In a recent conversation with Financial Times, Elke König, chair of the Single Resolution Board, rejected suggestions from the European Central Bank (epressed in a letter by Andrea Enria to FT) that the EU needs to set up a network of “bad banks” to handle higher non-performing loans (NPLs). I am following the discussion regarding a European Bad Bank since a while and my take is that a solution similar to Italian Gacs would be more transparent and less distortive of market dynamics.
Ms König summarized her doubs with quite straightforward words:
“The entire debate . . . always lacks one component: who is footing the bill,” (…) “it feels sometimes as if this is the magic system,” [one where losses are supposed to evaporate, something] “that is not going to happen”.Elke König, chair of the Single Resolution Board
To point out again my take on the point I’d like to suggest 2 main reasons why a Bad Bank is not the optimal solution to address the issue and 2 supporting arguments for an alternative that has been successfully tested in Italy: a state guarantee scheme on senior notes of securitization vehicles: “Garanzia sugli Attivi Cartolarizzati”, GACS.
First and foremost, Bad Bank is a proposed fix to a market failure that does not exist: if no one is ready to buy banks’ toxic assets you need the government to step in, but this is not the case. According to Banca IFIS (see the the September 2020 NPL Market Watch) European NPLs have been reduced from 1.1Tn in 2015 to 0.5Tn in 2020 proving that a strong market for these assets do exist.
In Italy, some 200bn have been traded in 12 months across 2017-18 proving that a single country can handle in one year almost a volume ranging from one third to one-quarter of the new extraordinary flows expected in the worse scenario.
Secondly, bad banks may threaten and harm that vey secondary market that Mr Enria was trying to promote as head of European Banking Authority. Facing the unfair competition of a state-owned companies may reduce the interest of private investors for a complex and illiquid asset class where a large set of specific skills ranging from real estate to country-specific judicial system are needed to properly assess and manage any investment and where any attempt of purchase requires expensive preliminary due diligence.
Two possible remarks on these arguments are that current market prices may be punitive for selling banks and that debt buyer may obtain extra profits due to the lack of competition. Both of them can be addressed by the alternative I am suggesting: a state guarantee scheme at European level similar to GACS, the one successfully applied in Italy in 31 deals for 77bn face value.
Within this newly created scheme banks would transfer bad loans to special purpose vehicles issuing notes to finance the acquisition. Notes would be differentiated according risk level and most senior notes should benefit from the public guarantee.
As proved by Italian experience this scheme would allow:
- convenient transfer price because the buyer can benefit from very cheap leverage for a very large share of the purchase price offered
- full derecognition of bad loans from banks’ balance sheet even though a large amount of senior notes is retained by banks themselves
- involvement of private investors to subscribe riskier notes and rating agencies to assess the risk of senior ones
- special servicing provided by independent companies
The 2 most relevant supporting arguments for such a scheme are:
- a lower distortion of the market dynamics since private investors are involved subscribing riskier notes and
- higher transparency of the entire process that requires a Rating for the notes that benefit from the guarantees and an independent special servicer for credit management.
In conclusion, there is a wide consensus that European banks may need some help to handle an extraordinary increase in non-performing exposures, since this may be done through a transparent and mostly market-based mechanism, there is no point in sticking to old fashioned and invasive institutions like state-controlled bad banks.
SaveTheDate On 24 November 2020 I will participate as a speaker in the virtual event: The management of credits guaranteed by real estate: prospects and critical issues following the health emergency organized by AGIDI – Italian Association of Real Estate Lawyers. Find out More.
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GLG – Gerson Lehrman Group – Council Member