The European Banking Authority (EBA) recently released its final draft for Non-Performing Loan (NPL) transactions in the European Union (EU). This new set of regulations is an important step towards creating a more integrated and unified market within the EU, and will have far-reaching effects on the way banks and other financial institutions do business in the region. The new rules seek to ensure that NPL transactions are conducted in a fair and transparent manner, in order to protect both the interests of lenders and borrowers. This article will provide an overview of what the final draft entails, including what the new guidelines mean for originators and buyers, and how they will affect the NPL industry.
Objectives of EBA’s final draft
The main objectives of the draft Implementing Technical Standards (ITS) is to reduce the gap of idiosyncratic characteristics across different countries, allowing:
- Geographical comparisons of NPL portfolios
- Reduction of information asymmetries between sellers and buyers (one of the biggest causes of inefficiency)
- The entrance of small players (both on the credit institution and investors sides) into the market.
The new draft ITS does not include only the minimum information to be provided in a loan-by-loan template, but also a glossary with all the relevant information, the instructions of the template and the requirements to treat the confidential information of a transaction.
The draft ITS are built according to the principle of proportionality and elasticity, providing users with different information according to the specific asset class of the transaction (RMBS, CMBS, retail, mixed, etc.) and different levels of information (loan, borrower, collateral, etc.).
Now, these drafts will be submitted to the European Commission for adoption before being published in the Official Journal of the European Union. The technical standards will apply 20 days after the publication in the Journal.
Structure of the new EBA template
The data tape is organized in the following templates:
- Counterparty, detailed information related to the borrower and the borrower group across different fields (financial statements, type of borrower, location, enforcement ongoing on the entire borrower, etc.);
- Relationship, which displays the relationships across the different levels of information
- Borrower-loan, the relationship between the loan and borrower identifiers;
- Mortgage loan-protection, the relationship between the mortgage loan and the collateral assets provided;
- Loan-protection, a loan other than mortgage loans may have several collaterals and collateral may be associated with several loans;
- Guarantor-guarantee, which shows any relationship between any other protections received (i.e personal and corporate guarantees) and its protection provider;
- Loan provides information related to the specific characteristics of the loan agreement (the outstanding balance, the default date, loan enforcement status, etc);
- Collateral, guarantee, and enforcement cover information about the provided protection on the loans (type of asset classes, location of the asset, type of guarantees, enforcement status of the protection, etc);
- Mortgage guarantee, give details about the mortgage itself such as mortgage amount, mortgage date, higher ranking loans, and lien position;
- Historical collection of repayment, look through the cash flow generated on a specific loan in the previous 36 months before the cut-off date.
Overall, the template provides 129 data fields out of which 69 data fields are mandatory for NPL transactions.
Taking into consideration the principle of proportionality, there are some cases where the EBA template shall reduce the number of compulsory fields:
i) non-granular transactions (sale of a single loan, single borrower, and syndicated loans)
ii) mandates to be sold outside the European jurisdiction
iii) unsecured exposures to natural persons that are outside of the scope of the Directive 2008/43/EC
iv) exposures not originated by credit institutions or acquired from the entities that do not credit institutions
Feedbacks, critics and updates on the new EBA template
Once the new draft proposal has been shared, there was a four-month consultation period in order to address the most important features and criticalities of the new template. The EBA has received 32 responses to this consultation and, thanks to this direct feedback, new changes have been incorporated in the final draft ITS.
Exclusion of specific exposure from the new template
The first important point touched by this discussion was, as stated above, the possibility to exclude from this template those exposures which, due to their characteristics, are not mainly focused on statistical analysis, but do require more investigations on the financial statement level and legal situation. In this case, the EBA states that the principle of proportionality can be applied to these exposures; hence there will be more room for larger or syndicated exposures to manage the compulsory fields of the templates.
EBA’s template application timeline
The second important matter of discussion was the window for the application of the new templates. According to Article 16(7) of Directive 2021/2167, these templates shall be used for loans originated on or after the 1st of July 2018 and that become non-performing after the 28th of December 2021. The goal of this time window is rather straightforward: in the past players found it challenging to populate the EBA templates with the poor information available.
Now, with the new underlying exposures, credit institutions should be well aware of the needed analytics, and thanks to the more powerful tools of origination they should be able to provide high-level data.
Therefore, a few recommendations have been made:
- Introducing phase-in arrangements for the application of the templates (i.e a transaction period in which the originators could have gotten used to the new template, as it has been done between ESMA and ECB templates);
- Not applying the templates to the ongoing transactions;
- Deleting the proposed text of the draft ITS to use the templates on the ‘best-efforts’ basis for transactions outside the scope (i.e using the new draft ITS also for transactions which do not enter in the perimeter of the analysis).
However, EBA hasn’t made any changes regarding the “phase-in arrangements” and the “best-effort approach”, and this could lead to significant problems for users in the foreseeable future:
- not providing a transaction period to players may increase errors and produce a delay in new transactions;
- the best-effort approach leaves grey areas to the applicability of the new templates for older portfolios.
The granularity of data
Another relevant topic of discussion was the granularity of the data (i.e the mandatory fields) and the templates’ structure. Of course, buyers were approving the new mandatory fields as they will decrease the information asymmetries that may arise during the underwriting process.
On the other hand, originators clearly stated that the granularity is still too high and they will not be able to gather all the information needed. EBA has worked significantly to integrate all potential amendments to create templates as comprehensively as possible whilst reducing the number of mandatory fields. The key points to take here are:
- The collateral annex (Template 4) is now split into two parts: collaterals (immovable property, financial guarantee, movable property, etc) and mortgage guarantee. The idea of splitting the information related to the protection on one side and the mortgage details (mortgage amount, higher ranking loan, and lien) on the other will significantly provide clearer information to the buyers;
- some legal information has been adjusted and moved from the counterparty level to the loan one. This major update provides a significant boost for the templates as some legal actions (for example foreclosures) are only taken on a single claim. Having the possibility to treat and assess these legal proceedings separately will significantly help for better loan pricing;
- The Historical Collection annex (Template 5) has been completely changed. The information on repayment plan schedules has little value when dealing with very volatile cash flows. Instead, replacing this information on historical cash flows up to 36 months can provide useful insights about the forecast of future repayments. Not adding the cash flow type is the only flaw of this major update, providing the nature of the repayment can boost even more the assessments about a specific loan.
A topic related to the structure is the confidentiality treatment of data. It has been noticed that confidential data may be shared with potential sellers close to or immediately after the sale contract agreement is signed. Nevertheless, in the previous month, EBA released the Guidelines for the best execution process for sales of non-performing loans on secondary markets, which highlights the significant steps for a successful NPL transaction and how an originator should share confidential information with the buyer at each stage of the transaction.
Finally, the last important topic to be mentioned is the absence of competent authorities in monitoring and enforcing the correct use of the templates. The absence of these authorities leaves again some grey areas in the well functioning of the entire process. Competent authorities are needed for avoiding incorrect data tapes, making the markets more efficient, and creating trustworthiness among the players.
Cardo AI’s insight on the new EBA template
The final draft of the EBA’s new guidelines on non-performing loan (NPL) transactions makes significant progress towards the parity of information between buyers and sellers. The communication breakdown that has plagued the NPL market for so long is being addressed through enhanced transparency. Plus, the presence of information for different asset classes and different focus levels will significantly help the secondary market to build a shared, well-known template for NPL transactions. We believe that all these elements will ultimately increase the speed of processes and improve the general tech efficiency of the market.
However, the draft still poses a number of challenges and potential bottlenecks for market participants. As mentioned above, it still contains too many mandatory fields and we are concerned that the information asymmetry between buyers and sellers will persist. To overcome this, we believe that the EBA could have considered a progressive phase-in of information requirements, coupled with a more stringent enforcement framework (targeting full transparency within 2/3 years) and complete removal of grey areas and possible opportunistic behaviours.
Looking forward, the soundness of the new EBA template will definitely be tested by the economic scenario ahead. Among the most impactful factors, we can mention the potential NPL wave coming in 2023 (which will condense the consequences of COVID), the Ukraine war and its effects on prices and supply chain disruption, inflation, and interest rates.