(Bloomberg) -- BlackRock Inc. is forecasting rapid growth for transactions that allow banks to shed risk in their loan portfolios as tougher capital rules take hold.
"Given greater acceptance of this as a tool and ongoing Basel III endgame regulatory pressures, there is a real world in which this market has a potential to grow at 30-to-40% each year for the next two years," William Im, a director in BlackRock's global opportunistic credit team, said in an interview before the release of a paper laying out the case for synthetic risk transfer deals.
SRTs, which pay yields in the mid-double digits, aren't a new area for BlackRock or Im, who has been at the firm since 2016 managing credit and alternative investments, and more recently has become a point person for synthetic risk transfers.
But the deals are likely to demand even more of his attention now, as other investing giants including Ares Management Corp., KKR & Co. and Blackstone Inc. devote more resources to the market.
Last year banks around the world sold $25 billion of SRTs partially offloading the risk of $300 billion of loans, according to an estimate by Pemberton Asset Management. While European banks have been the biggest users of such transactions in previous years, the big rise in SRT volumes will come from large Wall Street banks under pressure to boost their regulatory capital requirements, according to Im.
The growth trajectory Im envisions "sounds like a stark number, but if you compare investor demand as well as bank demand that well may be the case," he said.
Stringent capital requirements known as Basel Endgame rules will dramatically boost the capital provisions banks have to set aside to backstop lending, with the burden falling most heavily on big money center banks.
That gives banks an incentive to shed risky assets, or build capital levels, or both. Beyond money center banks, regional banks with shaky balance sheets may also use SRTs to build their capital positions back up.
In its paper, BlackRock cited the collapse of the Silicon Valley Bank and other regional banks as a factor driving growth in the market for regulatory capital securities.
In SRT transactions, a bank earmarks a pool of assets on its balance sheet and buys credit default protection on the first 5% to 15% of the losses of that pool, so if losses materialize, the holders of the SRTs absorb the hit, according to BlackRock.
Revolving credit facilities and term loans to large companies are among the most common type of reference portfolios behind the SRTs. Fund financings in the form of subscription facilities or net asset value lending lines, are also cropping up more often now. Meanwhile, smaller lenders are hedging consumer including auto loans. Some have linked deals to commercial real estate loans.
New York Community Bancorp is said to be considering securitization as a way to offload risky real estate loans.
For the growth expectations to materialize, US regulators should provide "regulatory clarity and more uniform support," Im said. Banks are still trying to assess "what's permissible and what's not," he said.
The Federal Reserve went some way to clarifying what types of transactions could be eligible for capital relief in September. In guidance released then, the regulator said passing on the risk of loans to a special purpose vehicle, which would then sell credit-linked notes to investors, can count as a synthetic securitization. Banks can also issue credit-linked notes directly but will have to ask for the Fed's "reservation of authority" first.
For banks, the big advantage is that they can get some capital relief on loans.
And for investors getting ready for an era of lower central bank rates, yields as high as 13% on US issues and 16% in Europe are a tantalizing prospect.
"We've come into this current period of a lot more focus, a lot more interest," Im said.
--With assistance from Paul J Davies and Bruce Douglas.
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