Global Risk Transfer Report: Chapter six

Global Risk Transfer Report: Chapter six

Wednesday 6 December 2023 12:22 London/ 07.22 New York/ 20.22 Tokyo

In the final chapter of our report surveying the synthetic securitisation market, SCI explores new frontiers in CRT

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 6: New frontiers
Together with the resurgence of the US market, new jurisdictions and asset types are the key growth areas for CRT in the near future. In particular, issuance across Central and Eastern Europe (CEE) is set to provide plenty of opportunities, following the opening-up of the Polish market to private investors last year.

The introduction of the STS synthetics regime was the key to unlocking SRT in Eastern Europe. “Without STS, it is very expensive for standardised banks to do transactions because you’ll need to place extremely thick tranches,” explains Olivier Renault, md and head of risk sharing strategy at Pemberton Asset Managers. “The only market participant that could do a transaction at an efficient price was the EIF. Now with the STS framework, you can do a transaction at economical cost of capital with private investors.”

The first transactions with private investors in Poland were funded structures, such as mBank’s debut synthetic securitisation – Project K2 - in March 2022. The STS deal was structured as a direct CLN, with the aim of supporting the development of the bank’s corporate and retail banking franchises.

Getin Noble Bank’s CRT – a funded first loss guarantee referencing a static portfolio of housing community loans - followed in July 2022. The transaction was one of a handful of standardised bank SRTs sold to private investors and enabled a significant reduction in risk weighted assets for the reference portfolio of more than 80%.

CEE challenges
While Renault now expects a general rollout of SRT to smaller banks across Europe, within CEE, moving beyond Poland could be challenging. “A lot of people are very comfortable with the Polish economy. It is much more difficult for some of the other countries. The banks are smaller and maybe the economic prospects are not as attractive.”

The current limitation, observers suggest, is that Poland is the only market with reasonable volume, accessible for institutional investors. But there are difficulties even there.

“One key challenge with Poland is the currency. It's quite volatile and not many investors have native złoty,” says Robert Bradbury, md and head of structured credit execution at Alvarez & Marsal.

He adds: “In every other CEE country where SRT has not already taken off, the market is smaller – and, in many cases, there isn't an equivalent securitisation framework. So, you've got some fairly fundamental roadblocks to CEE SRT outside the development banks.”

On one side, potential CEE SRT issuers are likely to begin with low-risk portfolios, such as residential mortgages, although diversified corporate portfolios could be another option. Tranching is also expected to be more conservative.

On the other side, potential CEE SRT investors will have to grapple with currency hedging, data availability and the fact that many of the local banks are not under the IRB approach. Another wrinkle was Getin Noble Bank’s bankruptcy in September 2022, which – although its SRT transaction remained unscathed – highlighted the risks investors have to consider when dealing with smaller and less experienced issuers in a relatively uncharted territory. 

Consequently, activity across the region is likely to continue to be dominated by EIF transactions. Together with the EBRD and the EIB, the EIF has been pushing for similar trades in places like Bulgaria and Romania.

“The EIF is likely to continue being the dominant player, as long as they have the capital to do it. They're still a lot cheaper than the private market. Their role should be to do transactions where a private market solution doesn't work - which has been the case for many CEE transactions; in particular, before the STS framework was introduced,” says Renault.

EIF activity
In the last 18 months, the EIF closed its first synthetic transaction in Bulgaria, with one of the largest banks in the country, UniCredit subsidiary Bulbank. The transaction was carried out under the European Guarantee Fund mandate, which was launched in late 2021 and had a short deployment period, until June 2022.

“It allowed us to invest in junior pieces for the first time, rather than our usual bread-and-butter mezzanine protection. We were able to deploy almost €1.4bn in investments,” says Georgi Stoev, head of Northern Europe & CEE securitisation at the EIF.

The Bulbank transaction had a very strong signalling effect. “We managed to close one more transaction in Bulgaria this June, with ProCredit Bank for around €300m. After they heard about the main Bulbank transaction, they decided to try it out for themselves. We started discussions in autumn 2022 and in June, we concluded a transaction,” explains Stoev.

The EIF is at an advanced stage with another banking group in Bulgaria, with whom it expects to sign a transaction this month (October 2023), while another transaction in Romania is anticipated towards the end of the year. The first Romanian transaction was with Deutsche Leasing in early 2021; then the EIF entered into a transaction with Raiffeisen Bank, Romania, in December 2022.

“We start the market and then we see the snowball effect,” observes Stoev. “It’s the same recipe we followed in Poland. Competitors of the first banks that concluded securitisation transactions with us followed suit.”

He continues: “We will keep on playing our role as an anchor investor. It sparks interest from hedge funds and insurance companies on the back of our initial deals.”

The next frontiers could be Croatia and Slovenia - EU countries where the EIF has yet to transact. The EBRD recently executed a transaction with Raiffeisen Bank Croatia, featuring a €25.6m unfunded mezzanine guarantee, which is smaller than the EIF’s typical appetite for transactions (in excess of €50m).

But Stoev says the trade “shows that those countries do have interesting prospects”. He adds that the EIF is discussing more potential transactions on a preliminary basis with several banks from these regions.

“Countries that have a local currency, but also have long exposures denominated in euros create some difficulties when the transaction is being structured. But for Slovenia, this is not an issue. I would expect either a Slovenian or Croatian transaction with our participation over the next 12 months,” he confirms.

Certainly, Arch MI is bullish on the prospects for CEE countries. “We've already seen increased issuance, but there are challenges for us to overcome in those markets,” says Michael Bennett, chief underwriting officer, European Mortgage at Arch Capital. “In some of the countries, the banking environment hasn't been established as long as in Western Europe. Obtaining a long time series of default and loss data, including data during a period of stressed market conditions, can be challenging in those countries.”

But he notes “that investors are able to negotiate the composition of assets in the pool and concentration levels to help mitigate those risks and enable transactions to be executed successfully”.

Stoev agrees that opening up smaller countries is challenging and they typically have more difficulty in attracting foreign or private capital. “But I could very well see the setting up of regional funds. During my meetings with hedge funds and pension funds, I see they start to grow their interest outside Poland. It will take some time, but I'm confident that one day we would see a market where private and public capital would transact equally in these markets.”

The EIF is as active in Central, Western and Southern Europe as it is in Eastern and Southeastern Europe – Greece, Bulgaria or Romania – he stresses. “I can't see transactions in the smaller countries eclipsing the amount of debt we deploy in Spain, Italy or Germany. But we are exploiting each opportunity that we have after a signal has been sent to the market, typically by a particular transaction.”

Supranational issuance
While institutions such as the EIF invest in SRT transactions, multilateral development banks (MDBs) and development finance institutions (DFIs) represent a potentially major new class of issuers. Alan Ball, director, structured and bespoke solutions at the Texel Group, notes: “The unfunded credit insurance market has a long, well-established track record of providing huge amounts of risk transfer to these institutions. The credit insurance market knows the sectors, asset classes and institutions in this space extremely well and perhaps better than any other investor base for these transactions. The insurance market is also able to offer pricing that is much more consistent with the concessional lending that these institutions engage in.”

An area where Texel has been particularly active is using credit insurance to ‘crowd in’ private capital from sources that would otherwise not support the MDB sector. “We’ve set several market firsts in this regard and much of the know-how we’ve developed is readily applicable to CRT transactions. Addressing the capital needs of such institutions is increasingly important, given the expectations placed on them as a result of inter alia the UN’s Sustainable Development Goals,” notes Ball.

He continues: “We’ve often mentioned the scale the insurance market can bring and the associated benefits when approached and managed well. Our work in the DFI sector shows the scale of this potential, where we’ve now arranged several transactions for different DFIs, each of which have provided cover for transactions approaching half a billion dollars.”

Global appetite
In terms of new geographies, investors appear to have appetite for transactions from issuers in the Middle East and Asia. More jurisdictions are expected to implement regulatory frameworks that enable CRTs, following the trend seen in Eastern Europe and Canada.

“I’d love Australia to open up, but the regulator is not signing off on transactions at the moment. Hopefully, it will look at the adoption of SRT technology across the world and change its position,” Renault remarks.

Meanwhile, issuance is expected to continue to be dominated by corporate portfolios. But the market might start to see more assets emerging where the risk weight has changed – for example, under Basel 4 – such as high loan-to-value mortgages.

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.

EIF as anchor investor
The EIF is a countercyclical investor, with a clear policy objective of supporting new issuers and new countries. The fund can be present in markets without the establishment of a securitisation framework. Additionally, the fund’s size threshold and timeframe are such that it can focus on deals where the private market is not necessarily comfortable with the jurisdiction or asset class.

The EIF has historically focused on SMEs, but tries to be flexible in terms of accommodating mixed portfolios, especially when it comes to smaller originators in smaller countries. For example, the Bulgarian transaction that is expected to complete this month comprises close to 50% consumer assets, as well as SME assets.

“If we see that the SME portfolio by itself is not sufficient for a meaningful transaction, then we would revert to other asset classes,” explains Georgi Stoev, head of Northern Europe & CEE securitisation at the EIF. “Occasionally, with bigger originators across Europe, we also do 100% mortgage transactions. We will enter into 100% consumer transactions or 100% auto loan transactions.”

The EIF’s use-of-proceeds concept means that as long as the new portfolio is composed of new SME assets, the fund can proceed with a transaction. Indeed, its mission is to open up new markets with counterparties for whom securitisation transactions may be more difficult to execute.

“Importantly, we make sure that the capacity we provide to originators is deployed for the SME sector, the backbone of the economies in the respective jurisdictions. We see now a very well-functioning Polish market, where originators execute transactions with us, as well as with private money. That wasn't the case 10 years ago,” Stoev adds. 

The EIF is also stepping up its efforts in respect of ESG transactions. For the total portfolio of transactions that the fund originates each year, at least 20% of the assets must be ‘green’.

Furthermore, in the Alba 13 SPV transaction from July, Alba committed to at least 20% of the new portfolio resulting from the EIF’s investment to loans extended towards female entrepreneurs. “I could see us including this requirement in CEE transactions. It could be 20% green assets and 5%-10% in loans that are granted to SMEs owned by female entrepreneurs,” Stoev suggests.

The EIF’s role will continue to evolve, he says, while staying true to its purpose. The fund has three main strategic pillars, the first of which is the use-of-proceeds concept, in order to ensure that lending is allocated to policy supported areas such as green lending or gender equality.

The second pillar is to facilitate the European capital markets union, whereby every country is able to deploy not only SRT, but also true sale transactions - which are equally as important, especially in the current high interest rate environment. “Being able to deploy securitisation instruments without being precluded by factors, such as lack of investor interest or lack of track record, is vital,” Stoev explains. “We want to make sure that there is enough track record in each market to allow private capital to feel more comfortable and further develop these markets.”

The third pillar is about enabling both larger and smaller originators. “With our investment book, we have proven that both larger and smaller originators are able to come to market equally successfully. We want to show our competitors in insurance companies, pension funds and hedge funds that this is possible and economically viable,” Stoev concludes.