Napier Park to increase investment in bank risk transfers

Napier Park plans to join the current fashion for credit risk transfer deals, in which banks free up capital by essentially paying hedge funds and other investors to share loan-book exposures.

“We expect there to be a secular move of risk away from the banks through third-party investment,” says Serhan Secmen, global head of Napier Park’s collateralised loan obligation (CLO) business. “And we plan to play an important role.”

The alternative credit manager, which has $21 billion in assets under management, has focused on structured credit and relative value investing for over a decade and in the past has been quick to embrace innovation. Co-founder Jonathan Dorfman helped launch the first tradeable credit index while at Morgan Stanley in the early early 2000s.

Napier Park was involved in the early days of credit risk transfer, too. In the decade that followed, though, the firm focused its attentions elsewhere. Now that’s changing.

Secmen says this year the firm has been looking to increase its involvement in so-called synthetic risk transfer (SRT) deals, though he declined to say precisely the scale of investment planned. 

Napier Park is joining a growing trend. Large asset managers like BlackRock have been vocal about the opportunities in credit risk transfer in recent times. SRT deals are offering in some cases returns as high as 15% over risk-free rates.

“The market has a lot of potential to grow,” Secmen says. “We estimate only a small portion of the potential has been tapped so far.”

We expect there to be a secular move of risk away from the banks through third-party investment

Serhan Secmen, Napier Park

The firm’s CLO managers say other reasons also exist to invest more heavily in SRT. The increasing maturity of the sector is one. In Europe, regulatory rules governing the transactions have become settled and market practices have crystallised. A track record of issuance and deal performance has built up.

Meanwhile, in the US, large banks have started in recent months to complete SRT deals once again after policy-makers clarified rules that previously held activity back. Notably, JP Morgan completed a first SRT deal last year and another early in 2024.

Bespoke deals

In Europe, SRT has followed a bifurcated path, with certain banks moving towards standardisation. Organisations such as Deutsche Bank and Santander issue trades to syndicates of multiple investors. 

Sometimes transactions involve dozens of parties. In one case, an SRT deal drew interest from as many as 100 investors. That has led established market participants to complain about new rivals that pitch too aggressively for deals, which arguably leads to terms that favour issuers.

The portfolio managers at Napier Park, though, are hoping to find and complete more “bespoke” transactions, specifically from newer-to-market US banks. In bilateral deals, or deals involving just a few firms, investors have greater scope to examine and possibly select the precise loans in a portfolio.

The market has a lot of potential to grow. We estimate only a small portion of the potential has been tapped so far

Serhan Secmen, Napier Park

Secmen emphasises improvements in how deals are structured and in the the quality of underlying loans in the portfolio. “The structures we have the most appetite for are those that are bespoke, where we can have more input in the structure and the collateral selection,” he says, adding that recently the firm has seen more such opportunities from “bulge-bracket banks”.

Last year banks offloaded risk from more than $300 billion in underlying loans in deals worth $25 billion. That figure is up from $20 billion in 2022 and $15 billion the year before, according to industry estimates.

Beyond CLOs

Secmen and Batur Bicer, a portfolio manager in Napier Park’s CLO team, see SRTs as a complement to the firm’s CLO investments. In particular, SRTs allow buy-siders to invest in parts of a bank’s loan book that cannot be packaged into a CLO, they say, such as revolving credit facilities.

The skill set required to assess deals is also complementary. “Similar to CLOs where you make sure you are comfortable with the manager, in SRTs, you’re underwriting the issuing bank. You also consider how the macro environment and the model portfolio look,” says Secmen. “From that perspective, I’m not really surprised that a lot of CLO investors are taking interest in looking at SRTs with similar structures.”

Meanwhile, SRT investments can provide a useful offset to more volatile CLO holdings, a potentially useful feature in an environment of rising default rates and growing credit strains.

“CLOs are known to be more volatile than the underlying assets,” says Secmen. “When the underlying asset like a double-B loan sells off 100 basis points, the CLO double-B tranche sells off 300 basis points.”

With SRTs, by contrast, the deal’s private nature tends to dampen volatility.

The tradeoff is illiquidity. And here the CLO managers acknowledge that investors must be careful. “CLOs historically have been known to be relatively liquid in good times and illiquid in bad times,” says Secmen. “SRTs by their nature are a lot less liquid, even compared to CLOs regardless of the environment.”

On the use of leverage in SRT deals, Napier Park’s managers also take a nuanced line.

SRT transactions offer embedded leverage because of their synthetic structure. And investors can add to that leverage by borrowing to finance deals if they so choose.

Leverage is not bad per se, the managers argue, pointing to other parts of the credit markets such as CDS trading where implicit leverage also exists. “One point to emphasise is that the CDX indexes and tranches are all unfunded,” Bicer says. “So any investor in those markets gets implicit leverage. That’s the nature of the product.”

That said, SRT returns are attractive enough that leverage becomes a choice rather than a necessity, he adds.

Editing by Rob Mannix