Hopes are high among US banks and investors for the expansion of the credit risk transfer (CRT) market after the Federal Reserve offered more regulatory clarity in September, but the main area of growth in the next year could be smaller regional banks — as big banks are likely to have to put expensive credit enhancement on deals.
In late September, in the form of an FAQ, the Fed offered further clarity on the capital rules for several types of CRT. The guidance would require that the so-called ‘p factor’ of the transactions is 1, which means that large banks would have to place expensive credit enhancement on certain tranches.
In Europe, the p factor can be as low as 0.2, according to one CRT lawyer.
Mark Kruze, senior vice-president of Pimco, said on a panel at IMN and FINN's ABS East conference on Tuesday that this could heavily restrict the scale and structure of CRT deals from large banks, and that smaller banks would be the major issuers of CRT deals for at least the next year.
“Banks are in need of CRT deals to free up their books, but it is not economically viable if the credit enhancement is too expensive,” said Kruze on the panel. “Luckily, we still have more than 4,000 smaller banks who are not subject to the requirement, so we’ll see most of the deals coming from them if they can get through the complexity of CRT deals.”
In the US, only a handful of smaller regional banks — including Western Alliance, PacWest, and Texas Capital — have done CRT deals, because of the previous lack of explicit “blessings” from regulators.
“The Fed’s clarification is the first time that it has acknowledged that there is a CRT market in the US,” said Kruze. “It has limits, but this is a huge step that everyone has been waiting for.”