Capital relief trades: Yield hunters chase synthetics as Basel IV looms

The growth of synthetic securitization as a capital-relief tool is in full evidence, with Nordea closing an €8.4 billion trade in August, the first in Scandinavia, two weeks after a €1 billion deal from Crédit Agricole.

Jonas Backlund, Nordea

Falling base rates and rising capital requirements are making synthetics ever more popular among European banks and investors, bankers say. 

“The market is growing by volume of deals and number of actors, including new specialized investors,” says Pascale Olivié, head of structuring, research and asset allocation at Crédit Agricole CIB’s finance division.

Some investors are so keen they are seeking out deals, says Peter Mason, co-head of EMEA FIG at Barclays, which helped structure the Nordea trade. He mentions a figure of between 25 and 30 such deals within the past 12 to 18 months. “There’s been a meeting of minds, between investors looking for yield, and banks looking for capital relief,” he says. 

The European Banking Authority estimates issuance volumes rose by 50% to €60 billion last year. Meanwhile, the European Investment Fund’s head of securitization George Passaris says in 2016 it has already doubled the synthetic deals it has executed. The EIF started guaranteeing junior tranches of SME-backed cash and synthetic deals three years ago.

Getting more precise figures on issuance can be hard, as most deals are sold to a single investor, or (as in the Nordea deal) to a small club with an anchor investor. Crédit Agricole, for example, tailors deals to an investor’s specific requirements in terms of structure and the portfolio, with the investor favoured on the basis of the bank’s confidence in its ability to follow through.

While investors must spend time on due diligence on the data quality and underlying risk, typical yields are between 9% and 12% where all junior and mezzanine tranches are sold, says Passaris. “The risk-reward for investors is quite good in the current context,” agrees Olivié.

In the Nordea deal, a 5% first-loss transfer saw risk-weighting on the portfolio fall from around 45% to 7%, giving a 30 basis points benefit to tier-1 equity. The deal also conformed to a typical length (between five and eight years). It drew inspiration from other European banks, but Nordea wanted a partly Nordic investor base, and needed to satisfy the Swedish financial supervisor.

“It’s been a learning experience for us; now, we’re comfortable that there is an appetite, and we have operational readiness for similar transactions,” says Jonas Backlund, head of credit structuring and execution in Nordea’s treasury and asset liability unit. 

Crédit Agricole’s smaller deal involved a 5% first and second-loss transfer and comes after CA CIB closed two similar deals late last year covering a total portfolio of $2 billion. The bank could now do deals over project finance and shipping loans.

Other banks in France, Austria, the UK and Germany have joined the fray, as in HSBC’s $5 billion deal in December, part of its push to cut risk-weighted assets. CaixaBank and Santander launched Spain’s first publicly disclosed synthetic securitizations since the crisis earlier this year (Dutch pension fund PGGM bought the Santander deal, covering €2.3 billion of SME loans). 

Nordea began preparations in early 2015, before news broke of impending regulatory restrictions to internal risk modelling. But so-called Basel IV rules could make the technique even more useful. While European regulations will make holding senior securitization tranches (both cash and synthetic) more punitive on banks’ capital, Olivié notes the weight of standardized risk weighting will be even heavier under Basel IV.

Synthetics are most relevant to corporate lending rather than lower risk assets like mortgages. Banks add that offloading these loans through a cash deal could also indicate a lack of commitment to the client. “We like the concept of risk sharing as it doesn’t interfere with the businesses and client relationships,” says Backlund. 

This is also a reason why Rabobank could return to the market after its last synthetic deal in early 2014, according to Jorgen de Vries, head of capital efficiency and secured products in Rabobank’s treasury department.

“The benefit is you still face the client, who does not even notice the risk has been sold,” says de Vries.

Though the Nordea deal contained loans to both large and smaller companies, SMEs help build the granularity the deals require and gain the favour of regulators, which must approve the risk transfer on a deal-by-deal basis.

Regulators have grown more comfortable with the trades as the market has grown, say bankers. EBA advice late in 2015 supported the inclusion of some SME synthetics in the favourable prudential treatment the EU plans to award securitizations it will brand as simple, standardized and transparent, next year. 

However, beyond SME deals, Passaris says the tide is still against synthetics. “The term synthetic creates negative connotations among politicians and regulators, because it sounds complex,” he says. “In synthetics there’s a lack of understanding [in the European Parliament] of the differences between a balance-sheet securitization and arbitrage deals.”