Europe's banks ramp up bespoke loan trades to reduce risk

European banks are increasingly turning to bespoke deals with investors such as hedge funds to offload some of the risk on multi-billion euro loan portfolios and improve their financial strength, several sources involved told Reuters.

Banks supervised by the European Central Bank (ECB), the biggest ones in the euro zone, completed a record 174 billion euros ($189 billion) of such deals last year, the regulator told Reuters.

These "significant risk transfer" (SRT) transactions are not new, but because they are usually bilateral and private, data on them is not public and their terms are closely guarded.

By offloading some of the risk on their loans, the banks can significantly reduce how much capital they need to set aside to cover potential losses, according to law firm Clifford Chance.

Unlike a traditional securitisation, in which a bank's assets are moved to a separate entity that then sells securities to investors, SRTs are often "synthetic" and mimic a sale.

A bank can normally transfer risks of losses equivalent to around 7% to 12% of a loan portfolio, two market sources said.

The attraction for the investor is a less volatile return than on many publicly-traded fixed income assets, and depending on the quality of the loan pool, higher rewards in the form of a coupon for the protection they provide to the bank.

"Investor interest has widened," said Jason Marlow, managing director in Barclays' corporate loan portfolio management team.

Marlow said banks that had in the past used SRTs once every three years could now deploy them "once or even multiple times" a year to free up credit lines that may be used for further lending in an increasingly capital-constrained environment.

With synthetic structures, a bank transfers the risk via credit derivatives or guarantees but keeps holding the underlying exposures.

To minimize the risk the bank would face were the investor unable to make good on its part of the trade, cash collateral is posted to cover the potential losses whose risk has been transferred, which market sources say is key for the bank to obtain the capital relief from the regulator.

https://finance.yahoo.com/news/exclusive-europes-banks-ramp-bespoke-050242069.html.