The third of five essays compiled in SCI's inaugural SRT Journal investigates whether CRT market terms will ever standardise

An increasingly favoured solution to banks’ capital needs, the US CRT market is poised for substantial expansion. However, for the CRT market to be scalable to smaller banks and smaller investors, market terms need to standardise.

Historically, Citi has been a regular US SRT issuer, while JPMorgan and Goldman Sachs have tapped the market periodically. However, over the last 12 months, regulatory tailwinds (combined with the failures of Credit Suisse, Silicon Valley Bank and First Republic, and increased interest in ways to better manage regulatory capital without selling assets below par) have permeated down to regional banks. Equally on the investor side, the stable and attractive returns that the CRT asset class has delivered over the years have made risk-sharing transactions increasingly popular.

Scalability
In practice, a CRT transaction is executed either through the issuance of a credit-linked note (i.e., a debt security) or a guarantee (e.g., credit insurance) or through the execution of a credit default swap. As part of the execution process, each of these documents is highly negotiated between the issuing bank and the initial investor(s) or counterparty.

For example, in a classic funded CDS structure, originator and investor enter into a bilateral credit protection contract. This instrument may be drafted as a guarantee or credit derivative. In turn, investor pledges collateral in favour of the originator to a value at least equal to its maximum possible payment obligations under the protection, and is only paid to the originator (or available by way of enforcing the pledge) as and when losses hit the protected tranche. Alternatively, the collateral may be transferred outright and returned to the investor minus losses at maturity.

Even for similar deals (e.g., prime auto), the terms vary widely based on the positions of each party. This is unlike other areas, such as MRAs (a Master Repurchase Agreement is a standardised agreement used in the United States for repurchase transactions, also known as repos) and ISDAs (ISDA Master Agreement, a standardised form agreement that is used to document OTC derivatives trades), where standardised documents see little change in most transactions.

In very simple terms, the CRT trade makes sense for the originator if the cost of funding the securitisation, taking into account its capital saving, is cheaper than funding the assets on balance sheet. Therefore and conceptually, for the CRT market to be scalable to smaller banks and smaller investors, market terms need to standardise, and with that negotiation costs should drop considerably.

A buyer’s market
Commenting on the recent broader CRT market developments in the US, Julie Gillespie, partner at Mayer Brown, highlights increased and substantial activity for the past two years, in line with the widely accepted view that the (re)entry of US banks provided a catalyst for growth for the CRT market as a whole. Regarding any potential standardisation of market terms, Gillespie notes: “Market terms for many asset classes within CRT still haven't standardised. In fact, I would not say it's been a quick process or that we are particularly close to standardisation within certain asset classes.”

She adds: “Regarding auto deals for example, I would argue that recent structures have tended to standardise more and to follow or align with the traditional securitisation documentation. However, within other asset classes, such as subscription loans, commercial loans and CRE deals, we have not witnessed a lot of standardisation. Therefore, I think that we are still a long way off from experiencing some comprehensive standardisation.”

As she further expands on recent market developments, notably in the last 18 months, Gillespie argues that the CRT market is still a “buyer’s market”. On this matter, investors have repeatedly reported that, although the market is experiencing continuous growth, there is still a fundamental imbalance between supply and demand and a lot of untapped potential.

Gillespie says: “Unsurprisingly, there is currently a lot of investor interest. Therefore, in terms of standardisation, we are still seeing protection buyers really improving on deals that they got six months ago or a year ago. Consequently, I feel that this is an area where, even if an issuer executed a deal at the end of 2023, the terms they're looking for today may be very different.”

Sagi Tamir, partner at Mayer Brown, further identifies the market’s apparent lack of maturity, as a clear hurdle for any imminent standardisation. He says: “Typically, for any product terms to standardise, in part, what you need is maturity of the product, and you need the deals that are being executed to be relatively public. They don't need to be public in the sense of a public offering, yet the more confidential they are, the harder it is for a product to standardise.”

He continues: “And so if you look at the US market, there is still a meaningful number of deals that in terms of confidentiality or free access to deal information versus complete transparency to all market participants (including those not participating in a given CRT transaction), the market is still more on the confidential side of things. Unsurprisingly, that gets in the way of standardisation. Therefore and reiterating what Julie mentioned above, I agree that we are ways off standardisation, except for certain asset classes that truly are being executed along the lines of a mature ABS programme.”

Market maturity 
Essentially, for market terms to standardise, it follows the linear logic that the market has to grow in maturity. Tamir adds: “Also one has to remember that, compared to its European counterpart[1], the US CRT market has ways to go to become a mature market. Additionally, a lot of banks have done and completed their first US deal in the last 24 months. Therefore it takes time for cross-pollination to operate and to start seeing true standardisation across banks.”

However, the maturity and trajectory of the US CRT market is often tied up with the regulatory uncertainties surrounding the regulatory regime, namely decisions around Basel 3 endgame and the imminent Presidential election. Nevertheless, as current conditions remain very favourable to banks, the phenomenon of a protection buyer's market – as is the case at the moment – persists.

Market growth is often self-fulfilling. Issuing a first time CRT deal requires considerable effort and internal coordination, especially for banks below the largest tier.

Moving forward, Tamir expects the snowball to start rolling down the hill. He says: “I am very optimistic as I think the fundamentals are there. We see the second, third, fourth tier banks looking to understand the product and its merits. Once a bank has completed an inaugural transaction, repeat issuance is much easier (and more affordable due to the amortisation of program setup costs). Based on the numbers of calls and the level of interest we are handling, I fully expect the market to keep on growing.”

Vincent Nadeau

SCI’s SRT Journal is sponsored by Arch MI and Mayer Brown. All five essays can be downloaded, for free, here.