Non-Performing and Re-Performing Loan Securitisation in Europe: What Does the Future Hold?

An elevated level of non-performing loans (NPLs) on European banks’ balance sheets drove a slate of legislation and regulation in recent years, including directives aimed at developing and enhancing a secondary market for NPLs and regulation on the development of NPL securitisation. The positive effects of these legislative packages continue to build, and as a result it can be expected that NPLs which have become re-performing (RPLs) may feature more prominently in the European securitisation markets going forward.

There has been a raft of legislation and regulation in the years since the global financial crisis of 2007/8 designed to tackle the high level of NPLs on European banks’ balance sheets. The Action Plan to Tackle Non-Performing Loans in Europe, adopted by the European Council on 11 July 2017 (the NPL Action Plan), was aimed at developing a secondary market for NPLs, as it is widely acknowledged that a functioning secondary market for NPLs is one of the building blocks of an efficient “Capital Markets Union.” European banks now have various options for addressing NPLs, including securitisation (e.g., via certain government guarantee/asset protection schemes), outright sales and asset management companies.

Against this backdrop, regulation in Europe has developed to remove constraints on the development of NPL securitisation, including amendments to the Securitisation Regulation (Regulation (EU) 2017/2402) (the EU Securitisation Regulation) and the Capital Requirements Regulation (Regulation (EU) No. 575/2013) (the CRR) as part of the Capital Markets Recovery Package of April 2021.

Aside from securitisation, the recently implemented EU directive on credit servicers and credit purchasers (Directive (EU) 2021/2167) (the NPL Directive) is designed to enhance the secondary market for NPLs generally, including increased regulation of not just selling banks but also the purchasers of NPLs and servicers, with enhanced loan-level data requirements designed to improve transparency in the secondary markets.

This Insight will recap such legislation and relevant upcoming policy and regulatory changes applicable thereto, how successful securitisation has been as a tool for dealing with the NPL overhang in Europe and looking forward, and how re-performing loan (RPL) securitisation may feature more prominently in the European securitisation markets.

WHERE IS THE MARKET NOW?

Securitisation on the basis of government guarantee schemes such as the Garanzia sulla Cartolarizzanione delle Sofferenze (GACS) in Italy and the Hellenic asset protection scheme (HAPS) in Greece has been instrumental in markets with high levels of NPLs because it is able to offer a lower average cost of funding, protection for senior investors, and legal certainty without contravening European state aid rules.

In Italy and Greece—both of which had elevated levels of NPLs—state-guaranteed securitisation has been instrumental as the local NPL markets at the time were not mature enough to absorb such large numbers of NPLs through traditional NPL securitisation. While these securitisations entailed higher transaction costs, they also minimised potential losses for senior noteholders compared to traditional securitisations and outright sales. NPL securitisations outside of government asset protection programmes are dependent on European securitisation market conditions, which have been volatile over the last few years.

As a result, largely due to their simplicity and lower costs, outright sales have been the first port of call for European banks to dispose of NPLs. NPL securitisation should generally pursue the same aims as an outright sale, which is to deconsolidate non-performing assets from the balance sheet with some added benefits, i.e., getting access to a broader spectrum of investors who cannot hold NPLs directly, and creating tranched securities with different risk profiles.

However, these benefits come with some complexity, including setting up the documentation framework and the systems to ensure that a transaction complies with regulatory obligations such as disclosure requirements. A further problem specific to NPLs is that fulfilling the business plan is subject to more uncertainties than in the case of performing loans. This uncertainty is, of course, reduced in the context of a developed, functioning market.

As the GACS scheme expired in June 2022, there will likely be a continued reduction in Italian NPL securitisations over the next 12 months. Conversely, the HAPS scheme was renewed in December 2023 with an expiration date of December 2024, and as such both systemic and other non-systemic Greek banks may take advantage of this renewal and securitise some or all of their remaining NPL portfolios before the guarantee expires.

RECENT LEGISLATIVE AND REGULATORY CHANGES

The package of measures aimed at reducing the NPL predicament in Europe has already been successful, evidenced as NPL ratios have decreased across the board. In this respect, there has been a plethora of regulations and legislation specific to NPL securitisation and NPLs.

These include amendments to the EU Securitisation Regulation, which, among other things,

• define a new category of NPL securitisations;
• allow the servicer to act as risk retainer (as its interests are more aligned to those of the investors in terms of the recovery process);
• provide for the size of the risk retention piece to be calculated by reference to the discounted value of the assets and not the nominal value to reflect the fact that it is the discounted value that represents the actual risk of loss to investors; and
• replace the requirements with respect to verification of credit-granting standards with a duty to apply sound standards in the selection and pricing of the exposures.

In addition, amendments to the CRR have, among other things, introduced specific and more risk-sensitive capital treatment for positions in NPL securitisations.

In terms of regulatory developments outside of securitisation, the NPL Directive imposes obligations on European banks selling NPLs, non-bank purchasers of EU NPLs, and NPL servicers. Whilst the NPL Directive carves out securitisations from its scope, the adoption and entry into force of the Implementing Technical Standards (ITS) on NPL transaction data templates is expected to foster consistency and transparency in terms of loan-data disclosure, in a similar way to how the EU Securitisation Regulation has developed a more coherent and standardised approach to disclosure in the context of NPL securitisation.

Notification to the European Securities and Markets Authority (ESMA) is especially important for NPL securitisations because such notification provides transparency about the securitised NPLs and the related risks, and the same applies to outright sales.

WHAT REGULATORY OR POLICY CHANGES ARE BEING CONSIDERED TO ADDRESS NPLS?

There are some open issues to be resolved under the NPL Directive. In particular, the European Commission is taking infringement action against member states that have failed to transpose the NPL Directive into national law by the set deadline of December 2023.

In addition, the adopted ITS under the NPL Directive do not address some of the issues relating to the other obligations of selling banks, purchasers or servicers under the NPL Directive, including the application of the obligations of purchasers to non-EU banks that buy NPLs, the application of the obligations of purchasers and servicers in relation to loans acquired by credit purchasers before 30 December 2023, and the treatment of facility agents and security trustees under the NPL Directive.

We expect these open issues will be addressed in due course by guidance from the European Commission, the European Banking Authority or national regulators, common industry approaches or national implementing rules.

Other Potential Reforms Relevant to NPLs in Europe

• Extension of the NPL Action Plan. The Bank Recovery and Resolution aspect of the NPL Action Plan is still at the legislative proposal stage. This is a framework for authorities to manage bank failures effectively and organise an orderly market exit for failing banks, but this needs to be viewed in context—European banks are now very well capitalised, which somewhat reduces systemic risk in the banking sector.
• Insolvency reforms generally. There are major inconsistencies between national insolvency regimes which pose issues with regards to avoiding a loan becoming an NPL, thus potentially hindering banks’ and other entities’ swift resolution of NPLs. The Association for Financial Markets in Europe has voiced its support for the development of European legislation harmonising minimum standards of insolvency proceedings to facilitate more predictable and efficient corporate restructurings.
• Potential centralisation of NPL transaction data. A challenge to the regulatory requirements around regulatory disclosure has been the quality of available data. ESMA has defined data validation rules to establish a minimum level of data accuracy, correctness and consistency, but in practice these only apply to public securitisations. As such, the centralisation of NPL transaction data is at the forefront of regulators’ minds to further improve market transparency and attract new investors. The NPL Action Plan also proposed the creation of an EU data hub that would be a repository to collect all transaction data for European NPL transactions, which would improve efficiency in the markets, eliminating the bid/ask spread issue posed by information asymmetries.

THE FUTURE OF RE-PERFORMING LOANS

Given the success of banks in reducing their NPL ratios and the growth of the secondary NPL market (aided by the legislative and regulatory changes highlighted above), we may see more RPL securitisations playing a part in the European securitisation market going forward and will perhaps see the volume of RPL securitisation issuance overtaking that of NPL securitisation. This is even more likely to be the case given advances in servicing technology, the increased regulation of servicers, and a more stable interest rate environment.

The uncertainties around the success of business plans in the context of NPL securitisation are to some extent eliminated where a loan has been restructured and become an RPL. This might include RPLs which are sold out of existing securitisations (both via “note sales” in a public securitisation but also out of private securitisation, back levered or warehouse structures, e.g., where an alternative investment fund has purchased a portfolio of NPLs using senior financing from a bank and has subsequently worked-out the portfolio via its own captive servicing platform) and seeks an exit.

Such an exit may take the form of an outright sale where financing costs remain high or, market conditions permitting, via public securitisation, or even to a bank which wishes to bring RPLs back into the banking system and rebuild potentially profitable relationships with customers.