Asset manager ArrowMark, a long-time investor in CRT, sees increased US usage

Despite the constraints imposed by Covid 19, this has been a banner year for the CRT market in the US, with headline-making deals from JP Morgan and Goldman Sachs while Citigroup, a longstanding user of the mechanism, has been rumbling along below the radar screen.

Kaelyn Abrell, a partner and portfolio manager at ArrowMark Partners, a $20bn asset manager based in Denver, Colorado, believes that the future is bright for CRT in the USA and a widening circle of participants will seek to use the structure.

“Absolutely I see it spreading to other banks. What has kept US banks out of the market is that they have been well-capitalised and the regulator hasn’t quite accepted it in the past. Now you have regulatory acceptance, so I expect the banks already in the market to issue more and for other banks to start issuing,” she says.

What has also helped bring the market to the fore this year has been the sudden focus upon balance sheet strength as a result of the Covid 19 pandemic and its impact upon loan repayments of all kinds.

However, Covid 19 has also, on the other hand, restrained the development of the market this year as, due to restrictions upon travel, investors have been unable to have face to face contact with l issuers. This has been a considerable impediment to potential buyers seeking to get their heads around what in most cases is a new asset class.

Moreover, not all US banks will be able to exploit the opportunities for CRT issuance. Sellers need diverse and large balance sheets to be able to generate a reference portfolio of sufficient size, and it’s also helpful if they have an in-house capital markets operation which makes the hire underwriter is not necessary.

ArrowMark has been investing in CRT offerings in the US and Europe for the last decade. Though Abrell describes herself as “asset-class agnostic” she believes the firm’s analytical and structuring capabilities are best suited for corporate loan CRT transactions. However, expertise across the broader securitized credit markets has enabled them to invest in SME, trade finance, mortgage, and auto loan transactions.

Structured Credit Investor was able to grab half an hour on the phone with Abrell earlier this week for her views on the market in the USA.

1./So, Kaelyn, as an investor, what makes you interested in the CRT transactions offered by JP Morgan and Goldman Sachs this year?

Expansion to the US is indicative of the continued growth and maturation of the CRT market. As an investor, it increases the options available from a capital deployment standpoint and supports our efforts to diversify across issuers, asset types, and geographies. Additionally, US banks are attractive partners given their strong credit ratings, large balance sheets, and differentiated assets.

2./JP Morgan has made headlines this year but will usage spread to others?

JP Morgan had a head start on the process with the mortgage transaction in late 2019 but we expect peers to follow. Typically, we see a large bank access the CRT market with a single transaction and then expand across additional asset classes after they understand all the benefits. Others then follow their lead. We have seen this dynamic occur in Europe and the UK and expect it to be replicated in the US.

3./What is it about the CRT market, in general not just the US market, that ArrowMark likes?

We are risk-focused investors and the SRT market offers a unique combination of risk, return, and alignment that is not replicated in other markets. A lot of investors have higher return targets for less liquid investments. As a result, some investors overlook the asset class because they don’t fully appreciate the resilience of CRT transactions. Our core focus is principal preservation. Regulators want these deals to be so well-capitalised that they can endure 2008-type stress. So there can be a meaningful amount of stress for an extended period of time and transactions can still generate positive IRRs.

The alignment is also unique. Banks originate the underlying collateral with the intention to hold and maintain exposure even after a security is issued, so our loss is their loss. That’s important.

4./What are the reasons why the US market will not be as big as the European market?

One potential restraint is that US banks are very well capitalized and, therefore, might have a lesser need than their European counterparts.

5./In many ways it has been impressive that the US CRT market has made such progress this year despite Covid complications. To what do you attribute this?

We believed that it was only a matter of time before US banks accessed the CRT market given the potential benefits to balance sheet hedging and efficiency efforts, as well as the help it gives to adapting to accounting-based rules and guidelines. The speed at which CRT issuance resumed after the initial Covid-related shock, for US and non-US issuers, reinforces the importance of CRT as a core tool for these banks.

6./Do you think the future of the US CRT market lies in smaller deals, either bilateral or with one or two investors, or larger transactions?

New issuers typically start with bilateral or small club transactions. As the bank increasingly understands the requirements of an SRT transaction, they start to expand their investor base through larger club or syndicated transactions. Broadening of the investor base is quite important to ensure constant market access. Given the benefits of issuing an SRT, both the regulator and the bank want to ensure that they can issue on a through-cycle basis.

7./Are there any complications that the CRT presents to an investor from an accounting, due diligence, or regulatory perspective?

Given the bespoke nature of the CRT market, we believe investors need a mix of sourcing, structuring, and fundamental analysis capabilities to be successful. Accounting and regulatory considerations are an important aspect of security structuring and therefore a thorough understanding is required in order to effectively negotiate transaction attributes.

8./Will 2021 be a big year for the CRT market in the US?

It’s hard to say. Will risk still be a big focus next year? We’ll have to see.

Thanks Kaelyn. It’s been a pleasure.

Simon Boughey