As European regulators pressure banks to speed up their deleveraging, securitising non-performing loan portfolios is viewed as one method of shifting large volumes of real estate secured and unsecured exposure, quickly.

There is precedent to banks packaging NPLs and selling them in multiple tranches of asset-backed securities. “Italian banks used this model to clear NPLs they had accumulated as a result of difficult macroeconomics and liberal underwriting in the late nineties,” says Francesco Dissera, a managing director leading European fixed-income structuring and advisory at financial services firm StormHarbour.

However, rated securitisations have re-emerged in the past two years to facilitate NPL portfolio disposals, primarily in countries which did not set up state-backed ‘bad banks’ and still have huge non-core debt piles to clean up. Italy led the NPL securitisation market last year, with €22 billion of sales related to securitisation. Issuance has been boosted by a government scheme introduced in 2016, designed to encourage investment in asset-backed securities. Known as Garanzia Cartolarizzazione Sofferenze – GACS – the scheme provides a state guarantee that the most senior notes in an NPL securitisation will be paid.

Up to eight Italian banks are understood to be considering GACS-backed sales this year. In May, Monte dei Paschi di Siena completed the securitisation of a distressed loan portfolio totalling around €24 billion, obtaining investment-grade ratings on the senior tranche. The bank said at the time it expects GACS guarantees to be obtained. In December, the bank sold the mezzanine tranche to Italy’s state-backed Atlante II fund. This allowed the bank to derecognise the NPLs and contribute to Tier 1 capital. Monte dei Paschi was subject to an Italian state bailout approved by the European Union last July.

Why it works

CMBS structures are “the perfect way to deal with NPLs secured by commercial real estate”, according to Iain Balkwill, partner at law firm Reed Smith’s structured finance team.

“Banks can offload a few billion of loans in one shot, compared with a standard NPL trade,” he explains. “Investors only have so much money to invest, which means the number of loans that can potentially be offloaded through a bilateral deal is limited. By issuing securitised notes to a range of investors the pool of money is deeper.”

There is also potential for issuers to take a share in the upside in the performance of the underlying collateral if an investor makes a profit on an NPL. “There is no reason you couldn’t build in a class X note whereby interest is diverted to the issuer, which makes sense for the bank,” Balkwill says.

For investors, the scale of NPLs that need resolving represents a major opportunity but trying to tap into this can be challenging. “A lot of banks are offloading large deals worth several hundreds of millions through auction processes which involve hugely ambitious timelines. Investors end up incurring legal fees on due diligence which makes it expensive, especially when there is no guarantee they will be successful,” continues Balkwill.

The ability to buy into debt at various tranches of risk also allows investors to secure NPLs at potentially cheaper pricing.

Limits to securitisation

Only some asset types are suited to rated securitisation, however, described by Ganesh Rajendra, managing partner at independent investment research firm Integer Advisors as “typically secured loans with relatively predictable recovery flows”.

A rating is mandatory to qualify for a GACS guarantee, and “rating agencies generally take a conservative view on both the quantum and timing of recoveries”, he says.

Loans should be first and second lien, backed by residential and commercial property mainly, with limited land and developments. “What can be rated has become more prescriptive since early 2000 when Italian banks used this tool,” says Dissera.

More than half of UniCredit’s €17.7 billion Project Fino NPL portfolio – the largest GACS to date – was secured, for example.

NPL securitisation has been less prevalent in jurisdictions such as Spain, partly because “the auction process has been successful so there is less incentive”, says Balkwill.

Instead, the market has seen ‘resecuritisations’ which involve mainly residential loans that have been corrected through an equity injection or an extension to the loan term. These are then securitised by private equity investors that have acquired large NPL portfolios.

“Big funds buying NPLs typically use pure equity and try to secure leverage soon after, allowing them to release equity to buy more assets. Of key importance is being able to get flexible finance at the best possible rate. Securitisation has been a cheaper source of financing historically,” says Balkwill.

NPL securitisations took place in Greece and Portugal last year. Greece’s Attica Bank securitised €1.05 billion of loans in an unrated deal, while in Portugal, Caixa Economica Montepio Geral completed a €580 million securitisation.

“These countries will likely see more activity since the markets are similar to Italy in having high NPL ratios but being behind the curve in tackling non-core exposure,” says Integer’s Rajendra.

With almost €900 billion of outstanding non-performing exposure held by European banks according to the European Central Bank, Dissera expects to see continued deleveraging in the form of direct disposals as well as securitisations, the latter executed by smaller financial institutions mainly in Italy, Spain and Portugal.

“Banks are under massive regulatory pressure to offload non-core debt, therefore they will try to find more inventive ways of maximising the price of such loans and securitisation could be a way of achieving that, which if proven will incentivise other banks to follow suit,” says Balkwill.

UniCredit was the first bank to offer investors the GACS-guaranteed tranche – relating to Project Fino – in January this year, an important step towards creating a liquid market for NPL securitisation.

However, securitisation is not necessarily a silver bullet for banks’ deleveraging woes. “Rated NPL securitisation is a complementary tool that allows banks to sell NPLs, but it’s not a magic tool to entirely resolve the NPL problem,” says Dissera. n

Promoting the secondary market

The securitisation of NPL portfolios is just one element in a wider drive to clean up banks’ balance sheets.

A European Commission action plan to reduce NPLs in Europe unveiled various measures aimed at creating a more liquid secondary NPL market in March this year. A key aspect relates to loan servicers, since the rate of growth in the servicing industry is not necessarily consistent with the pace at which the NPL market is developing. Investor interest in Italy’s NPL stock is high, yet the market suffers from a lack of servicer capacity, for example.

To better facilitate NPL investors the EC seeks to define the activities of credit servicers and set common standards for authorisation and supervision, as well as conduct rules to apply in all member states. Firms purchasing NPLs will be required to notify authorities of any loan acquisitions, while third-party purchases of debt will need to be conducted through an authorised EU credit servicer.

The Commission has also proposed creating national asset management companies (AMCs) to which banks could transfer NPLs. It hopes the AMCs will improve transparency and information as well as encouraging new lenders into the market.