Banks face big decisions as money floods into synthetics
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Banks face big decisions as money floods into synthetics

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Europe’s SRT party keeps growing as US issuers join in despite looming regulatory clouds, reports George Smith

The synthetic securitization market is having a party to rival any that will be held on the Barcelona beachfront this June, with new banks and investors continuing to rock up. The question that incumbents are asking, however, is whether these gatecrashers are here for a good time or a long time.

On the issuance side, sources agree that growth is sustainable. But on the investor side, a recent influx of money has drawn comment.

Robert Bradbury, Alvarez & Marsal

“There’s a lot of new capital coming in,” says Robert Bradbury, managing director at Alvarez & Marsal. “The new investors are generally competing on price, as opposed to structure or anything else. Unless — or until — they get burned, or relative value moves away from SRT into other assets like broader private credit [and] CLOs, there’s no reason they’d back off.”

With demand outstripping supply, spreads have been driven tighter, which has sidelined some of the market’s traditional investor base.

“A lot of long-time investors are sitting with dry powder waiting, because they can’t, or choose not to, compete with money that, in their view, looks only at the price,” says Bradbury. “It’s not to say they think the price is ‘wrong’, but they would generally rather wait and see, or explore other avenues of relative value in the meantime.”

Tightening alone then is not the problem. Indeed, it was expected.

“Investors want SRT to offer a premium versus public markets,” says Juan Grana, managing director and senior portfolio manager at Chorus Capital. “If those markets keep tightening, then there’s a risk that SRT could follow a bit too, although the pent-up supply from banks will continue to prop up spreads.”

Ideological battleground

The situation demonstrates the ideological battle about how SRT is done.

Banks face a choice. The traditional approach has been to build partnerships with certain investors, negotiating bespoke deals with all the terms on the table. However, with new money driving spreads tighter, some have been showing deals to every investor in the market, with price as the only negotiable variable.

“We’re focused on being in partnership with our counterparties,” says Matthew Moniot, co-head of credit risk sharing at Man Group. “This is a relationship business and we believe capital will migrate to firms who want to have strong relationships.”

I expect there’ll be plenty of participants who’ve recently entered the market who will still be here in 10 years and who will have made a success of it
Matthew Moniot, Man Group

Aggressive bids, though, can be too good to refuse.

“[The new investors] are generally targeting the big banks’ syndicated platform deals,” Bradbury says. “They’re generally more straightforward to get into [than] smaller banks or bilateral transactions. There’s plenty of historical data to support the investment case.”

Such deals are large, so it is possible to invest in size without having to take the whole transaction.

“Once you get multiple parties and multiple bids it becomes a large chunk of the syndication universe,” Bradbury says.

Banks can take both approaches out of different shelves, and many do. But it has not been enough to quell the feeling among some incumbent investors that new money means there is less to go round.

By most accounts, many of the newer names are US hedge funds. And not everyone who has entered the market recently takes the same approach.

“I expect there’ll be plenty of participants who’ve recently entered the market who will still be here in 10 years and who will have made a success of it,” says Moniot.

Cheyne Capital was an investor between 2004 and 2018 but withdrew from the market because it saw limited opportunities. Earlier this year it returned, hiring Frank Benhamou, the architect of Barclays’ Colonnade SRT platform, as risk transfer portfolio manager.

Frank Benhamou, Cheyne Capital

“We are interested in transactions where we can add value to the process,” says Benhamou. “Our strength lies in our credibility, sophistication and the robust team and set-up we have, ensuring we stand as a committed long-term partner to banks.”

Others might be flightier though, meaning that if banks end up depending on that money, they may not be able to find a bid during trickier times. Incumbent investors are willing to deploy more capital, but only with banks they trust. Having investors come and go could also make the whole market more volatile, particularly if exiting investors try to sell bonds.

“Consistency of capital is beneficial to the market,” says Moniot.

SRT issuance share by country 2010-2023

Sources: Pemberton Asset Management, SRT Chronicles 2024, based on data collected from bank annual reports, stock exchanges and dialogue with law firms, issuers and other market participants

US hype

The positive for investors is that supply is growing too — although maybe not as quickly as some would like.

There’s a lot of money coming in. The good news is there’s a lot of growth in supply, but I think some transactions are a bit crowded
Olivier Renault, Pemberton Asset Management

“There’s a lot of money coming in,” says Olivier Renault, head of risk sharing strategy at Pemberton Asset Management. “The good news is there’s a lot of growth in supply, but I think some transactions are a bit crowded.”

Finding solid data for SRT issuance is tricky, but market participants estimate that volumes have been rising by around 20% year-on-year over recent years — both because of existing banks scaling up their programmes and new banks entering the market.

“An increasing number of banks are coming on board,” Renault says. “For the past four years, it’s been 10 banks a year on average. This year is no different. It’s US banks and also some new European banks. We’re also seeing existing banks doing more deals.”

In Europe the market has blossomed into the mainstream and is essential to banks’ capital management, while US issuance began, to much fanfare, in the second half of 2023. Despite the hype, the US comprises only a small part of the market, and deals there differ significantly from their European counterparts.

Perhaps the most eye-catching aspect about the US deals is their size. US banks are bigger, and the tranches they sell are thicker, meaning the notes sold can be twice as big as typical European deals.

Notably, also, US deals have been far shorter than the five to seven years the deals in Europe can run, with regulatory uncertainty hanging over banks. In summer 2023, the US regulators published their ‘Basel III Endgame’ proposals. The reaction to the plan was overwhelmingly negative, and alterations that will have implications for SRT are now highly likely.

Andrew South, S&P Global Ratings

“The immediate thought is [that] if banks have to manage down their risk weighted assets, then more SRT is one way of doing that,” says Andrew South, head of structured finance research, EMEA, at S&P Global Ratings. “But there are effects on the securitization side as well, on how the retained senior tranche is treated.”

For most deals, the greater impact of the Basel III Endgame regulation would be the effects on the securitization. The uncertainty therefore incentivises banks to keep deals short.

“The current proposal for the Basel endgame in the US could materially reduce issuance by large US banks,” Renault says. “They don’t believe it will actually be implemented, which is why they are doing trades, but US deals tend to be much shorter than European ones. That means [that], even if they do become inefficient, they will have rolled off.”

Even if the pressure on banks is eased, US issuers are sticking around in SRT, as small US banks are not subject to the Basel endgame.

“Even if the Basel endgame proposals were to end up as very light touch and with no resulting pressure on banks, I still don’t think you’ll see no SRT at all,” says Bradbury. “Enough banks have done it now and seen it work. There are enough banks outside of the systemically important ones that could benefit from SRT more broadly and outside of Basel endgame that you’ll see SRT continue as awareness continues to grow.”

Basel endgame pressure is not even necessarily driving current issuance volumes.

“A lot of the activity that’s been going on [in the US] has nothing to do with Basel III endgame — it is focused on capital optimisation under the current regime,” says Grana. “However, some banks are adapting their issuance to the uncertainty around the timing of implementation, which is probably holding some banks back a bit.”

The other difference between the early US deals and Europe is the spread. US deals generally price tighter, though that is no surprise given the shorter durations and thicker tranches. In addition, US issuers are securitizing less risky collateral.

“The primary driver for the choice of structure is regulation,” Benhamou says. “In the US, banks generally take into account the standardised approach for determining their capital consumption, leading them to prefer high-quality collateral in SRT transactions to secure more attractive pricing for similar capital savings. Additionally, US securitization rules push towards thicker tranches, incentivising investors to seek leverage.”

The separation between the two markets means it is unwise to read too much into the difference between spreads in US and Europe.

“There are quite a few new investors coming in, but often their interest has really focused on specific types of assets, mainly US assets,” says Grana. “Just because you’re printing US IG deals at very tight levels doesn’t mean everything else will follow.”

By most estimates, the US still only accounts for a fraction of total issuance, with Renault putting it at 20% last year. It will take time for it to ramp up further.

“Some people assume, too optimistically, that the entire US market can implement SRT immediately, but a bank’s first SRT transaction can be a resource-intensive process taking typically around nine months before being streamlined for following transactions,” Benhamou says. “Therefore, we should not expect an abrupt expansion of the US SRT market but rather a steady yet still material growth.”

Number of synthetic SRT transactions 2010-2023

Source: Pemberton Asset Management, SRT Chronicles 2024. Note: As transactions are mostly private, Pemberton acknowledges that its database is probably incomplete. But it is confident that it covers at least 90% of the market, including bilateral transactions. This chart only includes synthetic SRT transactions placed with private sector investors; i.e. the many transactions executed by EIF/EIB and a few other public sector bodies are not included in the statistics.

Strength to strength

That is in contrast to Europe, where SRT has truly come of age. As Renault says, SRT “is still a European market”. In the EU much of that is down to the regulators.

“[In Europe] regulations are very clear,” says Renault. “Adhering to market standards means [deals are] more likely to obtain regulatory approval. [Regulatory certainty] has really helped the growth in the market.”

European banks have been doing SRT for long enough that it is now baked into their operation.

“SRT is a core part of their strategic capital management and banks have been able to show shareholders and regulators that they can issue in all market environments,” says Grana. “Additionally, many banks have to issue just to replace what is coming off. Not issuing is not an option for most banks.”

But there is still some flexibility around exact timings.

Renault says: “The vast majority of deals are pro rata amortising, so there’s natural amortisation. It’s not a cliff where you have to call the deals, so there’s no ‘refinancing wall’.”

The UK is caught somewhere between the Europe and the US. While it has not dealt entirely with the problems of Basel IV [the UK’s terminology for Basel III endgame], it does intend to.

“The treatment of the Basel IV floor is a cloud hanging over the UK market,” says Renault. “The regulator has said they are very aware and will find a solution, and the UK is desperate to show [that] their regulatory framework is at least as good from a competitive standpoint as Europe, so [no solution] would be a big surprise.”

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