Text on screen: Actionable Alternatives Synthetic Risk Transfer
Images on screen: Exterior building, data center, airplane departing
Kraus: Today we're going to talk about synthetic risk transfer transactions, or SRT as they're commonly referred to.
Text on screen: Kristofer Kraus, Portfolio Manager
Text on screen: PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.
SRT involves the purchase of credit protection on a portfolio rather than on a single asset and can be a useful tool for banks seeking to manage their overall credit exposure and the use of capital supporting the balance sheet. Today you see a wide range of underlying asset types from consumer related risk, such as auto loans and student loans, to corporate related exposures.
FULL PAGE GRAPHIC TITLE: Originating Bank. The graphic illustrates a Loan Pool example with a box on the left labeled Loan Pool in green, followed by an arrow in blue labeled SRT, which means Synthetic Risk Transfer. The arrow points to a purple box on the right labeled Synthetic Senior Tranche (larger top part of box) and a blue box labeled First Loss/Junior Tranche (smaller bottom part). An arrow next to that blue box points to a white box on the right labeled PIMCO.
Banks are able to free up capital by selling into the private credit markets, the first loss tranche, this can be the zero to 10% part of a capital structure, for example. And for that the investor will be paid a yield for the risk that they are taking.
The bank does continue to retain exposure to the portfolio and will bear losses which exceed the protection provided by the investor’s SRT purchase.
Images on screen: London exterior, bank transaction
We have seen banks in Europe use SRT for many years as an effective tool for managing capital in the early days of the Basel rule rollout and subsequent versions of that.
FULL PAGE GRAPHIC TITLE: US SRT Market Issuance: 2021-2024. The bar chart shows Reference Notional Issuance in U.S. dollars (millions) on the left hand scale for each year starting in 2021. The first quarter of each year is shown in dark blue, the second quarter in green, the third quarter in magenta, the fourth quarter in light blue, and estimated second half of 2024 in gray. In 2021, SRT issuance for quarter 1, 2 and 4 totaled less than $10 billion. In 2022, total issuance for quarters 2 and 4 was approximately $15 billion. In 2023, total issuance for all four quarters was approximately $62 billion, with the bulk of issuance in the fourth quarter. In 2024, total issuance for quarters 1 and 2 was approximately $24 billion, with the estimated issuance for the second half of 2024 reaching $50 billion.
It has been adopted more recently by US banks following the approval of the Federal Reserve in September 2023.
Our view is SRT issuance in the United States will match the level of issuance we've seen in Europe and will have done so in less than a two year period of time from its rollout into the market.
Text on screen: Mark Kruzel, Business Development, Capital Markets
Kruzel: From a bank perspective, the key benefits of SRT include balance sheet management, giving
FULL PAGE GRAPHIC TITLE: Benefits to the bank and Benefits to investors. The graphic shows Benefits to the bank on the left including Risk Mitigation, Free Up Capital, Balance Sheet Management, Cost Efficiency, and Flexibility. The box on the right shows Benefits to investors, including Unique access, Leveraged exposure, Diversification, Cost Efficiency, and Flexibility.
banks a tool to be able to dynamically manage their capital requirements, concentration risk, and credit risk. From an investor standpoint, SRT actually gives us access to bank originated assets in a way we might not be able to replicate in other forums.
So let's talk about a hypothetical example of a bank contemplating raising capital and looking at their various alternatives.
A bank might consider raising capital to either buffer their own capital ratios, fund organic growth, or even something as strategic as contemplating M&A. There's generally three different alternatives that a bank could have to raise capital.
FULL PAGE GRAPHIC TITLE: Three ways a bank can raise capital. The graphic shows three boxes. The box on the left labeled number 1 is titled Raise Equity, illustrated by dollar sign and a bar chart as graphic icons. The box in the middle labeled number 2 is Sell Loans, illustrated by a hand and dollar bill graphic icons. The box on the right is labeled number 3 and is titled Enter into SRTs, or Synthetic Risk Transfers, illustrated by left and right graphic icons.
Number one is going to the equity markets directly. In today's market conditions that could be very expensive but it is open selectively. Number two is they could contemplate selling loans, but given today's interest rate environments, that's generally quite difficult 'cause there's a lot of embedded mark-to-market losses just given how high interest rates are today. Or they can contemplate an SRT whereby they will sell the equity risk, the credit risk of a certain portfolio, relieve the capital requirements of that book, and keep the assets on their balance sheet without actually transferring them into a structure or incurring any mark-to-market loss there.
The bank will generally drive the conversation of what assets to put into an SRT.
Let's say the bank considers to move forward on a mortgage SRT, they will put forward a portfolio, a suggestion of where the starting point for that kind of transaction would be.
We would take a look at the underlying portfolio, suggest tweaks around the edges based on our own preferences for asset selection, and also engage in a conversation with them on how much protection we want to provide them under the SRT structure.
FULL PAGE GRAPHIC TITLE: Structure can be tailored for bank priorities, investor preference, or other objectives. The graphic shows four boxes. The first box on the left in green is Bank Loan Pool, followed by an arrow with SRT (or Synthetic Risk Transfer) written on it. The second box to the right of the arrow is labeled Synthetic Senior, with the largest, top part shown in magenta, followed by Mezz A (short for Mezzanine loans) and Mezz B in varying shades of blue for each row, with Mezz C and First Loss Tranche shown at the bottom rows in varying shades of gray for each row. The third box is labeled Synthetic Senior on top in magenta (the largest part segment), followed by Mezzanine Tranche in blue and a smaller First Loss Tranche in gray at the bottom row. The fourth box is labeled Synthetic Senior in magenta on the largest, top part, followed by First Loss Tranche in a smaller blue row at the bottom.
There's a regulatory minimum of the amount of protection the bank is going to need, but there's also a fair degree of flexibility to be able to say maybe we want to offer a less levered or wider tranche to the bank, which gives us a slightly different risk proposition as opposed to a more highly leveraged structure, but also gives the bank themselves a little bit more flexibility in a downside scenario.
Our advantage in these conversations is generally our ability to operate across multiple asset classes. We're one of the few entities in the market that is truly flexible across so many different asset classes there. And it's because we have the ability to tap all of the resources that are PIMCO and all of our asset expertise across all the different verticals that we touch as an asset manager.
Text on screen: For more insights and information visit pimco.com
Text on screen: PIMCO
DISCLOSURE
Past performance is not a guarantee or a reliable indicator of future results.
Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.
Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown.
A word about risk: Investing in banks and related entities is a highly complex field subject to extensive regulation, and investments in such entities or other operating companies may give rise to control person liability and other risks. Bank loans are often less liquid than other types of debt instruments and general market and financial conditions may affect the prepayment of bank loans, as such the prepayments cannot be predicted with accuracy. There is no assurance that the liquidation of any collateral from a secured bank loan would satisfy the borrower’s obligation, or that such collateral could be liquidated. Investments in residential/commercial mortgageloans and commercial real estate debt are subject to risks that include prepayment, delinquency, foreclosure, risks of loss, servicing risks and adverse regulatory developments, which risks may be heightened in the case of non-performing loans. Corporate debt securities are subject to the risk of the issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price volatility due to factors such as interest rate sensitivity, market perception of the creditworthiness of the issuer and general market liquidity. Mortgage and asset-backed securities are highly complex instruments that may be sensitive to changes in interest rates and subject to early repayment risk and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee, there is no assurance that private guarantors will meet their obligations. Credit-linked notes are complex financial instruments that are subject to the creditworthiness of the issuer and involve default risk and liquidity risk. Credit default swap (CDS) is an over-the-counter (OTC) agreement between two parties to transfer the credit exposure of fixed income securities; CDS is the most widely used credit derivative instrument. Derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. The current regulatory climate is uncertain and rapidly evolving, and future developments could adversely affect a portfolio and/or its investments. In addition, there can be no assurance that PIMCO’s strategies with respect to any investment will be capable of implementation or, if implemented, will be successful.
Alternatives involve a high degree of risk and prospective investors are advised that these strategies are appropriate only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment.
PIMCO does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns.
This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517, 11 Baker Street, London W1U 3AH, United Kingdom) is authorised and regulated by the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. . Since PIMCO Europe Ltd services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. | PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963, via Turati nn. 25/27 (angolo via Cavalieri n. 4), 20121 Milano, Italy), PIMCO Europe GmbH Irish Branch (Company No. 909462, 57B Harcourt Street Dublin D02 F721, Ireland), PIMCO Europe GmbH UK Branch (Company No. FC037712, 11 Baker Street, London W1U 3AH, UK), PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E, Paseo de la Castellana 43, Oficina 05-111, 28046 Madrid, Spain) and PIMCO Europe GmbH French Branch (Company No. 918745621 R.C.S. Paris, 50–52 Boulevard Haussmann, 75009 Paris, France) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the German Securities Institutions Act (WpIG). The Italian Branch, Irish Branch, UK Branch, Spanish Branch and French Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) (Giovanni Battista Martini, 3 - 00198 Rome) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland (New Wapping Street, North Wall Quay, Dublin 1 D01 F7X3) in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN); (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) (Edison, 4, 28006 Madrid) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively and (5) French Branch: ACPR/Banque de France (4 Place de Budapest, CS 92459, 75436 Paris Cedex 09) in accordance with Art. 35 of Directive 2014/65/EU on markets in financial instruments and under the surveillance of ACPR and AMF. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. According to Art. 56 of Regulation (EU) 565/2017, an investment company is entitled to assume that professional clients possess the necessary knowledge and experience to understand the risks associated with the relevant investment services or transactions. Since PIMCO Europe GMBH services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2, Brandschenkestrasse 41 Zurich 8002, Switzerland). According to the Swiss Collective Investment Schemes Act of 23 June 2006 (“CISA”), an investment company is entitled to assume that professional clients possess the necessary knowledge and experience to understand the risks associated with the relevant investment services or transactions. Since PIMCO (Schweiz) GmbH services and products are provided exclusively to professional clients, the appropriateness of such is always affirmed. The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (8 Marina View, #30-01, Asia Square Tower 1, Singapore 018960, Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited (Suite 2201, 22nd Floor, Two International Finance Centre, No. 8 Finance Street, Central, Hong Kong) is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. PIMCO Asia Limited is registered as a cross-border discretionary investment manager with the Financial Supervisory Commission of Korea (Registration No. 08-02-307). The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Investment Management (Shanghai) Limited. Office address: Suite 7204, Shanghai Tower, 479 Lujiazui Ring Road, Pudong, Shanghai 200120, China (Unified social credit code: 91310115MA1K41MU72) is registered with Asset Management Association of China as Private Fund Manager (Registration No. P1071502, Type: Other). | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862. This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. To the extent it involves Pacific Investment Management Co LLC (PIMCO LLC) providing financial services to wholesale clients, PIMCO LLC is exempt from the requirement to hold an Australian financial services licence in respect of financial services provided to wholesale clients in Australia. PIMCO LLC is regulated by the Securities and Exchange Commission under US laws, which differ from Australian laws. | PIMCO Japan Ltd, Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association, The Investment Trusts Association, Japan and Type II Financial Instruments Firms Association. All investments contain risk. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is an independently operated and managed company. The reference number of business license of the company approved by the competent authority is (112) Jin Guan Tou Gu Xin Zi No. 015 . The registered address of the company is 40F., No.68, Sec. 5, Zhongxiao East Rd., Xinyi District, Taipei City 110, Taiwan (R.O.C.), and the telephone number is +886 2 8729-5500. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | Note to Readers in Colombia: This document is provided through the representative office of Pacific Investment Management Company LLC located at Carrera 7 No. 71-52 TB Piso 9, Bogota D.C. (Promoción y oferta de los negocios y servicios del mercado de valores por parte de Pacific Investment Management Company LLC, representada en Colombia.). Note to Readers in Brazil: PIMCO Latin America Administradora de Carteiras Ltda.Av. Brg. Faria Lima, 3477 Itaim Bibi, São Paulo - SP 04538-132 Brazil. Note to Readers in Argentina: This document may be provided through the representative office of PIMCO Global Advisors LLC AVENIDA CORRIENTES, 299, Buenos Aires, Argentina. | No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. ©2024, PIMCO.
CMR2024-0822-3807531
