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NPL Securitisation is a term that is very much en-vogue at the present time. Although its rise to prominence can be attributed to a number of factors, in recent weeks the chief contributor has been the European legislature steps towards amending the Securitisation Regulation and the Capital Requirements Regulation. These steps are being taken to ensure that securitisation is better placed to facilitate banks offloading NPL’s in the aftermath of the COVID-19 pandemic. In the months and years ahead, the term NPL securitisation will no doubt be bandied around a lot, but what exactly is NPL securitisation? As an attempt to de-mystify this, I thought it would be helpful to give an overview of the different types of structure.

In essence, an NPL Securitisation describes a financial structure whereby an owner of NPLs sell these to a special purpose orphan 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 NPLs on a daily basis with a fee structure that incentivises them to maximise recoveries on the underlying loans. On a broad level such a securitisation falls into two categories:

  • Primary Securitisation – which involves the seller (typically a bank) using this technology to remove NPLs from their balance sheet.
  • Secondary Securitisation – which involves an acquirer in NPLs using securitisation as a form of leverage to maximise their internal rates of return.

We will now delve into a little more detail with respect to each of these categories of NPL Securitisation.

Primary NPL Securitisation

Primary NPL structures are rightfully receiving a significant amount of attention from the regulators as this technology has been identified as having the potential to play a hugely significant role in enabling the banks to clean up their balance sheets. There are three divisions of this type of structure.

Third Party NPL Securitisation – here a securitisation structure is used to offload loans from a balance sheet with the resultant issuance being solely subscribed for by third party investors. This is of course the ideal mechanism to transfer problematic credit risk from the banking sector to the capital markets and these transactions will be of increasing importance in the coming years. More information around these types of structure are detailed in articles I recently had published in The World Financial Review (Time for securitisation to be a friend and not a foe of the NPL hit banks) and World Finance (Securitisation – the antidote for non-performing loans).

Retained NPL Securitisation – in this instance, all of the issued notes are retained by the NPL Seller on the basis that they will command a more favourable capital treatment for holding securities in lieu of the non-performing loans themselves. In other words, NPL securitisation is being used as a balance sheet management tool which may also involve a repo.

Government Backed Securitisations – these types of structure constitute the most prevalent type of NPL Securitisation in recent years although only confined to Italy (“GACS” (“Garanzia Cartolarizzazione Sofferenze”)) and Greece (“HAPS” (“Hellenic Asset Protection Scheme”)). In both jurisdictions, governments have enacted a scheme whereby they provide a guarantee for the most senior class of notes whilst at the same time the junior class of notes are sold to third party investors.

Although these are the broad categories, there are often hybrids of these structures in place in situations where issued securities are both retained by the seller as well as issued to third party investors.

Secondary NPL Securitisation

As has become customary in the NPL market, leverage has been a key ingredient for investors to boost their internal rates of return on NPLs. The predominant form of leverage to date has taken the form of loan-on-loan financing which has been provided by the seller or a third party bank either on the acquisition date itself or at a later point time. In the context of NPL securitisation what is envisaged is that in lieu of loan-on-loan financing, a securitisation takes place in order to provide a form of leverage. Indeed, if it can be demonstrated that this form of leverage is cheaper and is capable of providing greater flexibility for the investor than otherwise would be the case for a loan-on-loan financing (which I understand is the case), then these are fertile conditions for growth of activity in this space. Similarly, it is worth noting that although not strictly an NPL securitisation, there have been a number of instances in the market where investors have transformed NPLs into re-performing loans and have securitised these.

Based on this canter through the NPL securitisation maze, there are clearly many different types of NPL securitisation which have their own unique characteristics and this is before we factor in the nuances of individual structures such as whether the issuance is listed, rated, public or otherwise. To make matters even more convoluted, given that for the purposes of the Securitisation Regulation loan-on-loan financings are technically classified as a securitisation, market participants frequently refer to these types of financing as securitisations despite the fact that there is no capital markets element.

In conclusion, the NPL securitisation label is extremely broad and although the rise to prominence of this technology can be considered hugely welcome, given the amount of attention these structures are rightfully receiving as well as the infancy of the market, a concerted effort to be properly prescriptive on what NPL securitisation actually means would pay dividends for the greater good of the NPL securitisation market as a whole.