Last year we reported on the EC proposal for a Directive “on credit servicers, credit purchasers and the recovery of collateral” which sought to facilitate a secondary market for NPLs, and introduce a new form of security for business (not consumer) loans enforceable without going to court (only if agreed by the lender and borrower in advance – this would not extend to existing NPLs). This proposal did not extend to the regulatory treatment of securitisations of NPLs. The EBAs 23 October Opinion to the EC (“On the Regulatory Treatment of Non-Performing Exposure Securitisations”) does. We commented on it briefly two weeks ago, and it may be helpful to say more about it. As it says, many EU banks are holding large stocks of NPLs and are under market and regulatory pressure to dispose of them in order to strengthen financial stability and restore the flow of credit, but they face various obstacles, including as regards securitising them, and so the EBA suggests various improvements that the EC could introduce. The Opinion is quite readable at only 36 pages. As it points out, NPL securitisations are fundamentally different from regular securitisations where the assets are not in default. Usually, the major risk transferred to the investors is credit risk. For NPLs, the risk is that the workout of the NPLs in question recovers less value than the discounted purchase price at which they were bought, and a major influence on that is the quantum of the discount at which the NPLs have been bought and the success of the workout. Typically, a special servicer is responsible for this and its fees are success-dependent. This produces anomalies, because the CRR and the Securitisation Regulation were both drafted with performing assets in mind, and in the context of NPLs, they do not really work:
- The regulatory capital position produces excessive capital charges (the detail cannot easily be summarised and we don’t need to know it, just to know that this is the outcome)
- The 5% risk retention under Article 6 of the Securitisation Regulation and Article 10(1) of the risk retention RTS is calculated by reference to nominal values, disregarding the acquisition price of the assets, but in the case of NPLs which have been bought at a substantial discount, this produces an excessive result. If 100 of assets are bought for 10 (90% discount) and then securitised under a 9 senior/1 junior (retained) structure, the 5% risk retention is equal to 5, which is 50% of the actual loss risk to investors rather than 5%;
- The risk retention can only be held by the originator, sponsor or original lender, but the person with most skin in the game is the special servicer, which will be on a success fee, and yet as it stands the special servicer is not permitted to hold it;
- The Article 9(3) verification requirements can be impossible for an acquired portfolio of NPLs (for reasons mentioned in several old FM Updates, and readers do not need an elephant’s memory to recall that the EBA’s answer to a question submitted by AFME in November 2018 about this said that the securitising originator should use “adequate resources” and “make reasonable efforts” to obtain “as much information as is available and appropriate for such verification in accordance with sound market standards of due diligence for the class of assets and the nature and type of securitisation”, helpfully indicating that the EBA views the Article 9(3) requirement with flexibility and is prepared to defer to good market practice.