 cents on Aug. 22, which was the highest since June 2011, according to the S&P/LSTA U.S. Leveraged Loan 100 Index. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has climbed from 90.75 at year-end.
While subprime and financial crisis-related losses at German banks totaled almost $105 billion, losses at the country’s insurers, including Allianz and Munich Re, were less than $7 billion, according to data compiled by Bloomberg.
Talanx AG isn’t evaluating senior secured loans, said Julia Thiem, a spokeswoman for Germany’s third-biggest insurer. HUK-Coburg Holding AG, Debeka, Wuestenrot & Wuerttembergische AG and Axa Konzern AG said they are not invested in the asset class.
That may change after German financial market regulator BaFin approved such investments, said Bakalar of ING.
“While in the U.S. insurers and pension funds are already a consistent investor in the asset class, the market in Europe is still dominated by banks and structures such as collateralized loan obligations,” he said.