RISK MANAGEMENT THOUGHT LEADERSHIP

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NPLs: a new asset class?

An approach for estimating the fair value of the various NPL securitization tranches

August 2019

Giuseppe Lusignani, Luca Pettinari, Riccardo Tedeschi


NPLs: a new asset class?

Abstract

In the Euro area, from 2015 to 2019, the market for impaired loans has grown rapidly in size as a result of bank reduction plans requested by supervisory authorities and market investors.

A significant contribution to reducing the impact of impaired loans on banks' balance sheets came from securitization. The senior, mezzanine and junior notes of the securitizations of impaired loans were also offered and underwritten by institutional investors, representing a new type of asset class to be combined with other traditional asset classes in order to achieve the target risk-return combination of the portfolio.

In this work, a parsimonious model is proposed, with a "top-down" approach, to simulate the recovery of guaranteed and unsecured non-performing loan portfolios and an approach for estimating the fair value of the various NPL securitization tranches. The model can be used by market investors to evaluate the purchase or sale of such securitization notes or by the banks during the structuring phase of the securitization operations.