The appeal of risk-sharing strategies to banks, investors, and innovative fund managers
Olivier Renault, Head of Risk Sharing Strategy, Pemberton Asset Management
Pemberton Asset Management is a €19.3bn AUM pan-European private credit firm, backed by insurer Legal & General. It employs more than 170 staff globally. Olivier Renault, Head of Risk Sharing Strategy, talked to Shaun Beaney, Editor of Preqin First Close, about the innovative significant risk transfer (SRT) fund he’s raising to invest in banks’ core loan portfolios.
Various terms are used to describe what you do: SRT; bank risk-sharing; credit risk transfer. What do these mean in simple terms?
The gist of it is hedging transactions for banks to free up capacity on portfolios of loans. That can be either regulatory capacity, such as Basel capital, or risk limits, where typically a bank wants to do more business with its borrowers and runs into capacity issues. SRT is the regulatory term in Europe. ‘Risk sharing’ reflects another point – that we insist the bank remains exposed to every loan that we hedge. If we take a loss, the bank also takes a loss.
What kinds of bank loans are you covering?
The technique itself has been applied to every kind of loan on a bank’s balance sheet, from commercial real estate, to mortgages, to project finance, shipping, and so on. We focus on large corporate loans, typically investment-grade/crossover. That’s the bulk of a global bank’s corporate lending portfolio and the majority of the volume of SRT transactions. And then, for banks in the domestic market, we’ll look at SME portfolios. The Pemberton DNA is very much corporate and SME.
How does this align with Pemberton’s traditional fund management in direct lending?
The narrative for direct lending and SRT is the same. Banks are struggling with risk capacity and regulatory capital capacity. They want to continue lending to specific types of borrowers, mostly because they get ancillary revenues in M&A transactions, cash management, derivatives – investment-grade, large corporates are a good example. The bank really doesn’t want to exit. So, it makes sense for a credit specialist to come in and help the bank to continue to lend from its balance sheet.
What form does the SRT fund take?
Pemberton Risk Sharing I is a closed-end fund with an investment period and harvesting period. It’s very much the same structure as a traditional private debt fund. We launched the strategy when I joined the firm two years ago. It took us a year to set up the infrastructure and then we started investing in 2022. However, we have the capacity to do SRT not only within dedicated vehicles, but also in our multi-strategy funds.
Where are you seeing investor demand?
For this asset class, it’s very much from pension funds and sovereign wealth. Less so from insurance companies, because, depending on their jurisdictions and regulatory rules, it might be too capital-consuming.
Is SRT regarded by LPs as a very niche investment category?
I would say, four or five years ago: absolutely. Two years ago: probably still pretty niche. But the vast majority of LPs I speak to now have heard about it and are thinking about it. Even in my two years here, I’ve seen a big difference in awareness. This market’s grown by 20% per annum since 2010. It used to be 20% of a pretty small number. Now it’s 20% of a pretty big number. It has gone mainstream.
By year-end 2023, about 70 banks had set up to issue and 43 banks brought transactions to the market last year. There were 115 transactions done. It’s growing by about 10 banks per annum. Last year, the total supply was $25bn of notes on portfolios of about $300bn.
For investors, what’s the risk/return profile?
Across the market, the assets themselves generate 12–16% returns, gross. After reserving for expected losses, the net returns after costs and fees can easily reach 10–12%, depending on the currency. Some investors want to reach mid-teens net return, which you can do with not a lot of leverage. From a risk standpoint, the asset class is very resilient because banks need to cover well above expected losses to get capital relief, so investors get paid an attractive premium to take on diluted risk.
Some people might feel nervous when they hear ‘bank risk transfer’. What’s the view from a macro banking and systemic point of view?
We focus on the main lending books of banks, so we’re not helping banks venture into areas they don’t understand or aren’t core to their businesses. If it is with a regional bank, we’re going to focus on their domestic SME book. If it’s with a large, global bank, it’s going to be their large, investment-grade corporates.
The protection we give is fully funded on day one. If we cover $100mn potential losses on the bank’s balance sheet, the bank will receive $100mn cash on day one. There’s no counter-party risk, so there’s no systemic risk.
Another very important thing from a transparency standpoint is that banks cannot be accused of hiding some of their positions. These transactions are done on balance sheets. Regulators have full transparency on what risks the banks have taken and what they have hedged. In addition to that, the regulators get transparency on the risk-sharing transactions. Each transaction is signed off by the regulator.
As of year-end 2023, around $900bn of loans were hedged in risk-sharing transactions. Across 70 banks, that represents 1.5% of their balance sheets. It’s a big number, but it’s a big number as a proportion of a huge number. Going from 1.5% to, say, 5% of their balance sheets would lead to a three-fold growth in this particular market. We think that’s easily going to be achieved by the end of the decade.
Shaun Beaney is Editor of Preqin First Close, the essential newsletter for the global alternatives market. It’s quick, easy, and free to subscribe here.
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The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin and Pemberton Asset Management providing the information in this content accepts no liability for any decisions taken in relation to the above.