Exclusive-Europe banks accelerate tailor-made loan transactions to reduce risk

Headquarters of the European Central Bank (ECB) in Frankfurt
A view of the headquarters of the European Central Bank (ECB) in Frankfurt, Germany, on March 16, 2023.

European banks are increasingly turning to bespoke deals with investors such as hedge funds to offload some of the risk on multi-billion euro loan portfolios and improve their financial strength, said to Reuters several sources involved.

Banks supervised by the European Central Bank (ECB), the biggest in the euro zone, carried out a record 174 billion euros ($189 billion) in such transactions last year, the regulator said at Reuters.

These “significant risk transfer” (SRT) transactions are not new, but because they are usually bilateral and private, data about them is not public and their terms are closely monitored.

By offloading some of the risk on their loans, banks can significantly reduce the capital they need to set aside to cover potential losses, according to law firm Clifford Chance.

Unlike a traditional securitization, in which a bank’s assets are transferred to a separate entity which then sells securities to investors, SRTs are often “synthetic” and mimic a sale.

A bank can normally transfer risk of losses equivalent to around 7% to 12% of a loan portfolio, two market sources said.

The appeal to the investor is a less volatile return than on many publicly traded fixed income assets and, depending on the quality of the loan pool, higher rewards in the form of a coupon for the protection they offer to the bank.

“Investor interest has widened,” said Jason Marlow, managing director of Barclays’ corporate loan portfolio management team.

Marlow said banks that used to use SRTs once every three years in the past could now deploy them “once or even multiple times” a year to free up lines of credit that could be used for other lending in an environment. increasingly constrained by capital.

With synthetic structures, a bank transfers risk through credit derivatives or collateral but retains the underlying exposures.

To minimize the risk the bank would face if the investor were unable to meet their part of the transaction, cash collateral is posted to cover potential losses the risk of which has been transferred, which, according to market sources, is essential for the bank to obtain the capital discharge from the regulator.

The ECB, which directly oversees the eurozone’s biggest banks, told Reuters the bulk of transactions in 2022 were in still-performing loans, a change from 2021, when downgraded loans accounted for more than a third of these transactions.

“Knock on the door”

The first quarter of this year “has been particularly busy,” said Olivier Renault, managing director of Pemberton Asset Management, which sold bank protection on loan portfolios.

His company is talking to lenders about “over 50” SRT plans and expects a strong pipeline for 2023 “as banks have fewer options to strengthen their capital ratios.”

The ECB, which has not published data for SRT transactions in 2022, generally does not name the banks involved, the number of transactions offered at any given time or the likely volume.

The Bank of England does not publish any data relating to the SRT.

However, some banks disclose them.

Germany’s Oldenburgische Landesbank AG said last week that it had entered into its first SRT and raised its common Tier 1 capital ratio, a key measure of balance sheet strength, by 40 basis points. OLB, backed by Apollo Global Management, previously announced a CET1 ratio of 13.6% for 2022.

And in November, BayernLB placed a €1 billion synthetic securitization that referenced a portfolio of corporate loans through which it released around half a billion euros in risk-weighted assets for new transactions, its chief risk officer Marcus Kramer said in a press release at the time

While banks were already using such transactions before last month’s banking sector turmoil, the bankruptcy of two US lenders and the bailout of Credit Suisse have heightened existing concerns about the impact of an economic downturn on loan portfolios. .

Banks are seeing “market disruption and greater scrutiny of idiosyncratic risk, and to consistently fund and capitalize their businesses going forward, they know they need to take action sooner than is normally the case.” case,” said Robert Bradbury, head of credit structure at Alvarez & Marsal.

Funding costs for lenders are also rising after the hit to holders of Additional Tier 1 (AT1) bonds by UBS’s takeover of Credit Suisse rattled the market.

Filippo Alloatti, head of credit at Federated Hermes, said the unseasonal pickup in SRT demand suggests to banks that the recession is “knocking on the door.”

Italy’s biggest bank, Intesa Sanpaolo, said last year it transferred credit risk through a number of transactions on loans totaling 15.7 billion euros, including one d a value of 7.5 billion euros in the fourth quarter among the largest in Europe.

In February, BNP Paribas and the International Finance Corporation (IFC) offered an overview of one such transaction. IFC sold BNP a $50 million guarantee on $1 billion in emerging market loans, they said, without disclosing terms.

While Europe has been at the forefront of risk transfers, the stock of loans covered by SRTs is small compared to the balance sheets of European banks. BNP Paribas alone had assets totaling 2.7 trillion euros at the end of 2022, according to data from Refinitiv Eikon.

The ECB says on its website that banks wishing to enter into such transactions must seek regulatory approval at least three months before their expected closing date.

He also warns that SRTs are closely monitored, as unsuccessful transactions could harm the bank concerned.

The European Central Bank (ECB) during a rain storm in Frankfurt
The European Central Bank (ECB) in Frankfurt, is pictured during a heavy rainstorm ahead of the ECB council meeting later this week, in Germany, March 14, 2023.

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