In the first of six chapters surveying the synthetic securitisation market, SCI explores how SRT has become a key component of banks' capital management toolbox

IACPM’s latest risk-sharing survey notes that 2022 highlighted not only a substantial growth in SRT product utilisation by banks, with €200bn in new issuance, but also some structural changes in the risk-sharing activity of banks. Nevertheless, a number of regulatory challenges remain outstanding.

SCI’s Global Risk Transfer Report examines how the risk transfer community is addressing these issues – through regulation or structural enhancements – and the fallout from the turmoil in the US bank sector in March. It also explores the new frontiers that are emerging across jurisdictions and asset classes.

Chapter 1: Introduction
Capital relief trades (CRTs), also known as significant risk transfer (SRT) transactions, were once regarded as a niche, regulatory-driven product. Not anymore: CRTs are now a key component of banks’ capital management toolbox, helping them to meet tougher capital, leverage and liquidity requirements introduced since the global financial crisis. At the same time, more investors and (re)insurers are entering the market, attracted by the sector’s historical performance and the returns on offer.

CRT volumes witnessed another record-breaking 12 months in 2022, with 87 transactions issued during the period, according to SCI data. By the end of that year, €500bn securitised loans were covered by €44bn of protected tranches, the International Association of Credit Portfolio Managers (IACPM) reports in its 2016-2022 risk-sharing survey.

Olivier Renault, md and head of risk sharing strategy at Pemberton Asset Managers, says the introduction of the STS framework for synthetic securitisation in 2021 “has led to 10 to 12 new banks joining the market”, alongside more issuance “by the usual players”.

It’s “the copycat effect”, he adds. “In most jurisdictions, the leaders have opened the market. Now we have the second tier of banks that have looked at what their peers have been doing and they are replicating the structures for their benefit.”

Vesna Vladusic, a broker in the structured and bespoke solutions group at The Texel Group, agrees, pointing to the increasing number of new issuers in the CRT space. This expansion, Vladusic explains, is both a product of the increasingly well-publicised success of the existing CRT market from both an issuer and investor perspective and the result of “less traditional bank issuers executing CRT transactions to make sure they have access to as many tools as possible to manage their capital positions as new capital rules are phased in.”

Indeed, regional and smaller bank issuance is a significant growth area for CRTs, according to Michael Bennett, chief underwriting officer, European Mortgage at Arch Capital. “SRT is a very efficient capital management tool for smaller banks. More banks are coming to the market and we're very happy to support them, where the trades meet our risk appetite,” he confirms.

He adds: “The standardised banks are increasingly willing to adopt SRT technology. They may be smaller in terms of resources, but they're willing to commit to it.”

In its May 2023 report, entitled ‘Securitisation & Balance Sheet Optimisation’, KPMG estimates that over 80% of CRT trades are undertaken on IRB portfolios. However, the proportion of standardised pools “has increased from about 0% to 14% during the six-year period 2016-2022”, the firm notes.

Cash versus synthetic
One of the most interesting developments in terms of SRT issuance trends has been the adaptability of issuers in terms of cash versus synthetic risk transfer. Until earlier this year, there was uncertainty around how to use synthetic excess spread, but this has now been clarified by the latest EBA guidelines (see Chapter 2).

Robert Bradbury, md and head of structured credit execution at Alvarez & Marsal, says: “We've seen people more willing to consider the use of excess spread; it is more efficient than it used to be. Is it perfect? No. But it's very positive.”

He continues: “The only parties who could potentially remain objecting to the way it is now are perhaps some of the largest and most sophisticated banks; those who have big programmes where they can mix and match many assets all at the same time, across potentially different originators and different asset types. Banks always want as much freedom as possible to be able to combine different asset classes.”

At the same time, the senior markets for ABS have been hard to access and comparatively expensive, meaning that - at least for certain asset classes (such as consumer loans) - issuance in early 2023 proved challenging.

Bradbury says: “Do you do cash and try to use the excess spread – but there might not be any excess spread because the market rates are very high? Or do you go synthetic, where you might not be able to use the excess spread and that makes the deal less efficient (prior to the new guidance)?”

He adds: “The adaptability of the market and the ability of banks to move between cash, synthetic and unfunded risk transfer, depending on the situation, has been very interesting. There has been almost a coming of age, where you can now rotate between different formats, depending on what you're looking for.”

Positive outlook
The CRT market continues to be dominated by European issuers. KPMG reports that 55% of issuance volumes in 2021 were from Europe, excluding the UK.

Bennett concurs “that the focus of the market has historically been European”, but points out that “awareness and the appetite to issue SRT deals has spread to North America and Asia as well”. Late 2022 and early 2023 saw an uptick in issuance in Canada - with three new banks entering the market - and the first deal from Hong Kong.

More recently, some moderately positive developments have emerged in the US, where there had been a moratorium on CRT transactions issued by Fed-regulated banks for the whole of 2022 and throughout the first half of 2023 (see Chapter 5 for more on North America). “The Fed came back and told the banks that they can resume issuing, as long as the transactions are according to the book. The expectation is that US banks are going to start issuing again,” observes Renault.

Overall, the prospects for the CRT market in 2023 and beyond are encouraging. Renault says: “In our opinion, it’s a story of continued growth. I would expect this year’s tally to exceed the 2022 record figure of US$20bn of tranches placed. The first quarter was very active. Last year there was a surge in issuance in Q4, with around 40 transactions coming in Q4.”

Supply and demand
From a supply point of view, the big banks are expected to continue operating in the market, while the smaller banks will need to engage because of Basel 4 and because of the impact of other global macro events, such as the failures of Silicon Valley Bank and Credit Suisse. “The impact that had on the implied access to additional tier one and tier two was significant. Banks were prudent in ensuring they retained their ability to access other forms of capital, so some deals were brought forward that might have happened later in the year or next year,” Bradbury notes.

Additionally, high interest rates mean that banks are increasingly incentivised to optimise legacy books. They want to deploy capital into new business, providing further motivation for them to recycle capital through the efficient use of well-structured CRTs.

Bennett says: “We're bullish on the prospects for the evolution of the growing SRT sector. We think we'll see a lot of new trades and issuance from existing participants, but also new participants, so it’s a very positive outlook.”

Demand is also rising from new investors that are interested in CRT and want to know more about the market. “There's a lot of investors who are in the space already. There's also a lot of people trying to come into the space because they've heard about the historical performance. They've heard about the yields and they think it seems attractive on a risk-adjusted basis,” Bradbury confirms.

As a greater number of investors become more familiar with the product, regulators seem to be increasingly supportive. Based on the results of its surveys and the increasing number of banks and securitised asset classes, the IACPM estimates that by end-2023 close to €60bn of aggregated capital will have been raised by private risk-sharing between banks, specialised investors and insurers acting as long-term partners of banks.

“Based on current trends, EU participating banks will contribute to at least half of this amount of capital released and the final decisions…by co-legislators on CRR3 should continue to support growth of risk sharing. The return of large US banks to the SRT market will trigger additional growth, but to what extent is still subject to regulatory uncertainties,” the association notes.  

While the sector may have been seen as somewhat niche and regulatory-driven 10 years ago, CRT is now a key part of the capital management strategies of many European banks, according to Bradbury. “In the same way as you need the RMBS market to function to make sure that mortgages can be granted efficiently, you need the SRT market to function to ensure that SMEs and corporates have efficient access to funding (obviously to a different extent, however, given the relative materiality of each space),” he explains.

He continues: “This sector is complicated, technical and very idiosyncratic, but that doesn't mean it's not important. Because it's highly leveraged, the impact of a single transaction can be worth a huge amount of money to the real economy indirectly. So it does make a big difference and I think it's important for everyone to remember that.”

SCI’s Global Risk Transfer Report is sponsored by Arch MI, Man GBM, Mayer Brown and Texel. The report can be downloaded, for free, here.