The rapid growth of the synthetic risk transfer issuance is one thing but the expansion of the investor base poses a nightmare for people like the growing number of buyers that have come to the market of late.
SRT has grown year on year since 2016 typically by 15%-30%, with the obvious exception of 2020. Lately, North American banks have entered the fray. Canadian deals came first, before a wave of US issuance in the second half of 2023. That will likely continue into 2024 and, along with European issuers stepping up their own programmes, will propel SRT volumes to new heights.
All this is piquing the interest of some new investors. Ares and Blackstone are among those taking more interest in the asset class, GlobalCapital understands. That’s not surprising considering the spreads that could be on offer, by one estimate up to a 200bp pick-up over similar risk in CLOs.
But the SRT market isn’t designed for dipping one's toe in. The investments are set up to be held for the long-term with typical durations of four to seven years. As a rule, if they’re being traded something has gone wrong somewhere.
SRT deals involve protracted negotiation and work best when entered into as partnerships between the originating bank and the investor. Therefore, sourcing opportunities requires proof that the investor will be around for the long term. Hence, even getting an SRT desk set up and staffed is an expensive business.
That's not ideal for a hedge fund looking to take advantage of short-term market dislocations with a staff of, say, half a dozen.
If these new investors, even the bigger ones, are going to avoid getting burned, either the market will have to become more transparent and liquid or they will have to spend big to build up their staffing. That is because if you’re going to raise dedicated money for an SRT investment desk, there are not thousands of people looking for work with the skills to staff it.
By one ballpark estimate, there are around 100 entities who buy SRTs across development banks, private investors and insurers. Each will have varying levels of staffing, but certainly expect to see some movement there as investment funds go on the poach.
One problem, though, is the population pyramid of securitization staff looks more like an egg timer, after a cutback in hiring since the global financial crisis. As such, there’s a lack of mid-level staff to make the step up to senior posts.
That applies not just in SRT but in CLOs or ABS, too meaning that sort of lateral thinking will not solve the hiring problem.
Within synthetics, niches have developed, with some of those more suited to ABS investors at least. Mortgage and auto loan backed deals have emerged, which more closely resemble traditional securitizations than they do the large corporate deals which account for up to half the synthetic market.
Some of those deals have even been rated and are simply alternatives to selling mezzanine bonds out of a cash deal.
As such, those who were buying the cash deals are starting to buy the synthetic versions, meaning that features of the cash market will be copied and pasted across. That will mean not just greater product familiarity but also improved liquidity and transparency.
But for those corporate deals, some of which are backed by blind pools, that’s impossible. The risk has to be underwritten on entirely an different basis — by building a partnership with the bank offloading the risk.
The pools backing SRTs might be designed to look roughly like the loan book of the bank but they can be highly concentrated and it can only take one loan to go bad for investors to suffer.
Few have the skills to underwrite that kind of risk. It requires a knowledge not just of of securitization structures but also the skill to analyse large corporates, the experience to judge bank risk and the ability to build partnerships with those banks. If all of those requirements were circles on a Venn diagram, the point where they all crossover would be very small.
Investors that want to commit to this market will need to hurry up and fish in that small pond and when they find them, they will make a killing for you.