UK Government-Owned Firm to Use Risk Transfers to Boost SME Lending
(Bloomberg) -- British Business Bank, a government-owned firm, is seeking to use SRTs to help UK-based commercial banks boost lending to small and medium-sized enterprises.
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The economic development entity wants to help lenders create significant risk transfers that are linked to the riskiest portions of their loan portfolios. That will reduce the amount of regulatory capital UK banks need to put aside to cover potential losses, allowing them to boost lending, according to Michael Strevens, the head of structured guarantees at the Sheffield-based institution.
British Business Bank already supports about £50 billion ($64 billion) of financing in part by guaranteeing mezzanine and senior portions of banks’ SME loan portfolios. But it doesn’t guarantee the junior tranches, which is why the government agency wants to bring in yield-hungry SRT investors.
“Given especially that there’s a large influx of SRT investors coming in at the moment and yields coming in, we thought maybe this was a good time to show them something a bit different,” said Strevens in an interview. It’s “the next phase in our product development.”
The way SRTs typically work is that a bank will earmark a pool of loans on its balance sheet and buy credit default protection on the first 5% to 15% of the losses of that pool, often by selling a credit-linked note. They’re gaining in popularity this year, with Chorus Capital estimating that global issuance for 2024 will reach as much as $30 billion, a record.
SRTs’ spread over the risk-free rate has tightened by more than 200 basis points since the widest levels in 2022 as there has been “notable” increase of demand from large private and structured credit funds, according to a July 11 report by the Man Institute, part of Man Group Plc, an investor in such notes.
Pilot Test
While British Business Bank’s plan is at an early stage, an initial deal could be for an SRT investment in the range of £10 million to £20 million, which would be linked to a loan portfolio of £400 million to £500 million, Strevens said. The SRT would be placed in a bilateral transaction, he said.
For the pilot test, the government institution would probably guarantee the mezzanine and the senior portion of the loan portfolio, so the bank taking the guarantee can easily comply with the regulations for obtaining capital relief, said Strevens. Once the program is at a more advanced stage, the British Business Bank may only be guaranteeing the mezzanine tranche.
“The combination of our exposures getting quite large in some instances, and the influx of new SRT investors driving yields down in more traditional issuances, mean it seems a good time to start exploring this,” said Strevens. He added that potential investors may be “asking for a premium” compared with a deal linked to a pool of large corporate loans, the most common type of SRT.
(Updates to add Chorus Capital SRT volume estimate in fifth paragraph, recasts)
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