Securitisation took a hammering after the global financial crisis. The scars run deep with structured credit still carrying a stigma among many institutional investors a decade later.
Efforts to reverse this attitude and revive the European market, however, are underway. Under the European Commission’s Capital Markets Union plan, securitisation has a key role in improving liquidity across the continent – a problem that has persisted across the European corporate world since 2008.
Where securitisation may play a role is in helping banks unload large piles of non-performing loans – another legacy of the crisis. In its aftermath, banks were encouraged to hold onto NPLs to try to ensure compliance with new regulations on capital requirements, but the European Central Bank is now encouraging them to offload the assets with securitisation to seen as a long-term component of the plan.
It’s possible that a thriving securities market may kick-start the sell off and squeeze out some of the distressed investors that specialise in purchasing these assets. Many market commentators have observed that while the opportunities are there, especially in Italy, the process has been too slow.
Some are not convinced that this will change in the near future. “If the enforcement framework in Italy changed hugely so that it became very efficient in terms of enforcing loans or working out solutions with borrowers then I can see a good reason for securitisation,” says Partha Pal, a partner at law firm Ropes & Gray.
“But I can’t see that happening anytime soon. The framework would have to be so vastly improved. An investor unfamiliar with Italy buying this paper will have to think there is no problem with enforcement. It’s the private equity players, however, that understand the complexity and have the necessary internal infrastructure and sophistication necessary to navigate the enforcement process.”
The Italian government has instituted a series of reforms to improve foreclosure procedures and introduced the Garanzia Cartolarizzazione Sofferenze (GACS) scheme. However, it has struggled to gain traction with many investors not pricing in the reforms, although this is beginning to change.
The structure places the assets into an SPV with proceeds paid out in a security split in senior and junior tranches. GACS provides a guarantee of the senior tranche, giving reassurance to investors by improving the credit worthiness of the debt.
These moves are a step forward, but a major obstacle for investors is the lack of data provided by sellers, creating wide bid-ask spreads, although banks are taking steps to rectify this.
Ilaria Farina, a research analyst at Fitch, says: “Banks are investing a lot of time into digitalising their paper records, which has helped Italian banks start to sell off their assets through securitisation. Some banks have hired advisors and auditors to translate the files electronically. That will help buyers understand the portfolio and help speed up the process of selling the assets.
“There has been a lot of interest in Italian assets and assets in other jurisdictions. Securitisation is one way banks can dispose of their assets. Some banks have decided to cluster the non-performing assets into homogeneous sub-pools so they can market them to specialised investors. Others have externalised the management of their portfolios using third party servicers.”
‘Market failure’
A recent study by the ECB described the NPL situation as a “market failure” and published proposals outlining how national governments can play an active role in getting the market in motion.
The report, Resolving Non-Performing Loans: A Role for Securitisation and Other Financial Structures?, recommends the implementation of the junior guarantee scheme and the forward protection scheme as a way of inviting more investors into the securitisation market.
As the authors state: “Appropriately structured co-investment instruments where the state co-invests at market conditions with NPL investors may incentivise states to implement necessary structural reforms and, through this explicit signalling effect, may also partially address wide bid-ask spreads.”
Whether securitisation serves as the long-term silver bullet to the problem remains unclear. The role of distressed funds, however, has helped to alleviate the issue for the time being and the model for bilateral transactions has pushed NPLs into the hands of experienced firms with the necessary infrastructure to work out such assets.
The revival of the securitisation market is seen to be complimentary to the bilateral transaction approach, but if the former begins to win favour with a wider group of institutional investors then opportunities for distressed funds to allocate capital may narrow.
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