Friend or Foe? The SRT Market Weighs Insurers’ Place in the Capital Stack 

Insurers are currently found occupying a few different corners of the SRT market. They can provide direct unfunded protection to banks, compete with SRT investors for allocations or, most interestingly, finance those investors and experiment with insurance-backed structures that put them one step further down the chain from a bank.

EU negotiators met on Sept. 29 without reaching a final deal on reform of securitization regulation, which includes whether (re)insurers can provide unfunded protection on simple, transparent and standardized, or STS, securitizations. A concluding round is now planned for Oct. 21. Those talks address insurers as protection sellers to banks, but not their growing role as financiers of SRT funds.

Traditional financing routes, such as repurchase agreement, or repo, financing, have recently come under pressure, with multiple market participants saying its use has been reduced following regulatory scrutiny of leveraged SRT investing because of concerns that transferred risk may be returning to the banking system. This has prompted investors to turn to alternatives.

“Repo financing remains available, but market participants are also considering alternative financing solutions, including [net asset value] facilities,” said Frank Benhamou, portfolio manager and head of SRT at Cheyne Capital. “The market is still evolving as participants assess the most appropriate financing structures.”

Insurers have stepped in as a versatile capital source, offering tailored solutions to both originating banks and the investors, who are typically interested in that risk.

“Insurers can play different roles in the market,” Benhamou explained. “They may invest directly in an SRT transaction or provide financing backed by SRT investments. Therefore, one of the challenges for a cash investor is that a potential financing provider may, in some cases, also be a competitor for the same transactions. This dynamic requires caution when sharing investment and underwriting information.”

The market may therefore have less of a reason to force insurers into choosing a side, and let them pick their place by where they sit in the SRT capital stack instead. Thus far, there is a valid case to do both.

An insurer selling direct protection is taking the risk of the SRT portfolio itself, whereas financing an SRT fund involves taking senior exposure to the fund manager’s portfolio and being paid for that financing. The economics can make either attractive, depending on the insurer’s return requirements and infrastructure.

“When an insurer provides financing, the all-in spread return is typically in the range of 250 bps-350 bps,” Benhamou said. “By comparison, a direct investment in an SRT tranche may generate an all-in spread return of approximately 700 bps-800 bps. These are quite different investment propositions, typically serving different investment mandates and risk-return profiles within an insurer.”

“Insurance wrappers can be particularly relevant for insurers that do not have significant internal SRT origination capabilities, as they can provide access to SRT transactions that may otherwise be difficult to source without the appropriate infrastructure, expertise and market relationships.”

For many SRT investors, however, the more important question is where insurance capital actually adds value. The market has been partly complementary, sources report. In an SRT trade, an insurer can guarantee a senior mezzanine tranche, giving a fund structural leverage on its investment lower in the structure. That test bites as insurance protection numbers keep growing and insurers’ appetite for junior mezzanine tranches may also emerge. This is also where Benhamou sees the least need for them.

“For insurers, mezzanine investments can be valuable to the market, as there is generally less investor appetite for mezzanine risk than for first-loss and junior tranches. Insurance capital can increase market capacity where it is most needed, whereas in junior tranches it is more likely to add to an already established pool of investors.”

Elsewhere in the market, insurance is now being used in different ways to address the same underlying demand for credit protection. In September, Aegon Asset Management launched its Aegon Insured Credit Fund, an evergreen vehicle for European and U.K. institutional investors, that will provide exposure to global credit investments fully insured by A and AA rated insurers.

The strategy has been run internally since 2021 but is now being offered as an institutional product. The structure actually places the insurer one step removed from the investor as Aegon originates and selects the underlying credit, while a third-party insurance company provides the protection. This serves as another example of how insurance is being built into the investment structure and can seemingly influence how credit risk is distributed and funded.

The Other Trust Problem

Public supervisory attention on SRT financing has largely focused on bank funding. The European Central Bank is surveying banks on SRT financing, including funding provided to investors in other banks’ SRTs, and an ECB working paper found that banks were 57% to 66% more likely to sell an SRT to a nonbank investor that they also lend to. Yet data on the scale of SRT financing are scarce. The banks have naturally responded by asking for more visibility regarding who stands behind their investors.

“Banks are increasingly seeking transparency around the financing of SRT investments, including whether financing is being used and the identity of the financing provider,” Benhamou commented.

Such a request for transparency sits oddly next to the trust that the bank itself already asked of the investor. In blind pools, which still make up a large portion of the market, the investor takes the issuer’s data and underwriting on faith. Once an investor takes on a financier, the same request runs the other way. Subsequently, an insurer providing senior funding against a portfolio of SRT positions might, in fact, be underwriting the manager’s judgment and diversification, much as the manager once underwrote the bank’s.