In the final chapter of SCI's survey of the synthetic securitisation market, we examine the sector's prospects for the future
Synthetic securitisation, once tarnished by association with the global financial crisis, has long since come in from the cold. The regulatory framework has developed significantly in Europe since the introduction of the new European Securitisation Regulation in January 2019, culminating in the inclusion of significant risk transfer transactions in the STS regime in April 2021. This label has provided CRT deal flow with additional momentum, broadened the issuer base and helped to legitimise the market.
So, how has the landscape evolved since then? While Europe has historically been the centre of CRT activity, what are the prospects in the US and beyond? SCI’s Global Risk Transfer Report traces the recent regulatory and structural evolution of the capital relief trades market, examines the development of both the issuer base and the investor base, and looks at its prospects for the future.
Chapter six: prospects for the future
Regulatory change has been a key driver of growth in the CRT market to date, but it is now expected to take a back seat. All eyes are on how the current macro themes will play out and the implementation of Basel 4.
“The outlook for the CRT market heading into 2023 and 2024 will most likely be dominated more by changes in credit conditions under the macro themes that are currently evolving. The regulatory aspect will probably be secondary, as the vast majority of regulatory items for the coming years are now well understood by market participants,” suggests Andrew Feachem, md at Guy Carpenter.
Raising capital in the equity market would be very expensive for banks amid the current volatile market conditions. As such, from a relative cost standpoint, SRT appears to be very attractive.
“Banks are once again faced with headwinds in relation to their earnings and capital ratios. They need to more actively manage their capital, as the environment remains very uncertain,” notes Kaikobad Kakalia, chief investment officer at Chorus Capital Management.
He adds: “For banks that have not issued SRT transactions previously, this is a wake-up call. This is exactly what they should be doing to manage RWA volatility at an efficient cost of capital.”
One major regulatory item remaining is the implementation of the new Basel 4 regime, which was originally intended to begin on 1 January 2022, with a phasing-in of the output floor to 1 January 2027. In March 2020, in response to the pandemic, the Basel Committee deferred the implementation timeline by 12 months to 1 January 2023.
The capital treatment of securitisations under the standardised approach are seen as quite punitive. Olivier Renault, md, head of risk sharing strategy at Pemberton Asset Management, describes the Basel 4 output floor as his “bugbear”.
“The Basel 4 floor means that a bank calculating capital under its own internal model cannot have an amount of capital which is less than 72.5% of the capital under standardised. The standardised methodology for securitisation is 72.5% of a very big number because the risk weights on securitisation under the standardised approach are very high. That makes these transactions far less efficient,” he comments.
Feachem agrees, suggesting that this will again lead to thicker tranching requirements. He comments: “As Basel 4 beds in, and with the continued maturation of the SRT market, we again see an important role for (re)insurers to play here combined with participation from real money funds.”
New jurisdictions
While the impact of Basel 4 is yet to be fully understood, ultimately it is expected to increase the capital need across bank portfolios, resulting in greater incentives to issue CRTs. At a high level, Seamus Fearon, Arch MI evp, CRT and European markets, says he is bullish about the growth of SRT in Europe. He expects existing issuers to carry out more transactions in greater volumes, as well as first-time issuances across new jurisdictions and banking groups, as banks seek to reduce their overall cost of capital.
“As an SRT investor, I think that the Basel 4 regime is likely to be a good thing as bank capital needs increase. It will be good for the overall health of the banking sector to diversify and reduce systemic risk through SRT. As an investor, if there are more deals in the market, it increases the choices you have and puts upward pressure on pricing,” Fearon observes.
He continues: “From a country perspective, you could probably see more transactions in the peripheral regions of Europe - the Baltics, Scandinavia and Eastern Europe. We’ll also see more where there has been strong issuance; predominantly Western European countries.”
This year has already seen the first-ever synthetic securitisation referencing buy now, pay later exposures from Nordic lender Klarna. And a housing community loan STS deal issued by Polish lender Getin Noble Bank broke new ground in a number of ways: one of a few standardised bank transactions sold to private investors, it was denominated in Polish zloty and featured an ESG component, given that the assets are linked to heating efficiency upgrades.
Another standout deal of the year was BNP Paribas’ Resonance Seven from July, which referenced a €13bn global corporate portfolio, representing the largest-ever CRT issued. The pricing of the seven-year €663m mezzanine tranche was described as “phenomenally tight”.
Overall, in 2022, SRT issuance continued apace - despite unfavourable conditions in the broader securitisation market – largely due to the ability to customise transactions. Issuers and investors have adapted their approach to executing CRTs to reflect volatile market conditions, Fearon notes, by excluding certain sectors and industries. Investors are also able to negotiate more in terms of pool composition and concentration.
Feachem cites parallels with 2020 in how issuers and investors are responding to the current challenging environment. “Depending on the nature of the underlying portfolio, banks will be flagging loans or sectors that are more impacted by the macroeconomic and geopolitical backdrop, with investors seeking to reduce single name and industry concentrations to those impacted exposures within the SRT.”
He adds: “We have seen risk-takers seeking shorter replenishment periods and more conservative tranching, again in line with 2020. However, while primary and secondary pricing of SRTs has been less volatile than, for example, CLOs, we have seen levels widen in a more sustained way than during Covid.”
Looking ahead, ArrowMark Partners partner and portfolio manager Kaelyn Abrell is optimistic about the market’s prospects. “Overall, the current market is offering a wider variety of transactions, which translates to increased opportunities for us. The ability for banks to issue transactions with differing characteristics also contributes to their ability to achieve various objectives on a greater variety of assets. Investors need to tailor their diligence appropriately, but we believe a wider universe of options is a positive for the broader market.”
SCI’s Global Risk Transfer Report is sponsored by Arch MI, ArrowMark Partners, Credit Benchmark and Guy Carpenter. The report can be downloaded, for free, here.
*For more on the outlook for global risk transfer activity, watch a replay of our complimentary webinarheld on 2 November.*