Introduction to NPLs

What is securitisation and What are the mechanics behind NPL Securitisations?

Securitisation relates to the financing of assets that carry credit risk (as opposed to market or other risks). It involves the structuring of tranched debt with at least two classes of seniority with a senior and a junior note (in some cases, a mezzanine note can be included). The effective exposure is only to the assets financed during the life of the deal. An NPL is securitised at a discount to its nominal or outstanding value and reflects the market’s and the special servicers’ assessment generating sufficient cash flows and asset recoveries. The risk for investors is therefore that the effective collection and workout of the assets do not generate sufficient cash flows to cover the net value at which the NPL has been purchased by the special purpose vehicle, or SPV. Typically, investors are therefore not exposed to the book value of the portfolio but to the discounted value -- net of the price discount at which the underlying assets are transferred.

What are the key features of NPLs?

• Exposures that have experienced a failure to pay
• Exposures that are deemed Unlikely To Pay (UTP) 
• Exposures that have undergone a distressed restructuring
• Exposures that are in insolvency, bankruptcy, or under bankruptcy protection
• Exposures at least 90 days days past due (DPD)
• Exposures that are categorised as Stage 3 for IFRS 9 purposes (credit-impaired)

What are the consequences of a loan being declared an NPL?

The loan is typically accelerated and foreclosure procedures or bankruptcy will start soon after. Bank has to further increase its provisioning, impacting its profitability. Banks will have to dedicate more resources to recovery and less to the origination of new loans. Ultimately, as banks cannot generate interest, they will have less money available to create new loans and to pay operating costs. The regulator has set a threshold of 5%, particularly for Significant Institutions. Institutions with an NPL ratio greater than 5% will need to change this by either managing the NPL stock or reducing the NPL stock. 

What are the ways in which an institution can reduce their NPL stock?

• Securitisation of NPLs has been used In countries where the banking sectors have experienced high levels of NPLs, such as Italy and Greece (GACS and HAPS) to remove impaired assets from the banks’ balance sheets and transfer them to external investors (securitisation)
• Another way to reduce NPL stock is through bad banks. In Spain, Sareb was established in 2012 on the back of the subprime and credit crisis. Sareb acquired NPL loans originated by a number of failed Spanish financial institutions. Sareb initially acquired property development loans from a number of failed banks in return for government bonds.
• The use of other ad-hoc special funds such as the Stabilisation Fund created by SNB in Switzerland. It acquired toxic ABS and non-ABS exposures worth $38.7from UBS. of these assets at market value to the funds. The fund was unwound in 2013 by UBS, achieving a small profit for the Swiss Tax payers.