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2017 | OriginalPaper | Chapter

7. Securitisation of Non-performing Loans

Author : Andrea Fabbri

Published in: Structured Finance

Publisher: Springer International Publishing

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Abstract

The chapter is aimed to understand how the securitisation of non-performing loans works and how to analyse and evaluate it. The first part is dedicated to the analysis of the cash securitisation on performing asset (“standard” cash securitisation). We will not enter into the details of the cash securitisation: we believe though that understanding the fundamentals of a standard cash securitisation is the key to then comprehend better the securitisation of non-performing loans and—above all—the main differences between the two structures. The second part of the chapter is dedicated to an overview of the cash securitisation market in Europe. In the third part of the chapter we will analyse the non-performing loans market in Europe with a focus on Italy where it seems to be a strong interest for this market to reopen and to succeed. The fourth part of the chapter is dedicated to the analysis of the securitisation of non-performing loans. The structure of the deal, the main counterparties involved, the risks implicit in the securitisation and the valuation criteria will be the main points analysed in the final part of the chapter. The main pricing factors of the securitisation of non-performing loans will be studied from both the Originator Bank and the Investors’ standpoint. The perspective which we have adopted in this chapter is the one of securitisation deals originated by banks: we won’t refer to securitisation originated by Corporates nor by other type of financial institutions.

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previous chapter Issues and Trends in Project Finance for Public Infrastructure

Capital Requirement Regulation (CRR) defines in art. 243–250 the Recognition of Significant Risk Transfer. Under certain conditions, the originator institution of a securitized exposure might exclude this exposure from the calculation of risk weighted amounts and from expected loss amount. In particular, the originator should provide evidence that a significant part of risk associated with the exposure has been transferred to third parties. Also, under certain conditions, a mitigation of credit risk exposure might be recognized.

Rating Agencies reports are available for more information on the criteria used to evaluate Asset Classes. For RMBS criteria, see for example Fitch Rating (2013) EMEA Residential Mortgage Loss Criteria.

If the underlying portfolio is represented by a combination of Residential and Commercial Mortgages the Asset-Backed Securities will be generically named Mortgage-Backed Securities (“MBS”).

From time to time the tranches are structured on a “reverse enquiry” basis as they are created to reflect particular Investors’ needs in terms of interest, subordination, maturity etc.

As showed by Das and Stein (2013), it is unclear whether PD or EL approach provides higher level of Credit Enhancement. Usually PD models are considered to be more suitable for analysis of default due to their focus on the Probability of De-fault whilst Expected Loss models should be used for managing economic losses. Different target level choices and the absence of any constant LGD assumption on collateral, that can translate a PD model into a EL model, make indeed, these two models difficult to compare.

Under this form of credit enhancement it is also possible to have a Cash Advance Facility (or Cash Reserve Fund) provided by the Originator Bank to guarantee the payment of Interest to the Investors of the ABS tranches during a certain period of time (e.g. term of 364 days).

Default rate can be defined as the gross loss rate i.e. it doesn’t take into account the recovery rate of the defaulted asset. Net loss rate is simply another way of defining the loss given default of the underlying defaulted asset i.e. the severity of the loss multiplied by the notional of the defaulted asset.

The most frequent Coverage Tests are the Interest Coverage (“IC”) and the Over-Collateralisation test (“OC”). OC test aims at ensuring that the assets are adequate to cover principal and coupon payment. IC test on the other side is a liquidity test, which measure the ability of the assets to generate adequate interest to cover interest payment and obligations (plus a buffer). In both tests each tranche is subject to its own test and the higher the seniority of the tranche, the higher the OC or IC ratio required, in order to guarantee a satisfactory protection of Investors.

Usually the swap counterparty has to be rated minimum single A but this can vary according to the different models of the Rating Agencies.

Other considerations on the structure of the securitisation are the legal soundness of the structure: evaluation of the efficiency of mechanisms such as Interest Coverage test and early amortization triggers events for the benefit of the investor; the experience of the Originator Bank and of the Servicer in relation to the specific underlying asset class. If the junior tranche is retained by the Originator Bank this can be a sign of alignment of interest between the Originator Bank and Investors of both the mezzanine and senior tranches.

Repo is an abbreviation of “repurchase agreement”, which is a contract where one party (the seller) sells an asset to another party (the buyer) at a specific price and commits to repurchase the assets at a different price (on demand or at a date in the future). The difference between the price paid at the start of the transaction and the price the buyer receives at the end of the transaction is the return (usually quoted in percent percentage per annum) on the cash that the buyer effectively lent to the seller and it is called “repo rate”. If the seller defaults, the buyer can use the asset as collateral and offset the losses.

The past-due criterion is recognized only if the payment was compulsory and there was a legal obligation—as such discretionary payments, such as Additional Tier 1 coupon payments should not be considered NPE in the non-payment event.

The “unlikely to pay” criterion is based on more qualitative criteria. Paragraph 145(b) of Annex V of Commission Implementing Regulation (EU) No 680/2014, set some defined situation that triggers the “unlikely to pay” criterion, such as bankruptcy of debtor. Banks are left some space to internally define some unlikely to pay linked situation, which should regularly be assessed. Further, in the context of an unlikely to pay situation, the exposure should be considered as non-performing even on the presence of full collateral.

For definitions of Gross Book Value and Net Book Value see Sect. 7.4.3.

Breakdown by type of debtor is 7.1% for individuals and 17.7% for corporates.

This is just an estimated value based on press news related to Monte dei Paschi possible sale of non-performing loans portfolios.

See also Sect. 7.4.3.

We focus on the role of the Special Servicer which has mainly an operating function. Master Servicer is the counterparty which is usually involved in the fulfillment of regulatory tasks and undertakes a guarantee role of proper representation and information toward the main stakeholders of the non-performing loans deal and toward the market.

Examples are sale of full title or of bare interest with the right of usufruct, leaseback etc.

The Servicer can also assist the Investors in the purchase of non-performing loans portfolios by offering advisory services such as structuring and management of the special purpose vehicles, due diligence on the buy-side, managing and servicing the loans also after purchase etc.

See Sect. 7.1.5 for tranching models of the Rating Agencies.

See Sect. 7.1.2 for the main counterparties in the standard cash securitisation.

If there is objective evidence that an impairment loss on loans and receivables or held-to-maturity investments carried at amortised cost has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate (i.e. the effective interest rate computed at initial recognition). The carrying amount of the asset shall be reduced either directly or through use of an allowance account. The amount of the loss shall be recognised in profit or loss (Commission Regulation (EC) No 1126/2008).

Servicing costs are accounted on an annual accrued basis on the P&L of the Originator Bank.

Regulators such ECB can ask to for a certain amount of Coverage Ratio to make homogenous the Coverage Ratios across countries in Europe.

According to IAS 39, the discount rate remains the same though as per the one adopted in the original loan concession (Commission Regulation (EC) No 1126/2008).

These hypothetical numbers could refer to a typical non-performing loans portfolio of a medium sized Italian bank.

See Sect. 7.4.1 for the structure of NPL securitisation.

See Sect. 7.1.5 for tranching models.

Due to their subordination in the cash flow waterfall structure the junior and mezzanine Investors are the ones which promptly suffer from a negative performance of the underlying portfolio compared to the expected one at inception.

Servicing fees are usually amongst the most senior fees in the cash flow waterfall structure: namely they are more senior than the interest payment to the senior noteholders.

See Sect. 7.1.5.

The guarantee fee paid by the Originator Bank to the State is determined as the average of daily mid-prices of CDS for baskets of Italian issuers as quoted on Bloomberg in the six months preceding the request for guarantee (Gazzetta Ufficiale 2016, Decreto Legge 14 February 2016, n. 18).

See Sect. 7.3.

An example can be a third party bank interested in financing the senior tranche of non-performing loans securitisation deal based on their internal models after a thorough analysis of the specific of the underlying portfolio and of the soundness of the securitisation structure. In this case an implied internal rating would be assigned to the senior tranche without the need of an official rating.

The use of third parties guarantees could help to achieve this outcome when senior notes are placed into the market. We assume that the senior notes return includes the price of the guarantee.

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Title: Securitisation of Non-performing Loans
Author: Andrea Fabbri
Publisher: Springer International Publishing
Book: Structured Finance
Print ISBN: 978-3-319-54123-5

Electronic ISBN: 978-3-319-54124-2

Copyright Year: 2017
DOI: https://doi.org/10.1007/978-3-319-54124-2_7