Loan Note: The growth of the SRT market; Howard Marks’ CRE concerns

AXA IM Alts highlights the growth of the significant risk transfer market. Plus: Oaktree's Howard Marks expresses concern about commercial real estate; and S&P highlights various potential stresses in the system. Here's today's brief for our valued subscribers only. 

They said it

“The cost of capital for corporate borrowers is already increasing and expected to remain elevated. This leaves refinancing risk and capital availability as key considerations for credit investors”

Taken from the latest BlackRock Alternatives Global Credit Weekly

First look

Shake on it: banks and funds have mutual benefits in the SRT market (Source: Getty)

A market where banks and funds co-operate
Those who view the world in stark “bank versus private debt” terms may not have come across the niche world of significant risk transfer. This is the subject of a market commentary from AXA IM Alts and makes clear how what is perceived to be a competitive relationship can also be a highly complementary one.

In essence, SRT involves an investor selling protection against a selected portion of a bank’s loan book defaulting. This enables the bank to improve its capital adequacy ratio while the investor obtains stable cashflows through the premium paid by the bank for protection against loss.

According to AXA IM Alts, the SRT market has been growing rapidly in recent years and has doubled in size since 2016. The market has been assisted by recent disruptions to the banking sector and the continuing need for banks to raise regulatory capital to improve their balance sheets and profitability.

The cost of capital, already under pressure from rising interest rates, is likely to rise higher following certain bonds (known as Additional Tier 1) that the banks used as “shock absorbers” in the face of possible collapse failing to perform that function in the case of Credit Suisse.

AXA IM Alts thinks that increased scrutiny of the AT1 market could be useful to the SRT market. While both provide capital relief to banks, SRT transactions do not form part of the bank’s liabilities. SRT offers “appealing premiums and an important source of diversification” according to AXA IM Alts.

Marks highlights CRE concerns
Assessing the significance of the SVB failure in his latest memo, Oaktree Capital Management’s Howard Marks sees little danger of a re-run of the global financial crisis. Referring to it as a “special case”, he says SVB was “particularly vulnerable to a bank run if adverse circumstances developed – and they did… I don’t think SVB’s failure suggests problems are widespread in the US banking system.”

However, that doesn’t mean to say banks in general get off the hook. Marks points to certain things SVB had in common with other banks, including asset/liability mismatches (“no bank can have enough liquidity to meet its needs if enough depositors ask for their money all at once”) and high leverage.

He also sees stresses building in the commercial real estate sector, where banks are estimated to hold about 40 percent of the $4.5 trillion of outstanding CRE mortgages (around $1.8 trillion). Losses on CRE mortgages could leave banks undercapitalised, in Marks’ view.

“No one knows whether banks will suffer losses on their commercial real estate loans, or what the magnitude will be,” says Marks. “But we’re very likely to see mortgage defaults in the headlines and, at a minimum, this may spook lenders, throw sand into the gears of financing and refinancing processes, and further contribute to a sense of heightened risk.”

Cautious tone in S&P report
“Overall, private credit is likely feeling a similar pinch to the public markets,” says a report from S&P Global Ratings that throws a spotlight on several areas of concern.

The report finds that: sponsor-owned companies are at the lower end of the rating scale, with S&P’s methodology “assuming that financial risks for a sponsor-owned company are commensurate with those of highly leveraged companies”. Around 75 percent of borrowers rated B and below are fully or partially private equity owned.

Within the collateralised loan obligation universe, 75 percent of companies making up CLOs have a B- rating and 10 percent are CCC. By contrast, only 36 percent of rated corporate issuers in North America are rated B- or lower.

Software services and healthcare businesses – which have been highly popular targets for private equity and private debt in recent years – are identified as “most vulnerable” to current economic conditions. Software has the second-highest leverage at 7.8x and the second-lowest cash interest coverage at 1.4x.

Business development companies are mostly rated BBB-. Exposure of BDCs  to payment-in-kind loans “represents a risk to these asset managers” with payment-in-kind increasing, partly as a result of the tendency to “amend and extend” loans.


First close for RoundShield
RoundShield, the European fund manager, is understood to have held a first close on around $750 million for its latest fund, Fund V, which focuses on European asset-backed special situations and distressed opportunities.

Having launched the fundraising process in December, RoundShield is believed to have a re-up rate of around 80 percent and is planning to hold a further close in the coming months. The previous fund, Fund IV, closed on its hard-cap of £670 million ($833 million; €757 million) in 2020.

RoundShield declined to comment on developments.

Nordics MD hire for Arrow
Arrow Global Group, the credit and real estate fund manager, has appointed Gabi Cohen as managing director, Nordics, client and product solutions. The CPS team is responsible for setting Arrow’s capital formation strategy and broadening the firm’s investor set.

Cohen joins from ICG, where she worked for 10 years as part of the business development function, including leading Nordic investor activities. She also spent two years at ESO Capital, as well as various banking roles at UBS and HSBC.

Arrow recently announced it had reached the hard-cap of its flagship strategy Arrow Credit Opportunities II Fund on approximately €2.75 billion, exceeding its fundraising target of €2.5 billion and attracting almost unanimous re-ups from ACO I investors.

Cohen will be based in London, reporting to Charlotte Gilbert, managing director, CPS.

Haynes and Boone brings in new finance partner
Haynes and Boone, a global corporate law firm active in private debt, announced that Aleksandra Kopec has joined as a finance partner. She will work out of the Charlotte, North Carolina office of the firm, which has 19 offices around the world.

Haynes and Booth was founded in 1970 and is headquartered in Dallas, Texas.

Kopec’s practice blends fund finance with leveraged finance. She has worked for eight years at King & Spalding, representing lenders in a range of finance transactions.

Her arrival is part of a broader build-up of the Charlotte office. Five other new finance partners arrived there recently from Moore & Van Allen, so the Charlotte office, which opened in 2019 with just three lawyers, now has 17, including Kopec.

LP watch

Institution: Virginia Retirement System
Headquarters: Richmond, US
AUM: $102.5 billion
Allocation to private debt: 13.8%

Virginia Retirement System has confirmed $550 million of commitments to private debt funds during its April investment advisory committee meeting.

The pension has committed $250 million to Ares Pathfinder II, $150 million to Ares Capital Europe VI and a further $150 million to Oaktree Opportunities Fund XII.

VRS has a current private debt allocation of 13.8 percent of its $102.5 billion investment portfolio.

Today’s letter was prepared by Andy Thomson with John Bakie, Christopher Faille and Robin Blumenthal contributing