Troubled community lender New York Community Bancorp (NYCB) is trying to show investors that it is better managing the risks embedded in its massive loan book.
One option is to shift some of those risks to private equity firms or Wall Street asset managers.
“We're at the very threshold of deciding whether to move forward or not,” NYCB CEO Joseph Otting told analysts earlier this month about the deal.
A potential deal for NYCB is a so-called credit risk transfer, one of the most popular ways for banks to reduce regulatory burdens, protect against future losses and weather difficult times for the industry. It is becoming.
These moves also highlight the growing importance of private equity firms, hedge funds and other large asset managers as they move deeper into the world of private credit.
A CRT is structured like an insurance contract. Banks issue credit-linked bonds representing a portion of the lender's loan portfolio to external investors in exchange for cash.
The big advantage for banks is that they are protected against future losses and no longer have to hold capital against their assets. The benefit for investors is that they can collect regular interest from the bank.
“Banks are buying insurance policies based on a basket of loans,” StoneCastle Partners CEO Josh Siegel told Yahoo Finance.
The cost of these transactions for banks increases with the risk of the loan, so most banks choose to seek insurance on some of their better assets.
This explains why these deals are so attractive to private equity, hedge funds, and asset management companies such as BlackRock (BLK), Blackstone (BX), Apollo (APO), Ares (ARES), and KKR (KKR). It is also useful for explaining what the target is.
“We've been working with a variety of high-quality banks,” Blackstone Chief Operating Officer John Gray told analysts on a recent earnings call.
He said the deal was a “win-win”, adding that this would reduce regulatory and balance sheet pressure on banks and “allow us to generate favorable returns”.
Such deals (also known as synthetic risk transfer or capital relief deals) have been around for some time, especially in Europe, where banks are accustomed to strict capital requirements from regulators.
Investors put about $25 billion into the $300 billion portfolio of bank loans around the world last year, a 25% increase from 2022, according to Structured Credit Investors. Most of those trades took place in Europe.
Such deals have traditionally been less common in the U.S., with the exception of some government-sponsored entities such as Fannie Mae, which turned to such deals after the 2007-2009 financial crisis.
But demand for them is growing in the U.S. as regulators prepare new rules known as the “Basel 3 endgame,” forcing banks to increase even more to provide a bigger buffer against future losses. It is likely that the company will be required to hold up to
Regulators are finalizing these rules this year after pushback from banks.
The volume of such credit risk transfers is expected to increase by 20% this year, said Mark Fontanilla, a fixed income strategist who created the index to measure the trades.
“We're seeing this trend spreading from Europe to the United States,” KKR co-CEO Scott Nuttall said on a recent earnings call.
“We need to approach it with great care.”
Some of the recent transactions in the United States range from small banks to some of the nation's largest banks.
Merchants Bank of Indiana issued $158 million in credit-linked bonds for $1.1 billion in long-term care and senior housing loans, and local banks US Bancorp (USB) and Huntington (HBAN) each issued auto loans. transferred hundreds of millions of dollars worth of risk.
Columbus, Ohio-based Huntington said the deal cost an estimated $23 million in fees and other costs and freed up about $2.4 billion in capital.
Some industry giants are also taking advantage of this. Morgan Stanley (MS) has purchased $250 million worth of protection on some loans, and JPMorgan Chase (JPM) is issuing credit-linked notes on auto loans starting in 2021. .
Wells Fargo & Co. (WFC) is also considering such a deal, according to Bloomberg.
Regulators don't seem overly concerned about these deals so far. Last year, the Fed expanded standards for how banks can use credit-linked bonds to reduce risk.
Months later, top banking regulator Michael Barr told Congress: “We approved them on a case-by-case basis.”
“We're going to wait and see how these instruments work,” said Barr, the Fed's vice chair for oversight. “If it works as intended, it could become more widely available,” he added.
At the same hearing, other regulators also issued some warnings.
FDIC Chairman Martin Gruenberg said, “I think there's a great deal of uncertainty, so we need to approach it with great care.''
Michael Hsu, acting Comptroller of the Currency, agreed, saying, “We need to be very careful about transferring risk, especially when it is thought of as eliminating risk, when in fact it is not.”
StoneCastle Partners' Siegel told Yahoo Finance, “I haven't heard of any regulators complaining.” “They know it's a bit of a game, but it's a game they know is legal because they wrote the rules.”
Some industry observers still note that these transactions are similar to the credit default swaps that caused so many problems during the 2008 financial crisis.
“That gives us shivers,” banking analyst Glenn Scholl said on a recent Blackstone earnings call. “I remember what happened 16 years ago.”
Warren Kornfeld, a senior vice president at Moody's Ratings, which monitors these trades, said “there are similarities,” but “hopefully the difference is the risk of the underlying assets.”
David Hollerith is a senior reporter at Yahoo Finance, covering banking, cryptocurrencies, and other financial areas.
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