The four large credit-linked-note (CLNs) offerings that came to market late last year raised expectations for a banner 2024 in terms of bank issuance of credit-risk transfer (CRT) bonds. Only one sizable CLN, however, appears to have been completed year-to-date and the outlook for more deals has moderated, although large and regional banks are likely to tap the market later this year.
In late March, Bayview, an alternative credit asset manager, issued $346 million in notes referencing loans originated and serviced by Huntington National Bank that are secured by new and used automobiles, heavy- and light-duty trucks, SUVs and vans. It is the first CLN issued through the Bayview Opportunity Master Fund, a bankruptcy remote special purpose vehicle (SPV) that has issued numerous non-CLN offerings.
Moody's Investors Service was the only agency to publicly rate the deal. In its presale report, it notes that payments on the notes are linked to a tranched credit default swap (CDS) between Huntington and the SPV issuing the notes, in which the bank was the protection buyer.
The initial protection amount, Moody's says, is 12.5% of the total reference pool and equals the principal amount of the rated and unrated issued notes. Huntington "will pay a fixed premium of 7.5% per annum paid monthly on the protection amount and will receive compensation for any credit losses incurred up to the initial protection amount," according to Moody's.
CLNs are a type of credit risk transfer (CRT) transaction, also called significant risk transfers (SRTs), that are done regularly in Europe and have been issued at times in the U.S., typically as bilateral or club transactions. Often described as "synthetic," the offerings enable banks to transfer loan credit risk to investors while retaining the assets on their balance sheets.
Following the Federal Reserve's July 27, 2023, release of its "Basel Endgame" proposal to revise U.S. banks' regulatory capital requirements, banks including J.P. Morgan and US Bank reportedly transferred billions of dollars of credit risk. The transactions referenced loans for automobiles, multi-family homes, private funds and non investment-grade companies.
Toward the end of last year, Huntington and three other large banking companies—Santander Holdings USA, US Bank and Morgan Stanley—directly issued CLNs all referencing auto loans that held the unsecured debt ratings of their bank issuers. (SEE ASR 032124, "Wall Street mulls CLN structures to facilitate more issuance"). Those transactions differed from the earlier ones because they were issued directly by the banks rather than an SPV and thus required approval letters from the Federal Reserve confirming favorable regulatory-capital treatment.
Issuing the notes directly is more efficient operationally for the bank issuer and costs less than setting up and managing its own SPV. In its recent deal, however, Huntington opted instead to issue the bonds through Bayview. Huntington declined to comment, citing the quiet period before earnings.
Robert Bradbury, head of structured credit execution at Alvarez and Marsal, a global consultancy that advises banks on CRTs, said banks may switch between the structures for various reasons, such as ensuring the operational flexibility to do both kinds and to satisfy investor needs.
A regulatory dampener?
In Congressional testimony in late February, Fed Chairman Jerome Powell acknowledged the predominantly negative comments regarding its regulatory capital proposal and said he anticipated significant changes to the final rule. That appears to have dampened the banks' motivation to issue CRTs, at least in the near term.
However, Bradbury noted, CRTs are typically negotiated with highly specialized alternative credit funds and increasingly specialized funds at large asset managers that will expect banks to pursue the offerings on a regular basis.
"Those investors will be pounding doors and asking, "when are you issuing?" Bradbury said, adding issuance could start to pick up in September.
CLNs tend to be more appropriate when CRTs reference a large pool of the bank's consumer loans, said Matthew Bisanz, a partner in Mayer Brown's financial services regulatory and enforcement practice. Smaller pools of bespoke corporate or commercial real estate loans, which require more due diligence by investors, tend to be negotiated and issued bilaterally or in club deals with just a few investors.
Bisanz noted that persistent higher interest rates may prompt some banks to pursue CRTs to increase their lending capacity without having to sell current loans and recognize market-to-market losses.
"We expect to see CRT deals from smaller banks through the course of the year, because banks with less than $100 billion in assets won't be affected by the Basel Endgame, so there's no reason to wait to do these deals," he said.
