Prepared by Cristian Sgaramella, Roberto Percoco, Valeria Saponaro e Adele Zuliani
On 21st October 2022, the European Commission (“Commission“), published in the Official Journal of the European Union as No. C/405/01, non-binding guidelines (“Guidelines“), concerning the “best execution process” for the sale of non-performing loans (“NPLs“) on secondary markets.
The purpose of these Guidelines, which are based on the best practices of the sector’s operators, is to encourage the standardisation of the NPL sale processes in the secondary markets of the European Union, favoring their effectiveness and efficiency. In particular, the development of such secondary markets will be crucial in the post-pandemic period to absorb the potential new wave of NPLs. In this macroeconomic context, the Commission has prepared the Guidelines to provide an outline to be followed not only by the largest credit institutions but also by those banking institutions and other smaller operators in the sector that intend to structure NPL sale transactions (loan portfolios or so-called ‘single names’).
From the point of view of the type of transactions, the Guidelines refer to portfolios of NPLs, or single name NPLs, having as underlying assets: (i) secured residential real estate; (ii) secured commercial real estate; (iii) exposures of small and medium-sized enterprises; (iv) unsecured consumers and businesses; and (v) leasing agreements.
In drafting the Guidelines, the Commission opted for a model split into specific phases placed in chronological order: (i) transaction structure; (ii) preparation of the sale process; (iii) pre-marketing activities; (iv) non-binding offer; (v) binding offer; (vi) underwriting and closing activities; and (vii) post-closing activities. Each phase was subsequently subdivided into specific sub-phases for each of which the Commission explored the main issues.
Proceeding with the analysis of the main passages of Guidelines, the first suggestion offered by the Commission, for an effectively structured process, has to be identified in the correct selection of the NPL portfolio to be sold (also through the involvement of the managers of the individual positions); such selection must take into consideration, on the one hand, the strategic targets of the transferor and, on the other hand, ensure on a case-by-case basis, that the selected portfolio is attractive to specific categories of investors (through the selection of homogeneous NPLs). In addition, the Commission points out that the identification of the correct size of the portfolio to be sold is one of the factors that can contribute to the success of the sale process (as undersized portfolios would make the process inefficient for investors in view of the high sunk costs).
In addition, simultaneously with the portfolio selection, the Commission suggests the usefulness of considering certain more technical aspects, including the enhancement of banks’ internal IT systems to allow a better and more timely flow of information to potential investors, thereby streamlining the process by reducing its duration and costs.
The second phase would instead be dedicated to process preparation activities (including the documental part, including the definition of a termsheet of the future transfer agreement (“LSPA“) and the set-up of the VDR. Of particular importance at this stage is the definition of a timeline that is as much realistic as possible as well as the seller’s choice as to determine whether to proceed with a two-phase (phase 1 and phase 2) or a single-phase process structure (in which case, process structures defined as “targeted auction” (with pre-selected investors) or “negotiated sale” (with exclusive negotiation with a single investor) can be envisaged.
Following this, and strictly connected to the previous phase, there would be the so-called “pre-marketing” phase. The Commission invites operators to carry out an initial survey that would allow the identification of a broad list of investors, identified, inter alia, based on the characteristics of the portfolio. To formally present the portfolio, or the single name, to investors who have signed a non-disclosure agreement, the preliminary documents of the transaction (including, for example, the teaser, the information memorandum, the process letter and a draft term sheet of the LSPA) should be provided.
The Commission requires that the so-called non-binding phase should be conducted in an efficient, transparent and reliable manner, and that all investors should be treated fairly by the seller.
After the non-binding phase, the seller will select one or more investors to get them to enter to the so-called binding phase, at the end of which the buyer will be selected. Also in this case, the Commission provides that this phase must be carried out in a transparent manner and that, to make the timing efficient, all parties involved must be clear about the steps to be completed as well as the documentation that must be produced; in particular, any changes must be communicated by the originator in the shortest possible time to the entire panel of potential investors.
The Commission, on the basis of the operators’ experience, has also examined what should be the best practices in the execution phase of the process: if carried out quickly and efficiently, this would allow the institution to avoid incurring any penalties provided for in the contract and enable the buyer to rapidly finalise the on-boarding of the NPL portfolio.
In particular, during this phase, the most significant steps are to be taken through agreed transition plans that appropriately represent the legal and economic understanding, with a pre-defined timeline. First of all, the Commission indicates that an appropriate period should be provided for in the LSPA between the date of signature and the closing of the transaction, having due regard to the complexity of the transaction, the steps to be completed and the risk of delays. The Commission also points to the possibility that the value of the exposure may deteriorate during the negotiation phase up to financial closing, and therefore reiterates the importance of designing the execution process in an efficient way. It would therefore follow that the assistance and involvement of in-house and/or external financial and legal advisors could be crucial.
Once the sale has taken place, since the so-called “post-closing” phase includes a series of activities in cooperation between the seller and the buyer, the success of the operation will, in the Commission’s opinion, consolidate the seller’s credibility in the market, avoid conflicts and attract other investors, ensuring an efficient relationship with investors and better conditions for potential future transactions.
In light of the indications provided by the Commission, it is possible to argue that the Guidelines may represent a further effort by the European legislator to enrich the regulatory framework for the NPL also due to their systemic importance and, in this sense, the hope is that, despite the fact that the Guidelines are not binding, the sector’s operators will be induced to comply with them in order to harmonise the processes for the sale of NPL credits in the European market, thus contributing to the development of a robust secondary market based on criteria of effectiveness, efficiency and transparency.
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