The Growth of Capital Relief
Capital relief transactions (CRT) have become a means of doing business for banks grappling with regulatory capital headwinds. They are also known as significant risk transfers (SRT).
Buy-side and sell-side motivations
For insurance companies and private capital sponsors, they are an effective means of gaining exposure to quality loan portfolios without the hassle of origination.
With increasing regularity, Banks have successfully transferred large tranches of first loss and mezzanine risk on core portfolios spanning multiple sectors and geographies.
In so doing, aided by the synthetic method of risk transfer, they have not compromised underlying customer relationships or relinquished control over loan management.
Meanwhile, product buyers are attracted to favourable risk / reward metrics when compared with direct loan or traditional securitisation exposures.
They benefit from the product’s embedded leverage and the ability to further leverage their investment using repack or repo structures.
Continued tailwinds ahead
CRT’s positive trajectory is set to continue as the Federal Reserve becomes more comfortable with its use by US regulated banks and as new asset classes are introduced annually.
CRT can also point to its successful navigation of a crisis. During the pandemic’s first phase, 15-25% market discounts available for certain CRT securities had more to do with distressed sellers dealing with extraneous liquidity issues than product fundamentals.
Structures
Structures vary with financial guarantees being favoured by some banks over credit default swaps which trigger mark-to-market accounting issues. First loss positions tend to be funded, whereas mezzanine loss positions can be unfunded thanks to an active insurance buy-side market. Single purpose vehicles are also present in many structures to facilitate tradeable investment format and improved counterparty risk management.
Specifically on US structures, they tend to be larger deals with shorter duration and thicker tranches leading to lower coupons and greater use of additional leverage. In addition, the impact of prudential regulation on participating standardised banks has resulted in relatively higher quality portfolios than European counterparts.
Product risks
Of course, the product is not without risks and buyers should be particularly aware of counterparty and eligible investment risk, loss events and calculation, together with limited or no investor downside control. It is also important to note that this insurance product is “negatively pooled” which can be particularly impactful on less granular portfolios.
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Please contact us to learn more about the product in order for you to determine whether it is suitable for your investment portfolio.
