Private Credit: Significant Risk Transformation Market Outlook

Abstract

Credit risk transfer (CRT) creates and sells financial instruments to transfer credit risk from one market participant to another. CRT is widely used in consumer and commercial credit markets as an integral part of credit underwriting and risk management, and it is relevant for almost all market participants, including banks, investors, and insurance companies. The CRT market, represented primarily by credit guarantees on asset-backed securities, supports the issuance of asset-backed securities and related products by taking on a portion of the credit risk. The term "significant-risk transfer" (SRT) describes credit risk transfer by government-sponsored enterprises when they issue securities not explicitly guaranteed by the government and without obtaining a credit rating equal to or above their own. This text contributes to our understanding of the workings and performance of the SRT market. It reveals how the GSEs complete SRT seamlessly and suggests that possible SRT market disruptions caused by reforming the GSEs are likely manageable. Moreover, it discusses institutional arrangements governing the GSEs' SRT transactions, risk-based pricing of the guarantees, and potential scenarios for the future of the SRT market. Since the mortgage risk market is of significant interest to the authorities under the new regulatory environment, this text also discusses the regulatory treatment of mortgage risk alternatives, including the remaining private credit enhancement market.