While the securitization of non-performing loans is not an entirely new product, it’s one that appeals to a small niche of investors in an already niche market.
Deloitte said last week that debt investors in NPLs have around €110bn in cash reserves to put to work this year — which with leverage, could be pumped up to €350bn — but ABS investment will represent only a fraction of that compared to whole loan sales.
The reason for the thinness of the NPL investor base is clear — the lack of steady, predictable cashflows from an NPL portfolio adds a layer of complexity to a deeply specialist, demanding market with a very high bar of technical competence.
Cashflows in non-performing loan ABS deals, unlike normal securitizations of performing loans, are reliant on the effective servicing of a portfolio to generate cash to repay bondholders. Any borrower repayments are likely to be forced, not offered, or come through the restructuring and rescheduling of the underlying loans.
Any investor willing to take a position in the junior tranche of such a securitization, which gets paid off last, but which also must be sold if the bank wants to deconsolidate the portfolio, or to obtain a guarantee from the Italian government for the senior tranche — has to be confident in the ability of the servicer to squeeze borrowers for repayments, as well as the efficiency of the legal system backing enforcement.
In contrast to buying a portfolio of non-performing loans outright, buying junior notes in an securitization also means relying on the servicer chosen by the originator or structuring banks.
NPL investors are frequently dedicated to the asset class, but many of the biggest potential buyers have their own servicing platforms to manage NPL repayments. The pool of buyers keen to take junior risk in non-performing portfolios, but happy to trust the trickiest part of repayment to a third party, is likely limited.
Italian banks looking to offload portfolios in ABS deals should therefore get in early, before there is a stampede of deals competing for a limited amount of investor capital, most notably the planned €9.2bn deal from Monte dei Paschi di Siena.
Banca Populare di Bari’s somewhat premature announcement of the “sale” of a €480m gross portfolio of bad loans to a securitization structure (none of the notes have been placed with investors, yet) might not be such a bad thing, then.
The bank announced the deal in March, before the details of the government guarantee scheme had already been passed into law. But as with all early movers in a new product cycle, they have benefited from almost six months as being the only announced deal in the market.
Better to turn up early than to miss out on the party completely.