The fast-growing significant risk transfer market looks set to receive a further boost as a result of the turmoil that has hit the European Additional Tier 1 capital market, according to market participants.
Amid the uproar in the wake of the rescue package assembled by the Swiss authorities for Credit Suisse, which wiped out US$17bn of the bank's AT1, there has been a surge in interest in significant risk transfer transactions, which banks use as a tool to reduce their risk-weighted assets, according to Robert Bradbury, head of structured credit at Alvarez & Marsal.
SRT is a type of securitisation in which banks offload the credit risk on a portfolio of loans to third-party investors. It can be structured as a traditional cash securitisation or as a synthetic transaction in which the investors purchase credit-linked notes. While it is difficult to quantify volumes given the market's opaque nature, researchers at Bank of America counted at least 40 transactions in 2022, almost matching the record of 41 set in 2018. The analysts said they could not be sure their database captured every transaction but were confident that it included the vast majority.
“Banks that are already issuing SRT will almost certainly have to do more, because they won’t be able to access the full suite of capital markets instruments that they could before,” said Bradbury. “Those who have previously faced pricing challenges have probably been shut out of the market entirely across the full range of instruments, potentially all the way to MREL."
The deal to stave off the collapse of Credit Suisse put the bank's AT1 holders in a worse position than its shareholders, who will receive equity in acquirer UBS, sparking consternation among bank capital investors and sending AT1 yields soaring.
Regulatory authorities in the EU and UK have scrambled to reassure investors in non-Swiss AT1s that they would not be treated in the same way, leading to a cautious recovery in bond prices, but banks’ funding costs are expected to remain higher for some time due to the series of events that started with the collapse of Silicon Valley Bank in the US.
Mitigating higher funding costs
Although SRT does not achieve the same outcome as issuing AT1 and other forms of bank capital, it can be used to mitigate weak profitability, a problem that will be exacerbated by higher funding costs, according to Gilles Marchesin, CEO of Chorus Capital, an investor that specialises in SRT.
“You can expect even more supply of risk sharing transactions, not so much as a replacement for AT1 but because the return-on-equity issues they’ve had since the global financial crisis are going to be further compounded by a rise in their cost of funding," he said.
And if AT1 and other bank capital costs remain elevated, some market participants believe it could be the final push some banks need to set up SRT programmes for their debut issuances, although not everyone is fully convinced by this idea.
“One accident in the market will not trigger a bank that has not previously issued into action,” said Marchesin. But he also said that the recent disruption in the banking industry was just the latest of several shocks – after the pandemic and the energy and inflation crises – that could collectively push more banks toward the SRT market.
In any case, it has been growing quickly, with issuance nearing a record high last year, and a new record was expected to be set this year even before the events of the past two weeks. This growth has been fuelled by established issuers like BNP Paribas issuing larger deals as well as new issuers coming to the market for the first time, as German Landesbanks Helaba and BayernLB did last year.
And although the investor base for SRT is smaller than for bank capital, Bradbury says they should be able to absorb the increase in issuance.
“Unless all banks immediately turned off the taps in every other capital tool and dramatically increased issuance, I would generally say there’s more than enough capital chasing this business for it to remain competitive,” he said. “If you’re a relatively mainstream issuer and referencing a mainstream asset type, it’s quite a deep market.”
Compared to other bank funding and capital management instruments, spreads in the SRT market have tended to be fairly insulated from upheaval in broader credit markets. But investors could push for better returns if supply continues to increase against a backdrop of generally higher funding costs.
“It bodes well for us because it means banks can pay up a little bit more on [risk sharing transactions],” said Marchesin. “There was already pressure on spreads due to the significant increase in supply over the last 12-18 months.”