Securitisation Glossary
Capital Relief Trade (CRT): a transaction whereby banks can improve their regulatory capital position by reducing the risk weighting of assets held on the balance sheet. Following the financial crisis, banks are required by their regulators to hold more capital against their assets, to mitigate against another Lehman Brothers-style bank collapse. For certain capital-intensive books of business where banks want to retain their relationships with clients and/or lend more to those sectors, they can free up some of the associated capital by transferring a portion of the risk to specialist investors. Those investors, in turn, benefit from unprecedented access to books of business that are well-underwritten and well-supported by banks and which otherwise wouldn’t reach the market. Investors typically take the first-loss risk (the equity tranche) and/or sometimes mezzanine risk (depending on their risk appetite), while the bank retains the senior tranche. Because CRTs are by their nature structurally complex and the CRT market is opaque, investors are compensated with high yields. In Europe, in order for regulators to grant capital relief on a synthetic securitisation, the transaction must qualify as a Significant Risk Transfer transaction.
Credit-Linked Note (CLN): A bond paying a risk-free rate with an embedded credit default swap; a tradeable security where the repayment of capital is conditional on a third-party entity performing on an unrelated financial obligation. CLNs are one of the legal mechanisms used to structure synthetic securitisations. If the defaults that reduce the amount of principal payable are on a pool of assets and the CLN is one tranche of the overall credit risk of the pool, the CLN becomes a securitisation.
Credit Risk Transfer (CRT): The US Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac bundle tens of thousands of mortgage loans into mortgage-backed securities (MBS), for which they guarantee that investors will receive all interest and principal. In exchange, the GSEs charge a guarantee fee, based on what they believe would adequately cover losses and expenses. Following the global financial crisis, the GSEs began issuing securities that transfer some of the credit default risk of the underlying mortgage loans to investors via synthetic securitisation to reduce their exposure to losses. Such transfer of credit risk aims to not only protect Fannie Mae and Freddie Mac in the event of another housing crisis, but also lower systemic risk. Fannie Mae’s Credit Risk Transfer programme is called Connecticut Avenue Securities (CAS), while Freddie Mac’s is called Structured Agency Credit Risk (STACR).
Full-stack securitisation: although most capital relief trades are executed as a synthetic securitisation, issuers do occasionally utilise full-stack (also known as true sale or cash) securitisations to obtain capital relief on a pool of assets. In these cases, the deal will be publicly marketed to a broad range of investors (as with any traditional securitisation) and the senior tranche will be issued for funding purposes, while the issuer will apply for capital relief for some or all of the more junior tranches.
On-balance sheet securitisation: the regulatory preferred name for synthetic securitisation. For example, synthetic securitisations are referred to as on-balance sheet securitisations in the EU Securitisation Regulation.
Risk sharing: transferring a portion of credit risk to third-party investors. Capital relief trades are often referred to as risk-sharing transactions because they are viewed as partnerships between investors and banks, whereby investors can influence which assets are included in reference pools to a much greater extent than in public securitisations and both parties share any losses on the pools.
Securitisation: a transaction, whereby the credit risk associated with an exposure or a pool of exposures is tranched; payments in the transaction are dependent upon the performance of the exposure or of the pool of exposures; and the subordination of tranches determines the distribution of losses during the ongoing life of the transaction. Securitisation transforms a pool of assets into marketable securities, typically for the purpose of raising cash (also known as funding) by selling them to institutional investors. Securitisations can be broken down into four main asset classes – ABS, CLOs, CMBS and RMBS. The vast majority of these deals are publicly marketed; sometimes a deal will be announced but has already been executed privately by being preplaced with a small ‘club’ of investors or retained by the issuer for some other purpose. Traditional securitisations are known as cash, true sale or full-stack deals because the assets are transferred from an issuer’s balance sheet to a bankruptcy-remote vehicle (SPV), which then issues notes secured by these assets that are bought by investors. Securitisations can also be executed in a synthetic format, whereby the assets remain on an issuer’s balance sheet and the associated credit risk is transferred via a credit default swap or financial guarantee.
Significant Risk Transfer (SRT): a type of capital relief trade. SRT transactions effectively help banks to manage their RWA exposures by transferring the credit risk on a portfolio of assets to third-party investors either via a traditional cash securitisation or a synthetic securitisation, so that they obtain regulatory capital relief on that portfolio while allowing banks to keep the loans on-balance sheet and maintain key customer relationships. Bank regulators have a complex set of rules under the SRT concept to determine if sufficient risk has been transferred away from a bank’s balance sheet and therefore whether the transaction can be approved and capital relief granted. Without SRT approval, the credit protection provides no capital benefit.
Synthetic Risk Transfer: a synthetic SRT transaction. In a typical synthetic SRT trade, a bank buys first-loss and/or mezzanine protection from an investor through a CDS contract referencing a portfolio of loans. The bank will pay a periodic fee to the investor for the term of the transaction based on the outstanding notional. In exchange, losses are borne by the investor, who has both its principal and coupons written down by the losses.
Synthetic securitisation: a transaction that utilises credit default swaps or financial guarantees to transfer in a tranched format the credit risk associated with a pool of assets held on a bank’s balance sheet. Unlike traditional cash securitisations, the pool of assets remains on the bank’s balance sheet. Synthetic securitisations are usually bespoke and sold privately to a single investor or a small group of investors. Because the securitised assets are not sold but remain on the balance sheet of the originator, synthetic securitisations are sometimes called on-balance sheet securitisations. One of the most common synthetic structures is a capital relief trade.
True sale: the traditional (or cash) securitisation format, whereby an originator effectively sells the underlying assets. In so doing, the originator typically benefits from funding and liquidity.