The securitization of non-performing loans is seen as a way of helping Europe’s (and particularly Italy’s) banks out of a mire. The standard industry line is that the technique is a way for banks to deleverage their balance sheets, distribute risk around the financial system to those that can best bear it, and free up capital for new lending to support the real economy.
There is certainly potential for the market to have a positive influence on the health of Europe’s banks. In theory, a way to leverage non-performing assets will help close the gap between the price investors want to pay for NPLs and where banks are willing to sell them.
The market, though, will struggle to reach the scale it needs to be in order to have a meaningful impact.
For a start, even if securitization can help a bit, the difference between what investors are willing to pay for the non-performing loans and what banks are willing to accept is often huge. The damage to a bank’s capital position by accepting the true market value of the portfolio could be ruinous.
A successful securitization exit is reliant on an investor finding an arbitrage between what they can buy the portfolio at and the cost of the funding they can themselves obtain against the loans in the securitization market.
The more investors have to pay up for the loans, the harder they must squeeze securitization investors. But with opaque pools, poor data quality, and uncertain servicing of the assets, securitization investors will be pushing hard themselves.
Securitization investors are also likely to push back on the more aggressive structural features that private equity sellers include in deals, designed to maximise the economic returns of the seller. But adding coupon caps, restrictions to the seller’s representations and warranties, and cherry-picking the portfolio are hardly likely to encourage a large investor base to flock to these transactions.
Banco Popolare di Bari’s first NPL deal, launched in March this year, initially aimed to be the first to benefit from a state guarantee scheme, which would help to lower costs to an acceptable level, and, hopefully, encourage other deals to follow.
But it has taken more than eight months for the bank to find a buyer for the crucial junior piece, which will allow the bank to derecognise the loans from its balance sheet, and now reports suggest it may not use the state guarantee after all.
The deal will not be the first to have trouble finding buyers. But the larger point is that it is difficult to read across too much from Bari’s deal to the others that could follow. Non-performing loan securitizations are by nature bespoke structures, and heavily dependent on careful analysis of underlying collateral in each transaction.
Expecting a functioning market to burst forth, each deal building on the features of the last, was misguided.
No doubt there will be more deals to emerge from bad loan portfolios, not only in Italy but in Ireland and across Europe as a whole. But the pace of the market’s growth is likely to underwhelm rather than impress.