In the fourth of six chapters surveying the synthetic securitisation market, SCI explores supply and demand trends in SRT

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 4: Supply and demand
The turmoil in the US regional bank sector and failure of Credit Suisse – and the subsequent write-down of its AT1s – in March has been viewed by some as an opportunity for CRT market participants, as banks seek new ways to manage their capital requirements. The situation has also emphasised the robustness of CRT transactions as an investment, given that the product continued to perform as expected.

“Credit Suisse was one of the most active issuers of SRT transactions and nothing has happened to the performance of the deal. It is another example of a bank going through resolution that was an issuer of SRT transactions and where the transactions have continued to perform,” says Olivier Renault, md and head of risk sharing strategy at Pemberton Asset Managers.

He adds: “It is great to be able to demonstrate to investors that this is not investing in bank equity or bank additional tier one. This is a completely different product.”

SRT transactions are not part of a bank’s liabilities, but rather a credit hedge that references a specific portfolio on its balance sheet. As AXA IM Alts points out in a recent note, entitled ‘SRT: poised for further growth’, the protection provided for those loans is in the form of collateral which can be posted either with the issuing bank or a third-party bank.

“This SRT collateral is akin to senior-ranked debt or uninsured deposits and is expected to rank above equity, AT1s and other debt held by the bank,” the note states.

However, that doesn't rule out the risk that the regulator of another bank might decide to bail in more of the capital structure of the bank and start to hit the senior depositors or the senior debt holders - in which case, that could affect the SRT market. “The approach most investors are taking is that it is very unlikely that the regulator would not intervene to find a solution for the depositors and the senior debt holders for systemic banks. That's what happened with CS and with other banks,” Renault says.

Although investors are incrementally more interested in the asset class, Matthew Moniot, md and co-head of credit risk sharing at Man GPM, says that his firm has fielded questions about the differences between structural, contractual and statutory protection and hierarchy of instruments in the capital structure. “Bank resolutions serve to remind us that banks can get into trouble. But many people seem to believe that SVB and CS went bankrupt,” he observes.

He continues: “In fact, banks don't go bankrupt – they get put into resolution or forced into sale. Both SVB and CS were acquired by other entities. From the standpoint of SRT investors, neither episode implied meaningful risk.”

Certainly, the AT1 market is now incrementally more expensive. “I’m not sure investors have taken on board that AT1 is not really senior to equity. As they do, to the extent that AT1 competes with SRT, banks may well decide SRT is the better option,” Moniot adds.

Counterparty risk
Following the Silicon Valley Bank and Credit Suisse failures, some investors have sought reassurance about taking on bank counterparty risk in SRT structures, in addition to the underlying asset risk. Indeed, Moniot stresses the importance of ensuring that counterparties are properly understood.

“The more complicated the banking system is, the more people think about issuer credit risks. That’s helpful to the SRT asset class,” he observes.

Some market participants have raised the prospect of the aftermath impacting issuance from smaller banks, with investors apparently perceiving larger institutions to be less risky. In response, smaller or newer issuers can bring deals where the cash is deposited with a third-party custodian.

Renault confirms that there is bifurcation between the bigger, more solid and systemic banks and the smaller institutions, where investors are seeking ways to hedge or mitigate the risk. “This hasn’t stopped the smaller banks doing transactions, but the focus on bank risk has increased,” he says. “We agree on a security package that hedges the bank risk. For example, instead of depositing the collateral with the bank itself, it may be best to put it with another bank or collateralise it with securities like ABS or covered bonds.”

Jack Thornber, broker, structured and bespoke solutions at The Texel Group, agrees: “Notwithstanding the challenging economic climate, small and regional banks across Europe, particularly the newly emerged so-called ‘challenger banks’, continue to explore – and investors continue to express interest in – trades intended to secure capital relief and this trend looks set to continue. The notion that CRTs are only viable for those banks that boast multi-billion dollar balance sheets and the ability to execute numerous trades backed by portfolios of over €500mn is becoming less universal.”

Across the Atlantic, regional banks in the US still need a lot of capital and raising other forms of capital remains expensive.

Michael Bennett, chief underwriting officer, European Mortgage at Arch Capital, suggests that, large or small, it’s the options for issuers and investors to customise CRT transactions that are key. “The attractiveness of SRT as a tool to access capital has likely increased compared to AT1 bonds. The ability of insurers and their investors to customise SRT transactions in terms of the eligibility criteria and the composition of the assets in the pool, and also the ability to customise the structural features of the transaction are very valuable,” he says.

He continues: “During volatile market conditions, deals can be executed which meet the investors' risk appetite and still meet the objectives of the banks. The customisable nature of the product has enabled them to withstand market volatility.”

One example of a structural feature that can be adjusted is the replenishment period, which can be shortened to reduce the term of the exposure. “Where market conditions are volatile, it can be an effective way to customise the transaction to satisfy investor demand,” Bennett concludes.

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.