Risk transfer diversity set to increase

The outlook for risk transfer issuance volumes is mixed, according to panellists at SCI’s Capital Relief Trades Seminar last week. However, they agreed that the market will continue to increase in diversity, in line with bank origination channels and balance sheet needs.

The traditional Northern European CRT jurisdictions have seen a lot of activity over the last couple of years and there has also been an increase in activity in Italy, Spain and Portugal. Indeed, Daniela Francovicchio, senior structured finance manager at EIF, expects significantly higher risk transfer volumes this year, compared to 2017.

“New counterparties are entering the space,” she observed. “The market is booming, also as a consequence of the new the regulatory changes that are coming into force in 2019.”

Kaelyn Abrell, partner and portfolio manager at ArrowMark Partners, agreed that the risk transfer market is expanding through increasing issuance from longer-term issuers, the entrance of new issuers and a greater variety of reference portfolio collateral types. “Recent activity reflects ongoing maturation and evolution of the asset class,” she stated.

She continued: “At the same time, investors are expanding the size and diversity of their allocations to private credit investments. The SRT market’s growth and development are being supported by an increase in capital available to deploy into the asset class, as well as interest from investors with differing risk and return objectives.”

But David Wainer, partner at Allen & Overy, is less optimistic about activity next year - especially in the first half of the year - due to the new securitisation regulations, particularly the onerous loan level disclosure requirements and higher capital charges.

Nevertheless, a number of banks are already considering what their deals will look like under the new securitisation regulations in order to maintain their efficiency, according to Chorus Capital cio Kaikobad Kakalia. “However, activity in Q1 is likely to be muted, as usual. In 2019, it may be more pronounced, as banks complete their capital planning for the year and adjust for the regulations,” he concurred.

One area that is likely to benefit is the market for mezzanine risk at a high attachment point. “Banks are in the process of implementing changes to their historical issuance approach, which will include selling protection on additional tranches,” Abrell noted. “We invest in first loss and mezzanine tranches to align with the diverse goals of our investors. I anticipate the investor base for mezzanine risk to grow as the market continues to evolve.”

Francovicchio pointed out that EIF always invests in mezzanine risk in connection with capital relief trades. “This allows the issuer to benefit from a lower weighted average price and for us to collaborate with third parties who participate in the equity tranche,” she said.

Equally, a security type that is likely to expand post-Basel 4 is transactions backed by first-lien mortgages. Wainer anticipates that the introduction of output floors for IRB models under Basel 4 could generate mortgage-related risk transfer transactions in the Nordics and Benelux to mitigate the switch from LGD to LTV – although he indicated this is likely to be issuer- and portfolio-specific.

Kakalia also expects mortgages to become a regular feature of the CRT market in time. “Mortgages are extremely interesting and represent the largest asset class on several European banks’ balance sheets. Under Basel 3.5, mortgages at IRB banks in most Northern European countries will be impacted by the standardised risk weight floor, leading to a material uplift in RWAs. Our expectation is that starting in 2020-2021, banks will be keen to address their RWA uplifts, in order to maintain capital ratios and ROE.”

In the meantime, he suggested that market participants need to adapt to the features of mortgages, which are significantly longer-dated than typical CRT assets like corporate and SME loans. “Most asset managers raise funds with capital committed for 5-8 years. Consequently, transactions may need to focus on more seasoned or shorter-dated portfolios, or a more active secondary market needs to develop, allowing investors to exit the risk prior to a transaction’s maturity,” he explained.

Overall, SRT diversity is expected to grow to mirror bank origination channels and balance sheets. Pascale Olivié, deputy head of structuring, finance department at Credit Agricole CIB, confirmed that her firm also uses synthetic securitisations to distribute risk and complement its cash distribution - which is expected to be more constrained under IFRS 9.

“Synthetic securitisation contributes to push further our originate-to-distribute model. It enables us to support business development with new origination and improves our balance sheet management,” she observed.

Matthias Korn, head of financial solutions at Caplantic, anticipates that a new generation of capital relief trades will emerge with banks requiring relief from IFRS 9 and the reduction of lifetime expected loss. “What is the reason behind bringing a deal? If it is to increase core capital, synthetic securitisation is the only answer for banks without capital market access, like public or cooperative banks. But if it is to increase RWA profitability or manage a portfolio effectively, securitisation is also an interesting solution,” he observed.

Kakalia added that regulators in other jurisdictions - including in North America, Eastern Europe and Asia - are becoming more open to risk-sharing transactions. “They recognise that the technology can be employed to address capital and balance sheet management goals,” he agreed.

Looking ahead, it seems likely that the UK is heading towards a hard Brexit, which Wainer indicated may be unhelpful for CRT players and assets. “Hard Brexit is likely to impact pricing and may even result in some downgrades,” he observed. “The UK Treasury has allowed for transitional arrangements, which is helpful, as the market needs certainty. But these alone will not be sufficient, if not reciprocated by the EU.”

He continued: “The UK PRA has in the past shown the ability and willingness to go it alone, so the CRT market is likely to see some divergence over time. However, there is no reason for documentation to not continue to be governed by English law.”

Finally, regarding the turn of the credit cycle, ArrowMark is attempting to mitigate any market downturn by applying more conservative assumptions during the evaluation of underlying collateral and incorporating additional structural protections. “We’re incorporating more punitive base-case loss assumptions and enhancing security structures to match our forward expectations. In any case, we employ a partnership approach to our SRT investments and work with issuers to ensure transactions meet their objectives, as well as those of our investors,” Abrell concluded.

Corinne Smith