10 Apr, 2024
Europe's banks set to increase use of mortgage risk transfer deals
European banks are set to increasingly use so-called significant risk transfer transactions to move mortgage credit risk from their books ahead of the finalization of global capital rules.
Most significant risk transfers (SRTs) are synthetic securitizations that allow banks to keep certain assets on their balance sheets but reassign credit losses to third-party investors. They have grown in popularity as a way to manage regulatory capital requirements, with issuance almost doubling in the EU between 2020 and 2022, according to figures from the International Association of Credit Portfolio Managers (IACPM).
SRTs will be particularly useful for banks that face their risk-weighting for mortgages being driven too high when Basel III capital regulations are finalized, according to Bart Joosen, professor of law at the Hazelhoff Centre for Financial Law at Leiden University in the Netherlands.
Outstanding mortgages at Dutch banks total about €800 billion and "SRTs provide a necessary solution," Joosen told S&P Global Market Intelligence.
Output floor
The final Basel rules will be phased in between 2025 and 2030 in the EU. An "output floor" will prevent banks' internally modeled amounts of risk-weighted assets (RWAs) from falling below 72.5% of the amount calculated by the Basel Committee on Banking Supervision's standardized approach, meaning most larger banks will have to hold more capital.
Overall Tier 1 capital requirements at EU banks will increase 9% by 2028, although the estimated capital shortfall had been virtually eliminated by the end of 2022, according to the European Banking Authority.
The SRT market in Europe totaled €98 billion in 2022, up from €52 billion in 2020, according to the IACPM.
Mortgages have been a less common asset class in SRT transactions historically but could be particularly impactful in terms of the inflation of the capital requirements, according to Alan McNamara, executive director at insurer Howden and former head of group balance sheet at Bank of Ireland.
"Mortgages will be one area of growth now," McNamara told Market Intelligence.
Residential mortgages made up just 7% of underlying assets in SRT transactions in 2022, according to the European Systemic Risk Board. Corporate mortgages comprised 8%. This compares to 57% for corporate loans, for which the capital benefit is especially pronounced.
"Historically it's been a corporate loan market because, after a transaction, your capital requirement reduces to around 10% depending on the nature of the transaction," McNamara said. "With corporates you may have anything from a 60% to 100% risk weight depending, so the reduction is even more meaningful. That's the big prize."
Such loans, along with small to medium-sized enterprise loans, will be in the spotlight in Ireland and Europe in general, he said.
Credit funds specialized in SRT transactions were the biggest participant in the SRT investment base in 2023, making up 45%, followed by asset managers with 30%.
Issuing SRTs has already become a feature of large institutions' operations.
SRT advantages
SRTs can be more appealing to banks than a simple portfolio sale for a number of reasons, according to Tauhid Ijaz, a partner in Hogan Lovells' corporate and finance team. With portfolio sales, banks get the capital advantage but lose the relationships they may have with underlying borrowers, which could be disruptive, whereas with SRTs banks are just optimizing the capital they hold against a position, he said.
Turmoil in the Additional Tier 1 market last year may also push more investors into SRTs, which are a safer form of debt. Credit Suisse AT1s were written down to zero when the bank was taken over by rival UBS Group AG in a forced merger.
"The Credit Suisse story with its AT1 bonds being wiped out will also have helped the SRT market's cause," said James King, head of structured credit at London-based investment manager M&G. King said the US has taken notice of the growing European SRT market.
"There is huge potential in the US," he told Market Intelligence.