The securitisation primary market is poised for a boost as banks explore this corner of the credit market to optimise their balance sheets while they brace themselves for stricter US capital rules.
Lenders navigate capital requirements through the structured finance market in two ways: securitising loans to raising funding and reducing their balance sheet exposure, thus cutting the capital required to protect against potential losses, or alternatively, selling credit-linked notes to transfer credit risk to investors, again freeing up capital.
"This is a bigger trend in the market where banks are looking to access various sources of capital and parts of the credit market," said Joseph Lau, chief operating officer at Lord Capital.
Banks are developing strategies to manage their balance sheets in the wake of a sweeping proposal unveiled by regulators in July, which would increase the capital requirements for large banks by a total of 16%. The proposal, intended to safeguard the banking system, emerged followed the collapse of Silicon Valley Bank in March. Regulators are gathering public comments on their capital proposal until November 30; they aim to have the requirements fully phased in by July 1 2028.
While the banking industry faces a likely capital squeeze from tighter regulations, it is already being pinched by soaring funding costs from declining deposits and the Federal Reserve's interest rate hikes since last year.
Amid this challenging climate, there are signs that the largest financial institutions are preparing to ramp up fundraising in the securitisation market.
JP Morgan, the biggest US bank by assets, plans to securitise more loans in anticipation of higher capital requirements, the Financial Times said on Thursday, citing people familiar with the matter. The New York-based lender made US$1.3trn of loans in the second quarter, which was up from US$1.1trn a year earlier.
Securitisation is a tool to optimise JP Morgan's massive balance sheet, but it is not a silver bullet for the bank to achieve the proposed capital levels, said a source familiar with the bank's capital planning.
Of late, the bank's asset-backed issuance has been modest. It has issued US$2bn in credit card-backed bonds and a US$472.2m auto loan deal, according to IFR data.
Bank of America this summer came back with its first auto ABS issue in more than a decade. The self-led offering raised US$913.9m. It also issued a US$1bn credit card transaction in June.
JP Morgan declined to comment about its securitisation programme. Bank of America did not immediately respond to a request for comment.
As banks mull whether to increase securitisations of assets, they received some clarity last week on another possible tool they can deploy to free up capital.
On September 28, the Federal Reserve via a post on its website signalled that banks can obtain capital relief if they issue credit-linked notes. These securities, which reference pools of loans, allow banks to transfer some of the default risk to investors. Investors receive attractive yields to own the paper in exchange for taking principal losses from rising loan defaults.
"A lack of clear guidance from US bank regulators has limited use of CLNs in the past, but the recent comments from the Fed may give new life to the sector," Santander's head of bank strategy Tom O'Hara wrote in a research note.
Even before the Fed came out with its CLN guidance, JP Morgan tested the water with investors in Europe. It arranged a securitisation that transfers credit risks from a €2bn portfolio of European leveraged loans, IFR previously reported.
In the US, CLN issuance has been scant this year. Of the few US credit-linked securities that have been priced since January, Santander issued one deal to transfer credit risk from US$1.1bn of auto loans, according to Moody's and another one from US$2.53bn of mortgages, according to Fitch.
To be sure, it is likely to take time for more US CLN supply to come to market as banks decide that it is economic for them to issue them, market participants said.
“It’s sort of late in the year to do a deal if you haven’t completed a lot of the work already. We are likely to see a wave of issuance early to middle of next year,” said Terry Lanson, managing director at investment firm Seer Capital.