Hedge fund Davidson Kempner Capital Management is partnering with the UK government to provide capital relief to agricultural lender Oxbury Bank through a synthetic risk transfer covering as much as £500m ($662m) of loans to small and medium-sized farming businesses, according to a report by Bloomberg.

Under the transaction, the British Business Bank will provide a guarantee covering the senior portion of the portfolio, while New York-based Davidson Kempner will invest in a junior tranche, according to the government-owned development bank.

Oxbury will retain part of the underlying credit exposure while benefiting from additional regulatory capital that can be used to expand lending to the agricultural sector.

The transaction forms part of the British Business Bank’s efforts to encourage institutional investors to participate in synthetic risk transfers through its Enable programme. The initiative is designed to make capital-relief transactions more accessible to smaller specialist lenders, which can otherwise find it difficult to use such structures because of the relatively small size of their loan portfolios.

Michael Strevens, managing director for structured financial institution solutions at the British Business Bank, said the structure could potentially be replicated by other agencies in the UK and Europe to help smaller lenders generate additional financing capacity.

Around 20 synthetic risk transfer investors have expressed interest in participating in transactions through the Enable programme, Strevens said.

SRTs are generally used for larger portfolios, with transactions involving loan books below £1bn relatively uncommon. Combining the government-backed Enable guarantee with institutional capital provides a mechanism for smaller banks to release capital tied up against their lending portfolios.

The Oxbury deal follows an earlier transaction involving Sona Asset Management and the British Business Bank covering as much as £350m of asset-based loans originated by Allica Bank.

The latest transaction builds on an Enable guarantee first agreed with Oxbury in 2023. The new risk transfer will support term lending to small and medium-sized agricultural businesses and is also intended to facilitate preferential financing for borrowers meeting specified sustainability criteria.

Those criteria include measures aimed at reducing carbon emissions and increasing the use of renewable energy.

For Oxbury, the transaction provides additional balance-sheet capacity without transferring all of the credit risk associated with its agricultural loan book. For institutional investors such as Davidson Kempner, meanwhile, synthetic risk transfers offer exposure to credit portfolios while providing capital to lenders.

The transaction adds to Davidson Kempner’s growing activity in structured credit and capital-relief investments. The hedge fund manager oversees more than $40bn in assets and invests in synthetic risk transfers and other capital-relief transactions.