BlackRock Inc. expects strong growth in transactions that help banks reduce loan portfolio risk as capital standards tighten. William Im, a director in BlackRock's global opportunistic credit team, said in an interview before the release of a paper arguing for synthetic risk transfer deals that this market could grow 30-to-40% annually for the next two years due to greater acceptance of this tool and Basel III endgame regulatory pressures.
BlackRock and Im, who has managed credit and alternative investments since 2016 and is now a synthetic risk transfer point person, are familiar with SRTs, which provide mid-double-digit yields. As Ares Management Corp., KKR & Co., and Blackstone Inc. engage more in the market, the deals may require more of his attention.
Pemberton Asset Management estimates that banks sold $25 billion of SRTs last year, unloading $300 billion in credit risk. According to Im, giant Wall Street banks under pressure to increase regulatory capital requirements will drive SRT volumes, despite European banks being the biggest consumers in recent years.
Im said his growth trajectory “sounds like a stark number, but if you compare investor demand as well as bank demand that well may be the case.” Basel Endgame standards will significantly increase banks' capital provisions to backstop lending, putting the most pressure on major money center banks.
That encourages banks to sell hazardous assets or increase capital. Beyond money center banks, regional banks with weak balance sheets may use SRTs to rebuild capital. BlackRock mentioned the Silicon Valley Bank and other regional bank collapses as driving regulatory capital securities market growth in its paper.
BlackRock states that in SRT transactions, a bank earmarks a pool of assets on its balance sheet and buys credit default protection on the first 5% to 15% of the losses of that pool, so SRT investors bear the loss.
SRT reference portfolios typically include revolving credit lines and term loans to large firms. Fund financings like subscription facilities or net asset value loan lines are also increasing. Smaller lenders are hedging car and consumer loans. A few have tied agreements to commercial real estate financing. Securitization may help New York Community Bancorp sell riskier real estate loans.
Im suggested US regulators provide “regulatory clarity and more uniform support” to boost growth. He said banks are still determining “what’s permissible and what’s not.”
September saw the Fed clarify whether transactions qualified for capital relief. The agency then noted a synthetic securitization can involve transferring loan risk to a special purpose business that sells credit-linked notes to investors. Requesting the Fed's “reservation of authority” allows banks to issue credit-linked notes directly.
The main benefit for banks is loan capital relief. Investors preparing for lower central bank rates are intrigued by US issue yields of 13% and European yields of 16%.
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