Regional banks want to slim down. Hedge funds smell a bargain.

Ohio-based Huntington Bancshares recently entered into an arrangement to sell investors some of the risk that its borrowers won’t repay their loans. That helps the bank meet new proposed standards meant to make lenders look healthy to regulators.

The deal is known on Wall Street as a synthetic risk transfer, and it offers cash-flush, private-debt fund managers—such as Ares Management and Blackstone—an attractive investment. Bayview Asset Management, the fund involved in Huntington’s December deal, stands to make as much as 15% on the trade and a similar one done for SoFi Bank, people familiar with the matter said.

Now others are doing the deals, too. Large regional lenders including Utah-based Ally Bank and North Carolina-based Truist Financial are working on their own transactions to sell the risk on billions of dollars of loans, according to the data provider Finsight and letters to the banks from the Federal Reserve.

Regulators are forcing the banks to meet stricter rules to protect themselves from crises of confidence, such as the ones that toppled SVB and recently shook New York Community Bank. Ultimately, risk transfers should help banks stabilize and start spending money again on such things as share buybacks and acquisitions, analysts said.

“You could call it aggressive defense,” said Ken Usdin, a banking analyst at Jefferies. “They are optimizing for regulatory capital, but they are paying up for it.”

New regulations loom

U.S. banks are preparing for new regulations announced last year after the regional-bank failures. They are expected to force midsize banks to meet capital requirements previously only applied to large financial institutions.

“We expect we will be in capital-preservation mode as we kind of see how all of that unfolds,” Ally Chief Financial Officer Russ Hutchinson said at a recent investor conference. Risk transfer “becomes a very attractive way for us to reduce risk-weighted assets and effectively preserve capital,” he said.

Historically, U.S. banks created a financial cushion by increasing capital through stock sales, or by selling loans. Many of the loans they own were made when rates were low, meaning they would take a loss if they sold them now. Selling new shares could push already-battered stock prices lower.

Late last year, the Fed gave U.S. banks another option, by letting them increase regulatory capital through risk transfers, a tool long employed by European banks.

About 20 U.S. synthetic transactions have been done, totaling $17 billion, compared with about $190 billion in Europe, said Kathy Jones, a structured-products trader at Raymond James. The U.S. could quickly outstrip Europe once smaller, regional banks start adopting the product, she said.

Merchants Bancorp, a relatively small Indiana-based lender, got the green light from the Fed this month for a synthetic risk transfer, according to a letter from the regulator.

Banks can transfer risk in two ways: One is selling so-called credit-linked notes to investors, boosting the banks’ balance sheets. Another is purchasing credit insurance from the investors, who post cash as a backstop. The banks pay interest or premiums to the investors. The investors are on the hook for losses from any defaults on the insured loans. Both options cover losses from defaults on as much as 12.5% of a loan pool.

That cost drags down profitability, which is already falling. Regional-bank stocks fell last week after Huntington lowered guidance for net interest income, the difference between what it makes from loans and what it pays on deposits.

A hot Wall Street product

Banks such as JPMorgan Chase and Morgan Stanley issued a flurry of synthetic risk transfers for themselves last fall. Now they are arranging deals for regional lenders—for a fee—and hope to start trading the instruments if the market gets big enough.

Morgan Stanley helped raise financing for Huntington’s transaction with Bayview. JPMorgan is currently marketing a risk transfer for Ally to investors and a second risk deal for Huntington that doesn’t involve Bayview.

Others are laying the groundwork for when smaller banks could issue risk transfers. The private-credit fund Crayhill Capital Management has retained as an adviser Tom Killian, an investment banker who helped pioneer the market for bonds backed by community banks’ preferred securities in the 2000s. Killian has held informal talks with banks and regulators about risk transfers, aiming to eventually help small banks access the market, according to a person close to the fund manager.

For money managers, bank risk transfers offer high returns and a new product to pitch to investors eager to buy into the red-hot market for private credit. BlackRock, the private-fund specialist KKR and the French insurer AXA have all published reports hawking them.

Florida-based Bayview has come up with a twist on the complicated deals: borrowing money in bond markets to enhance its returns. Bayview manages about $20 billion and specializes in buying mortgage and consumer loans, often from such banks as Huntington. The firm has been pitching banks risk-transfer deals for at least five years, people familiar with the fund manager said.

Bayview offered to sell Huntington credit-default swaps, a type of insurance, to reduce capital charges on a pool of about $3 billion in car loans. The bank agreed to pay a 7.5% annual premium, and Bayview committed to compensating the bank for seven years for any defaulted car loans up to $375 million, or 12.5% of the loan pool.

To back up that commitment, Bayview issued about $315 million of bonds at a blended interest rate of about 6.75%. Cash from the bonds went into an interest-bearing account. Over time, the bonds will be paid off with money from Huntington’s premiums, the money in the account and accrued interest. Bayview will pocket the difference. If defaults on the auto loans exceed Bayview’s projections, the fund could take a loss.

Write to Matt Wirz at matthieu.wirz@wsj.com