Securitisation – the antidote for non-performing loans

With the pandemic continuing to cause intense global economic strain, the NPL market looks likely to swell in volume, and banks must now look at removing these loans as efficiently as possible

Author: Iain Balkwill, Partner at Reed Smith LLP
October 5, 2020

Without doubt, the collateral fallout from COVID-19 will herald in a new era for the global non-performing loan (NPL) market, as not only will there be the inevitable surge in NPL volumes precipitated by COVID-19’s impact on the economy, but these new volumes will be accretive to the current NPL stock that is residing in the banks as a hangover from the global financial crisis (GFC).

Indeed, as the banks commence the unenviable task of picking through their loan book and identifying those NPLs that they must offload, they will also be cognisant of how they do this in a highly efficient manner that maximises returns. In terms of process, although the prime candidate for this will be the hugely successful competitive auction processes that have become an intrinsic part of the NPL market, in practice we are likely to witness securitisation step up to the plate and assume a critical role in alleviating the pain of the banks.

Conceptually, the application of securitisation technology is the perfect medicine for the cleansing of bank balance sheets. In essence, these structures involve a bank selling a portfolio of NPLs to a special purpose vehicle that funds such an acquisition by issuing debt securities into the capital markets. The vehicle will in turn appoint a servicing entity that will manage the underlying loans on a daily basis with a fee structure that incentivises them to maximise recoveries.

The use of securitisation makes a lot of sense. This technology has the capacity to enable a significant volume of NPLs to be removed from the banks in one fell swoop. Given the only limitation in sizing a transaction is the magnitude of the universe of investors that can competitively price and absorb an issuance, then we could be talking about pretty hefty deals. The opportunity afforded by securitisation, of offloading NPLs in either one large deal or a series of large transactions, is infinitely more appealing than the alternate scenario of a protracted period of auction processes, that we have witnessed to date.

Securitisation technology also counteracts one of the major stumbling blocks that has traditionally made banks reticent about off-loading NPLs: the pricing. Although NPL securitisation cannot guarantee decent pricing, it does possess a number of features that load the dice in favour of the banks when it comes to trying to achieve the best possible return.

Given the bounty of benefits, it is hard to see why securitisation cannot play an instrumental role in mopping up the balance sheets of banks. Indeed this is not a new concept and there is precedent for this in the United States, in the late 1980s, when securitisation technology played a key role in enabling the Resolution Trust Corporation to liquidate assets once owned by the savings and loans associations.

Similarly, had securitisation not been perceived as one of the main assailants of the GFC, then without doubt it would have been the perfect candidate to clean up NPLs in the wake of the GFC.

Ten years on, it can now be said that securitisation is a very different beast. Through the actions of investors, regulators and market participants, securitisation structures have now been finessed and structural shortcomings fixed. Furthermore, the recent Securitisation Regulation has encouraged and incentivised securitisation structures to be simple, transparent and standardised.

In summation, given the hugely positive attributes of an NPL securitisation when coupled with the fact that this technology is now ‘fit for purpose’, then the requisite fertile conditions currently exist for these structures to be deployed at scale to offload NPLs. Indeed, the fact that the governments of Italy and Greece in recent years turned to securitisation for “GACS” (“Garanzia Cartolarizzazione Sofferenze”) and “HAPS” (“Hellenic Asset Protection Scheme”) respectively, could in itself be construed as a massive endorsement of the role that this technology can play.

Ultimately, since these structures efficiently enable incredible volumes of NPLs to be distilled from the banks, which in turn enables banks to eradicate their NPL issue on a more timely basis, then securitisation should truly be considered the NPL antidote. Banks choose not to embrace this at their peril.