3.1. The EIB Group in SME loan securitisation transactions
The EIB Group may enter into SME loan securitisation deals by guaranteeing the mezzanine tranche23 (i.e. the middle tranche, senior to the first loss/equity piece), and/or investing in the senior (safest) tranche.
The guarantee provided by the European Investment Fund transforms the initial rating of the mezzanine tranche into a triple-A rating (Figure 18), although such tranche usually provides investors with an interest rate higher than the senior tranche (also triple-A rated) not benefitting from a guarantee of the European Investment Fund.
Furthermore, as such securities have a rating above A, if the investor purchasing the guaranteed securities is a financial institution, it can use the securities purchased in repurchase agreements with other financial institutions, as collateral in transactions undertaken in the derivatives market, and/or in liquidity operations with their central bank. In addition, as the securities are guaranteed by the European Investment Fund, they carry a 0% risk weight under Basel regulation, thus making them even more attractive to financial institutions.
The investment in the senior tranche (triple-A rated) made by the European Investment Bank might give rise to a so-called EIB retrocession, which may even lower the cost of such tranche to the originating bank.
Figure 16: EIB Group involvement in SME loan securitisation deals
SECURITISATION VEHICLE
ASSETS LIABILITIES
Loans to SMEs: EUR 250 million Securities:
Senior Tranche A - rating AAA
Mezzanine Tranche B - rating BBB AAA First loss Tranche C - rating BB
23 During the 2008 financial crisis, the European Investment Fund exceptionally guaranteed senior tranches in SME loan securitisation transactions, as for instance in the Atlantes SME No. 1 transaction.
European Investment Fund
Guarantee Investors (Tranches A + B): EUR 230m
European Investment Bank Investor Senior Tranche A
If the EIB Group gets involved in a SME loan securitisation deal as investor and/or guarantor, the originating bank has to commit to grant new loans to SMEs pursuant to the securitisation in exchange for being granted with funds or a guarantee from the EIB Group.
3.1.1. The European Investment Fund Guarantee fee
In exchange for providing a guarantee, the European Investment Fund receives a fee calculated on the outstanding balance of the guaranteed tranche. For instance, in the Portuguese SME loan securitisation transaction “Douro SME Series 1”, such fees amounted to 0,51% per annum on the outstanding balance of the guaranteed tranche.
The European Investment Fund determines the value of its guarantee fee based on its internal scoring of the operation. The European Investment Fund then assesses interest rates charged on other similar European SME loan securitisation transactions (market price) to ensure that the all-in interest rate to be charged on the guaranteed tranche remains below the market price.
3.1.2. The European Investment Bank retrocession
As it is enjoying a triple-A rating, the European Investment Bank is able to raise funds on the capital markets at advantageous rates. As it is also operating on a non-profit basis24, the European Investment Bank charges low interest rates to its clients.
Such interest rates represent the sum of its borrowing cost (yield curve of its issued bonds) and a spread to cover credit risk and its operating expenses (Chart 3)).
Chart 3: European Investment Bank’s yield curve compared to Germany, France and Italy sovereigns
Source: Moody’s (2013)
24 Article 309 of the TFEU (EIB, 2013a and Eur-Lex, 2013).
If the European Investment Bank’s all-in-cost is lower than the interest rate it receives as investor, the European Investment Bank gives back to the originating bank the difference between the two. This is the so-called “EIB retrocession”. Such differential should then be passed on to SMEs in the form of lower interest rates.
Assuming the European Investment Bank would charge an interest rate equal to EURIBOR 3 months + 7 basis points on a EUR 50 million loan to ZYX bank and that EURIBOR 3 months is equal to 2%, then the European Investment Bank would be entitled to receive EUR 1 035 000 as interests from ZYX bank.
Considering now that instead, it invests EUR 50 million in SME loan-backed securities originated by ZYX bank carrying an interest rate equal to EURIBOR 3 months + 10 basis points, then the European Investment Bank would be entitled to receive as investor EUR 1 050 000 in interests, thus more than it would if it would have lent directly EUR 50 million to ZYX bank. In that case, the European Investment Bank would give back to ZYX bank as EIB retrocession the difference between the interests it receives as investor and the interest it would have charged on an equivalent direct loan to ZYX bank, i.e. in the present example EUR 15 000 (Table 6).
Table 6: Numerical example of the EIB retrocession mechanics
Interest received higher than the interest it receives as investor, then there would be no EIB retrocession, nor would ZYX bank be requested to pay the difference to the European Investment Bank.
3.2. The EIB Group and SME loan securitisation in the literature There is no academic literature that I am aware especially studying the role of the EIB Group role in SME loan securitisation, apart from studies, reports, and working papers on the subject prepared or ordered by European institutions (European Commission, 2004 and 2007; EIF, 2003, and Kraemer-Eis et al., 2010 and 2013), or by
the Euro Debt Market Association (AMTE, 2006). Such reports provide information on mechanisms available to support SME loan securitisation, such as the KfW PROMISE programme, the European Investment Fund’s guarantees, and the public sector guarantees to SME loan securitisation available in Spain25 and Portugal26. Some of them also mention Portuguese SME loan securitisation transactions but do not get into much detail (Table 7). Apart from the AMTE report, none of them attempts to evaluate and/or quantify the value added by the EIB Group’s support to such transactions. Nevertheless, the AMTE report only evaluates the qualitative value added of the European Investment Fund’s guarantee based on general data (i.e. not on a specific transaction). In addition, it does not take into account the possible involvement of the European Investment Bank in SME loan securitisation transactions.
Table 7: Portuguese SME loan securitisation transactions mentioned in institutional literature Deal Name Study / Report / Working Paper AR Finance 1 plc European Commission (2004) Douro SME Series 1 AMTE (2006)
Promise Caravela 2004 European Commission (2007)
In light of the above and using data on Portuguese SME loan securitisation transactions, it would be valuable to understand what the mechanics of the EIB Group involvement in a specific SME loan securitisation transaction are, as well as the qualitative and quantitative advantages it may eventually bring, comparing it with a Portuguese SME loan securitisation transaction without EIB Group’s support.
25 Fondos de Titulización de Pequeñas y Medianas Empresas (FTPYME): Spanish Government program directed to financial institutions committing to grant new loans to SMEs: http://www.ipyme.org/en-US/Financiacion/FondosTitulizacionfinanciacion/Paginas/TitulizacionFinanciacion.aspx
26 Fundo de Garantia de Titularização de Créditos (FGTC): Portuguese State-owned fund managed by PME Investimentos (http://www.pmeinvestimentos.pt/fundo-de-titularizacao/apresentacao.html#), owned by the Portuguese State-owned entities IAPMEI (88%) and “Turismo de Portugal” (12%)