Chris Redmond, global head of credit at Willis Towers Watson, answers SCI's questions

Q: How and when did Willis Towers Watson become involved in the securitisation market?
A: Willis Towers Watson has an international team conducting research of all credit managers and products, including securitised credit. While we had exposure to securitised credit via broad, generalist mandates beforehand, it was in the aftermath of the financial crisis when we started making dedicated, specialist allocations to securitised credit.

At that time, we worked with managers to put in place solutions exploiting the 'cheap beta' - investing predominantly in senior tranches of non-agency US RMBS, as well as European CLOs and Dutch RMBS, exploiting the highly discounted prices. We were very successful in playing this credit burn-out theme, whereby the initial surge in default rates and loss severity wasn't sustained.

Since then, we've rotated into segments of securitised credit where the barriers to entry are higher and tilted towards greater active management; targeting asset classes where we see greater scope for active management to be well rewarded, such as in the lower-trafficked asset classes. While we are generally quite cautious on credit, we continue to see pockets of attractive opportunity in securitised credit, particular where we can buy senior tranches with credit enhancement. Where possible, we are looking for less credit risk, more illiquidity risk and where the supply/demand dynamic is imbalanced.

Q: What are your key areas of focus today?
A: As mentioned above, we continue to view securitised credit as a ripe space for active management. Consequently, we are focusing on identifying highly skilled, highly active managers capable of exploiting a market niche or dynamically managing exposures across asset classes.

One thesis we like is the fact that rating agencies review structured finance ratings on a quarterly basis (and sometimes less frequently), meaning that it's possible to benefit from structural improvements that haven't yet been reflected in the rating. Small pockets of market inefficiencies exist in some of the lesser followed securitised credit asset classes, such as in railcar ABS.

We're also looking closely at 2007-vintage US CMBS: we expect the value to break either in the mezzanine or AJ tranches. It remains an interesting distressed opportunity.

The average LTVs at today's prices are typically in the 80s; however, this disguises a pool of loans including some with 120%-125% plus type LTVs. Identifying the right securities and those with less exposure to troubled retail names appears to be the key to success.

Many loans will fall due in the next six months and some kind of value realisation event should occur. Hedge fund and real money are sellers at the moment, as they have little appetite for extension risk and challenging work-outs, so it's possible to acquire decent AJ bonds at around 80c.

Another area of research focus for us is Trups CDOs, especially in terms of regional bank trust preferreds. Industry consolidation needs to occur: there are thousands of regional banks that don't know what to do with their Trups and many securities are non-compliant.

In these cases, one strategy would be to collapse the structure and put the Trups back to the bank. The opportunity comes from allowing the bank to book a profit by buying back the par debt at a discounted price, while still providing outsized returns to the owner.

We are increasingly avoiding the more mainstream securitised credit asset classes and those with a heavy correlation to trade; for example, shipping.

Q: Which challenges/opportunities does the current environment bring to your business and how do you intend to manage them?
A: We expect a modest pick-up in capital relief trade volume this year, as many European banks remain insufficiently capitalised. There remains an impetus for banks to conduct credit risk transfer type transactions to improve capital positions, namely the EBA's stress tests and stricter bank regulation. For example, a number of French banks are working on more new transactions to help improve their capital position from infrastructure assets.

The broader CRT space appears to be becoming a permanent financing tool at a bank's disposal. Regulators are involved in each one and they generally appear supportive of banks accessing a broad array of financing channels, indicating that CRT activity isn't a fad.

We believe that capital relief trades are often the cheapest way to buy assets in the current environment. However, we've shied away from middle-market corporate deals - given our cautious macro view - and instead favour infrastructure loans and counterparty risk exposures, where we feel downside is better protected.

We like CRTs because they're typically quite short-dated and can be structured to focus on more defensive assets. So far, we've deployed around €1.5bn of capital, with our managers completing some 20 transactions over the last two years. The structuring of the deals is often in the form of insurance against a first or second loss exposure.

The emergence of syndicated deals is reducing some of the opacity in the capital relief trade space, but investors still require a unique skill-set to be successful, including banking relationships and credit/structuring capabilities. Investment managers would need to replicate the infrastructure of a bank in order to fully underwrite a regulatory capital relief transaction. Consequently, for some, the credit work is predicated on statistics.

Our preference is a slightly more fundamental and thorough credit underwriting, thereby constraining the number of credible buyers. I would say there are only a handful of credible institutional managers in the space.

Nevertheless, the syndicated route could be a serious avenue for growth of the CRT market - although the potential increased disclosure of balance sheet means it will remain appealing for some banks to execute bilaterally.

Running out of good collateral is one potential limiting factor for the market, however. CRTs generally are most efficient for triple- and double-B rated assets, where the associated capital charge bites.

Q: What major developments do you expect from the market in the future?
A: We have some concerns over the simple, transparent and standardised (STS) securitisation regulation and how negotiations are shaping up at the European Commission is concerning. Risk retention in Europe, as currently proposed, is likely to kill the ABS and CLO markets and is contrary to policymakers' stated aims of boosting the economy and strengthening banks (through having access to different financing channels). It could also trigger a divergence in regulatory environments between Europe and the US - although this may, in turn, create opportunities.

CS