Perish the thought. Securitization, the very technique blamed for so much of the global banking sector’s past pain, might be part of a remedy for its current ills. Banks are under enormous pressure to strengthen capital ratios under Basle III. At the same time, banks are being heavily penalized on capital held against loans and derivatives.
Raising equity to bolster capital adequacy ratios is tricky, at best. Deleveraging, whether selling loan portfolios, business segments, or entire businesses, is one capital-raising solution, albeit drastic and costly for the seller. Liability management is another way banks can raise capital.
An alternative option, however, involves securitization.
A bank could securitize a portfolio or part of a portfolio of loans or derivatives and sell the associated risk to a third-party investor, thereby gaining relief from penal capital charges, and freeing up space to lend.
Some big, sophisticated global banks, such as Credit Suisse, Deutsche Bank and Standard Chartered, have been doing just that for the past three to four years through regulatory capital relief or risk transfer trades.
Now smaller, domestic lenders are warming to it too.
The UK’s Co-operative Bank emerged earlier this year with a reg-cap securitization on a UK mortgage book, quite possibly the first time UK mortgages have been used in such a transaction, which have typically involved transferring the risk on SME and corporate loan books.
This particular deal broadly says two things: banks outside of the top tier are increasingly willing to engage in this technique, potentially expanding the supply universe; and, the types of collateral on which the risk is transferred is broadening, suggesting investor demand is too.
“Where appropriate, we would welcome second-tier, medium-sized banks embrace this technology so they have a little bit more flexibility in managing their capital and growing their lending profile,” says Walter Gontarek, chief executive of Channel Capital Advisors.
Speak to anyone involved with this tight little corner of finance and they will tell you the investor base is broadening to hedge funds, asset managers and insurers and that new reg-cap funds are being raised reasonably frequently.
Part and parcel of that is an expanding investor base in the hunt for new risk exposure away from SME and corporate loans. Risk-transfer specialists are beginning to source real estate, distressed and consumer loans and trade finance assets to securitize.
Evidence of this growing demand can be seen in pricing.
Certain regulatory-capital-motivated transactions a year ago were offering returns of at least 15% to 16%. Today, returns are closer to 12% and moving lower, which should incentivize banks to look seriously at reg-cap trades because of the lower cost of capital involved in executing them.