- Investors, lawyers keen to expand risk-sharing deals on offer
- Structures under review could give market access to insurers
- Banks shed around $25 billion in loan risk via transfers in 2023
- U.S. lenders flocking to market, but rules are strict
A financial product that enables banks to shed risk from loan portfolios is gaining more popularity among lenders in the United States, with investors and lawyers devising new structures to broaden its appeal.
In deals known as credit risk transfers, banks effectively buy insurance from hedge funds and other investors against the risk of losses from loans. The deals can free up precious capital for lenders, while producing juicy returns for investors and handsome fees for the arrangers.
But structures currently in use come with constraints. US regulatory requirements set by the Federal Reserve restrict participation from insurance companies in these deals. The types of loans, mostly auto and mortgages, also limits the pool of potential investors, five investors and lawyers involved in credit risk transfer deals said. Now, some of those parties are pitching US lenders with different variations of credit risk transfer products that could address those issues.
Under this structure, an intermediary bank would buy protection against loan loss from an insurance company, and then sell protection to a different bank seeking to execute the risk transfer transaction, according to a senior portfolio manager at a large institutional investor who did not want to be named.
It is unclear whether the Fed would grant capital relief to a lender using such a structure as it would depend on whether the protection sold is funded – an insurance sale backed by a cash collateral – or unfunded. The Federal Reserve declined to comment.
Issuing banks in the private sector sold off an estimated $25 billion of the risk of losses on loans totaling $300 billion globally in 2023, compared with $20 billion sold on $250 billion of loans in the previous year, according to Olivier Renault, head of risk sharing strategy at Pemberton Asset Management, which invests in non-investment grade debt on behalf of global institutional investors.
The risk offloaded in 2023 is equivalent to only around 2% of the issuing banks’ combined balance sheets, Renault told Reuters. It is the “tip of an iceberg,” he said.