Insights from the SCI Workshop
The European market for synthetic securitizations and Significant Risk Transfer (SRT) transactions continues to mature and expand, as evidenced by the large turnout at the Structured Credit Investor event in London. While 2022 and 2023 saw a strong global issuance of SRT transactions, Europe is expected to maintain momentum in 2024. However, issuance in the U.S. has fallen short of expectations. Over the past 18 months, credit spreads have narrowed significantly, with new investors and banks entering the market. Notably, spread compression has been most pronounced in the large corporate segment, which has historically priced wider than SME deals, yet recently, corporate spreads have tightened beyond those for SMEs.
In the current environment, corporate SRT deals are more likely to cover first-loss tranches, while SME transactions tend to involve mezzanine tranches, sometimes accompanied by synthetic excess spread (SES). Strong investor demand has allowed banks to lower the overall quality of their loan pools by including more Stage 2 loans (loans experiencing significant increases in credit risk). Another emerging trend is the rising popularity of unfunded structures, which offer flexibility, particularly for ramp-up portfolios or those referencing future cash flows.
U.S. Market Dynamics
The U.S. SRT market experienced a boost after the Federal Reserve’s FAQ publication in mid-2023, which ignited a surge in trades. However, uncertainty surrounding the upcoming election and ongoing regulatory ambiguity have tempered issuance in 2024. Unlike the European market, U.S. banks must purchase protection on thicker tranches due to the prevailing standardized risk weights and the simplified supervisory formula. Large, systemically important banks have been the dominant players in this space, while regional banks have lagged, partly due to challenges in finding suitable portfolios and building the necessary performance data and reporting infrastructure.
Auto loans remain a promising asset class for SRT in the U.S., given their relatively high risk weights despite low economic risk. However, overall activity among regional banks has been limited, hindered by regulatory uncertainty around the Basel Endgame implementation.
Regulatory Developments in Europe
In Europe, regulatory conditions have improved, though concerns remain about the Basel IV output floor. The recently reduced p-factor calculation offers some relief but is only a temporary measure. Risk-weight floors for senior retained tranches are still a topic of debate among industry participants. As of today, more than 70 banks have utilized SRT transactions, some to such an extent that regulators are considering imposing limits on the capital relief that can be achieved through SRT.
At the workshop, various investor types—credit and pension funds, insurance companies, and Multinational Development Banks—emphasized their commitment to supporting issuers “through the cycle” and building long-term partnerships.
The European Market and Bank Valuations
One major theme that emerged during the workshop was the persistent price-to-book discount among European banks, which remains below 1. SRT was presented as a tool to potentially narrow the valuation gap between European and U.S. banks, but some scepticism remains. While SRT can indeed help improve capital ratios and return on equity, it also increases leverage and may reduce net income. For banks accumulating low-risk, low-return assets, merely reducing capital charges is unlikely to drive meaningful improvements in valuation multiples.
Investor Concerns and Practices
Investors also debated the broader implications of SRT transactions. Some raised concerns about banks offloading credit risk to credit funds, while simultaneously providing leverage to those same funds on a net asset value basis. Additionally, there were worries that banks might invest in each other’s mezzanine tranches, though this practice doesn’t appear widespread.
领英推荐
The Need for Transparency and Standardization
One recurring issue was the lack of transparency and reliable performance data in private securitization transactions. Regulators have called for more evidence to support the industry’s lobbying for less stringent securitization disclosure requirements for private deals. Given that public ABS performance data is often used to calibrate capital charges for all securitizations, the lack of data from CLOs, corporate loan SRTs, CMBS, and NPL transactions creates challenges, as these segments have exhibited weaker credit performance compared to the public ABS market.
Workshop participants acknowledged that standardization is another challenge. The SRT market is highly bespoke, with little to no liquidity in the secondary market. This lack of standardization is unlikely to change soon, as both banks and investors prefer the ability to tailor deals to meet specific needs. The European Investment Fund (EIF) plays a key role in ensuring some degree of comparability across jurisdictions, but most private investors have shown little interest in adopting standardized deal structures.
Global Perspectives
The workshop also highlighted the growing role of SRT transactions in Latin America, particularly in Mexico, Brazil, Chile, and Colombia. However, Mexico’s regulatory environment has recently become less favourable, presenting challenges for international banks seeking capital relief at the local level.
Meanwhile, the EIF continues to be active across the EU, with significant SRT investments in Poland and the Baltic states, which have seen increased activity. In contrast, the Nordic countries, especially Norway and Denmark, remain cautious due to more conservative regulatory stances.
The Rising Role of Insurers
Insurance companies have also become more involved in SRT deals, moving beyond their traditional role in senior mezzanine tranches to taking on first-loss positions. The high capital charges under Solvency II have been a limiting factor for insurers, but the ongoing consultation from the European Commission may address some of these constraints, potentially unlocking more investments from the insurance sector.
Our Proposals for Improved Transparency
The European SRT market is dynamic, but a lack of data and transparency is hindering its growth. To improve market efficiency, we propose the following ideas to improve transparency and foster standardisation: