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Nearly eight years ago I penned a piece about the hugely important role that securitisation can play in alleviating the pain suffered by banks on account of the large volumes of non-core assets and non-performing loans residing on their balance sheets. The deployment of securitisation technology certainly made a lot of sense; after all it ultimately involves distilling problematic credit from the banking sector and transferring this risk to the capital markets where there is a deep and diverse pool of capital as well as appetite to absorb this risk. In addition, unlike the highly regulated banks and also thanks to the discounted purchase price paid for these assets, the securitisation structure had the much needed freedom and flexibility to work through the book and resolve these NPLs one way or another.

Given these positive attributes (and there are many others) it is no surprise that the European NPL securitisation market is truly flourishing. The volumes of issuance that have taken place over recent years is certainly impressive, and NPL securitisation has certainly delivered on its promise of alleviating some of the NPL pain in the banking sector. The chief proponents of this technology have been Garanzia Cartolarizzazione Sofferenze (GACs) in Italy and the Hellenic Asset Protection Scheme (HAPs) in Greece, and these can largely be attributable to not only delivering impressive figures when it comes to the volumes of NPL Securitisation issuance but these schemes have also been instrumental in ensuring that Europe has the infrastructure to ensure that NPL securitisation transactions can properly take place at scale.

It is important to appreciate though that as impressive as GACs and HAPs have been, these are NPL securitisations that are reliant on the support of the Greek and Italian governments respectively. These schemes are also not a long-term proposition, but a short-term fix for their banking woes which is subject to permission to renew from the European Commission every year or so. Given the significant volumes of NPLs that were residing on the balance sheets of the Italian and Greek banks embracing this technology with sovereign support certainly made a lot of sense. However as the levels of NPLs residing in these banks are reduced to more palatable levels, the need for the these programs will wane and with it their contribution to the remarkable volumes of NPL issuances that we have enjoyed to date.

It is inevitable that the next evolutionary step for the market is for those funds and special situations desks that have been active in acquiring NPLs, to start embracing securitisation technology in order to maximise their returns. Already some funds have done exactly this, with a handful of transactions that have graced the European market which have ranged from NPL securitisations in the purest sense to securitisation of portfolios of re-performing loans. The reality is that embracing NPL securitisation technology should not be dismissed by investors as they are already reliant on leverage in the form of loan-on-loan facilities in order to super-charge their investments and achieve the internal rate of returns demanded by their stakeholders. In simple terms, for these investors embracing NPL securitisation would mean substituting their current debt financing with a securitisation structure that features rated, listed notes that are sold to third party investors in the capital markets.

Admittedly structuring a securitisation is an involved process, but investors that are willing to roll up their sleeves and embrace this technology will be richly rewarded with a number of immediate economic advantages. including:

  • Cost of funds will be appealing as the weighted average interest rate on a securitisation is likely to be less than a loan-on-loan financing.
  • The level of leverage will be higher on a securitisation than compared to a loan-on-loan, thus improving their internal rate of return.
  • Significantly longer maturity date on a securitisation, thus affording the securitisation structure the requisite period of time to work through the portfolio and free the sponsor up from having to refinance a portfolio every few years.

On account of these positive features (and there are many more), there is absolutely no reason why NPL securitisation should not be baked into investor business plans as they go about the process of bidding for portfolios. At this point in time, it can be considered an ‘optional extra’, especially given the efficiencies and the well trodden path of loan-on-loan financings. However for those trail blazing funds that are looking to not only maximise returns on their investments but also secure a competitive advantage when it comes to pricing, they should be actively embracing NPL securitisation technology.

The huge strides made by HAPs and GACs mean they can largely be credited with establishing the infrastructure and solid foundations for the market to flourish. As the European NPL market continues to evolve and adapt, now is time for NPL investors to pick-up the mantle and not only be the true architects of NPL Securitisation but drive activity and spur growth in the years ahead.