(PrivateEquityCentral.net) Financial services giant AIG has securitised $1bn worth of its private equity partnerships portfolio and completed the placement of roughly $250m in triple-A rated bonds backed by the funds, according to several sources close to the transaction.
The deal allows New York-based AIG to reclassify a large portion of its risk-based capital and free up cash for fresh commitments to the private equity asset class. AIG was advised by Morgan Stanley and Switzerland-based Capital Dynamics on the deal. Standard & Poor's and Moody's Investors Service did the rating work on the deal.
The AIG securitisation marks the first time a portfolio of private equity partnerships has received the highest credit rating from rating agencies. The triple-A designation was assigned without the benefit of an “insurance wrap”, a capital guarantee on the principal value supplied, at considerable cost, by an insurance company.
Last January, insurance group Aon Corp securitised roughly $450m of its private equity partnerships portfolio, with the senior-most tranche receiving a double-A minus rating from S&P, according to a source. In that transaction, the bank in charge of placing the bonds ended up holding them.
In 2001, a blind-pool private equity vehicle called Prime Edge and sponsored by Hamilton Lane, Swiss fund manager Rainer Marc Frey, and Capital Dynamics marked the first time a bundle of private equity funds received a credit rating. But Prime Edge's double-A rating was made possible by an insurance wrap from Allianz Risk Transfer.
The AIG transaction is structured with a senior tranche of $250m in triple-A bonds. All these bonds were successfully sold by Morgan Stanley in the first quarter of 2003 to a range of insurance companies and financial institutions on a global basis, according to sources. The bonds pay a quarterly cash dividend based on an undisclosed rate tied to LIBOR.
The remainder of the capital structure, including an unspecified, non-rated equity strip, will be held by AIG, which has no current plans to sell the securities. “They may want to sell these in three or four years,” said a person familiar with the situation.
The securities are based on an underlying portfolio of between 50 and 100 private equity partnership interests from the AIG inventory. The partnerships represent a diversified range of vintage years, styles and managers. Only US-based partnerships were contributed to the securitisation.
For Morgan Stanley, the structuring, underwriting and sale of the securities was a first. The firm is an experienced player in the structured debt market, but not with private equity as an underlying asset. “It was a novel transaction,” says a person familiar with the placement effort. “There was an education process for getting fixed income market guys comfortable. There are no contractual payment streams emanating out of private equity portfolios. We had to go through the quality of assets and say what the motivations were, that AIG was not simply looking to dump assets.”
One buyer of the senior notes had the securities wrapped in a capital guarantee by an unnamed insurance company, according to a source.
A source close to AIG said the firm was discouraged from seeking liquidity in the private equity secondary market because of the low valuations at which private equity fund interests are currently changing hands. “Right now, with interest rates where they are, there's huge spread between the cost of debt and cost of equity,” said a source. “Equity buyers are asking for a discount. In the current debt market, the cost of money is much cheaper.”
With the securitization, AIG's private equity division was able to get liquidity for 40 per cent of the net asset value of its portfolio on a non-recourse basis, meaning the firm is not liable to the lending institutions should the value of the assets be sold for less than the value of the loans.
In rating the senior tranche, the rating agencies studied historical private equity returns, as well as “stressed tested” the bonds in simulated outlier economic situations, such as the depression of the 1930s and the inflationary environment of the mid-1970s.
At least one aspect of the securitization suffered due to complications of an entirely human nature. Prior to the final closing date of January 1, 2003, a key decision maker at one of the underlying funds could not be located for final approval, and as a result his fund was left out of the securitisation. “We were trying for multiple days to find this guy,” says a person close to the deal. “His lawyers tried, his co-workers tried, but the guy could not be located.”
All GP groups involved in the transaction consented to the transfer of ownership.