European banks use SRT transactions to offload risks
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European banks are focusing on bespoke deals with investors to mitigate the risks of multi-billion euro loan portfolios and boost their financial strength. The “significant risk transfer” transactions are common, private, and bilateral. However, the data on the deals is not public, and the terms are sealed.
European banks used bespoke deals to lower risks
When these banks mitigate some risks on their loans, it reduces the capital that should be set aside to cater to potential losses. Significant risk transfer transactions are also synthetic and usually mimic a sale.
These products attract investors because of the less volatile returns than most publicly-traded fixed income assets. Moreover, the quality of the loan pool can also determine the extent of the rewards that will be available to investors in the form of coupons for the protection they issue the bank.
Investor interest in these products has grown, according to the managing director of Barclays’ corporate loan portfolio management team, Jason Marlow. The executive said that banks used SRTs in the past once every three years. However, these banks could now use these products several times in a few to free up credit lines.
When these products are used with synthetic strictures, the bank will transfer the risk using credit derivatives or guarantees. Cash collateral is used to cater for the potential losses whose risk has already been transferred to lower a bank’s risk if the investor fails to meet their end of the trade. According to market sources, this was important for the bank to access capital relief from a regulator.
The European Central Bank noted that most transactions in the eurozone banking industry in 2022 came from still-performing loans. This was a notable change from 2021 when poor loans accounted for over a third of these trades.
Renewed interest in SRTs
The managing director at Pemberton Asset Management, Olivier Renault, noted that the first quarter of 2023 was busy as the firm had sold banks protection on loan portfolios. The firm is currently engaging with lenders about more than 50 SRT plans, and it anticipates having a strong pipeline for this year.
Last week, Germany’s Oldenburgische Landesbank said it secured its first SRT deal, increasing its common equity Tier 1 ratio by 40 basis points. OLB, backed by Apollo Global Management, initially reported a CET1 ratio of 13.6% last year.
In November last year, BayernLB placed a 1 billion euro synthetic securitization that freed up around half a billion euros worth of risk-weighted assets for new transactions. Banks were initially using these deals before the turmoil seen in the banking industry last month.
