In the fifth of six chapters surveying the synthetic securitisation market, SCI examines trends in the North American CRT market

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 5: North America
North America has, for the last 18 months or so, shown a stark contrast in the treatment of CRTs. The US private CRT market paused last year, due to apparent distaste from the Federal Reserve, thought to be related to CLNs. The Canadian market, meanwhile, is booming.

Three new Canadian banks joined perennial issuer Bank of Montreal (BMO) to tap the CRT market over the last year. “Canadian banks have been active now for over five years, with a lot of different programmes. With the current economic backdrop, it seems reasonable that regulators might consider stress testing various interest rate-sensitive asset classes,” suggests Matthew Moniot, md and co-head of credit risk sharing at Man GPM.

These would include commercial and residential real estate, leveraged finance and commodities. “It’s not particularly surprising that Canadian banks are thinking seriously about their balance sheets. SRTs serve as a useful tool for banks to net down such risk,” Moniot adds. 

BMO has been in the market since 2017 and saw record issuance in 2022. So far this year, Toronto Dominion Bank (TD), Canadian Imperial Bank of Commerce (CIBC) and Bank of Nova Scotia (BNS) have also issued debut transactions.

One source suggests that Canada is probably the best example of CRT becoming very relevant when regulatory pressures reach a certain critical point. Canadian banks rushed to issue after the Office of the Superintendent of Financial Institutions (OFSI) brought forward to 1 January 2023 the implementation of Basel 4 and the output floor in the jurisdiction. This was followed by an increase in the Domestic Stability Buffer (DSB) by another 50bp to 3.50% in June - only six months after it had been increased to 3%.

Vesna Vladusic, a broker in the structured and bespoke solutions group at The Texel Group, says that the increase in Canadian activity demonstrates the attraction of CRTs. “SRT transactions are a highly efficient capital management tool. As more onerous capital requirements are phased in, it is increasingly important for banks to make sure they’ve established the necessary infrastructure and systems to execute these transactions. With the precedents already set in Canada and the front-loading of the output floor, it’s not surprising that Canadian banks want to make sure this tool is available to them,” she observes.

BMO’s most recent foray into the market is expected to close this month (October 2023). Market sources told SCI that the trade is from its well-established Algonquin platform, which references pools of US and Canadian dollar-denominated loans to SMEs in both countries.

BNS, a standardised bank, sold its first CRT in July, with BNP Paribas as arranger – a securitisation of investment grade loans, in a transaction dubbed Granville USD. TD brought a deal in February, while CIBC issued its debut transaction in April.

Basel endgame
Meanwhile, the US may be moving on from the Federal Reserve-induced pause in CRT activity among large banks. The Fed, FDIC and OCC’s proposed final implementation of Basel 4 (dubbed ‘the Basel 3 Endgame’), introduced at the end of July, as well as the Fed's FAQs on CLNs from September are seen by many as encouraging signs.

“There's an implicit recognition in the Basel 4 proposal that CRT can be used to benefit banks. The proposal is not the full-throated endorsement that we wished for. But it also doesn't prohibit CRT, and it doesn't include any other factors that would make it more difficult,” says Sagi Tamir, partner at Mayer Brown in New York.

He adds: “For the banks who are subject to the proposal and FAQs, there is some degree of comfort that the regulators are at least willing to consider their requests.”

Jon Imundo, md and co-head of credit risk sharing at Man GPM, suggests that the turmoil surrounding bank failures earlier this year provides further impetus for regulatory action. “I think it’s possible we will see the Fed provide some incentive to banks to start issuing more programmatically. Having an approved structure is really helpful; it allows banks to issue more securities with different types of collateral, and it can provide different solutions. Those solutions can create different kinds of transactions and therefore different opportunities.”

Indeed, risk transfer is starting to branch out into areas that might address other bank needs, such as internal risk limits. “I think the market will continue to grow beyond just the traditional capital side of the equation. Ultimately, there's a unique opportunity to create attractive risk-adjusted returns for investors that solve various different needs for banks across internal risk limits,” Imundo adds.

Capital rule
However, one striking recent development is that US regulators appear to be heading in the opposite direction to the EU when it comes to the capital treatment of securitisation. The Basel 3 Endgame proposal to increase the p-factor from 0.5 to 1.0 means that risk weightings applied to the more senior segments of the capital structure do not descend as rapidly. Consequently, to achieve optimal risk weightings, credit enhancement must be increased.

“The proposed final implementation of the Basel 3 Endgame contains a lot of new things that the banks are going to need to digest. There are some really positive developments from the SRT market point of view, in the sense that proposed regulatory changes are going to push up capital consumption on balance sheets even more in the US by removing the ability of banks to use their own models to calculate capital. The regulators themselves expect the changes to create significant capital needs,” observes Olivier Renault, md and head of risk sharing strategy at Pemberton Asset Managers.

He continues: “On the other hand, the treatment of securitisation - not specifically SRT, but in general - is going to be less favourable, as the current proposals roll out a risk weight formula which is less efficient than the current one used by US banks. At the moment, it's just a proposal from the regulator and this will be intensely negotiated and lobbied. Stakeholders have 120 days to provide feedback; then the regulators will take that feedback into account.”

But in a joint letter to the US Fed, FDIC and OCC filed in mid-September, the Bank Policy Institute, the American Bankers Association, the Financial Services Forum, the Institute of International Bankers, SIFMA and the US Chamber of Commerce called for a re-proposal of the regulatory capital rule, in order to remedy what the trade associations claim are violations of the Administrative Procedure Act (APA). The letter states that the proposed regulations would significantly increase capital requirements for larger banks, yet the rule repeatedly relies on data and analyses that the joint agencies have not made available to the public. As such, the associations suggest that this reliance on non-public information violates clear requirements under the APA that agencies must publicly disclose the data and analyses on which their rulemaking is based.

Because of such “critical procedural deficiencies”, the associations say they are unable to fully and properly comment on the proposal at this time. Accordingly, they have requested that the agencies make available all evidence and analyses that was relied on in proposing the rule and re-propose the rule with a new comment period.

Nevertheless, the expectation is that the proposal will lead to regulatory changes that will be implemented from July 2025. This could lead to US banks bringing transactions ahead of those changes with regulatory call language, or potentially some waiting to see what the final rules will look like before executing.

Julie Gillespie, co-head of Mayer Brown’s structured finance practice, notes that for the vast majority of smaller US banks, not subject to the proposal, there is still a lot of opportunity for CRT. “Those banks have traditionally had less scrutiny, fewer regulatory requirements and more permissive supervision. They have been more willing to utilise CRT. I see a lot of growth in the US smaller regional banks market because those banks will be well positioned to be CRT partners,” she 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.