By Iain Balkwill
As the world continues to get to grips with the fallout from COVID-19 and we start to witness the gradual removal of fiscal stimulus measures and government support across the globe, banks will also start to assess the damage to their balance sheets as a consequence of the pandemic. It is inevitable that in the coming months there will be a significant increase in the quantum of non-performing loans (NPL’s) and therefore it will be critical for the good health of the banks that these are removed in an extremely efficient and timely manner. Having been stigmatised for the excesses of the past, securitisation has all the positive attributes to be a healer of the banks in the future.
The past ten years or so has proven to be a tumultuous period for the banking sector, as banks across the globe have not only gone about repairing the damage inflicted by the global financial crisis (GFC) but also learning to operate in its wake. Meanwhile, a myriad of other challenges has graced the sector including a sustained period of ultra-low interest rates, a heightened level of regulation as well as the emergence of a multitude of shadow banks.
In recent years, the banks have certainly had a rocky ride, but their challenges have not all been external. Indeed, one of their major issues has been the presence of significant volumes of NPL’s that have caused a real drag on profitability as well as the absorption of valuable internal resource. Inevitably, the neutralisation of these loans has been a top priority and despite there being a number of tools to do this, the most effective method to date has proven to be the disposal of portfolios of loans to distressed debt investors through competitive auction processes.
For the banks, NPL disposals have demonstrated that they are not for the faint-hearted given that these processes are not only time and resource intensive, but also involve banks crystallising losses through agreeing eye-watering discounts. The corollary of this is that although a bank may be keen to embark on such a deleveraging exercise, the harsh reality is that it is not always in their gift given the need for a strong balance sheet that is capable of absorbing the resultant losses. Inevitably, to facilitate this painful but essential task, restructurings and re-capitalisations have gone hand in hand with these disposals.
Since the GFC, banks have undertaken these disposal exercises at varying paces which have largely been driven by the jurisdiction of the bank in question, as well as the location of the underlying assets. In recent years, NPL reduction targets set by the European Central Bank has acted as a catalyst in deal flow. The consequence being that certainly in Europe, there has been year-on-year growth of NPL activity as banks have gone about the messy business of realising their losses and trying to reposition their businesses on a more profitable trajectory. Indeed, 2020 was all set to be another bumper year for disposals had COVID-19 not caused NPL processes to stop in their tracks or, at best, stagnate.
Although in the short-term COVID-19 has clearly had a profound impact on NPL disposal activity, in the medium to long-term, the pandemic will inevitably generate an entirely new wave of NPLs as individuals and businesses succumb to the economic fallout from the virus. For those banks that already have a significant volume of NPL stock on their books, then they will no doubt be rueing with the prospect of having to address a heightened volume of bad debt.
As COVID-19 NPL’s begin to stack up, it is important to be mindful of some of the lessons learnt from the GFC and, in particular, the fact that the sooner banks deal with NPLs, the better for not only their own profitability but also for the greater benefit of those economies in which they operate. In an ideal scenario a robust and efficient mechanism can be identified to efficiently offload NPLs, restore balance sheets and return banks to a more even keel. Although in some quarters the suggestion of identifying such a mechanism could be considered fanciful, nevertheless it is quite possible that securitisation, as the foe of the banks in the past, could prove to be their friend of the future.
How does the application of securitisation work in practice?
Conceptually, the application of securitisation technology is the perfect solution for the cleansing of bank balance sheets. In essence, these structures involve a bank selling a portfolio of NPLs to a shell company that funds such an acquisition by issuing debt securities into the capital markets. The vehicle will in turn appoint a servicing entity that will manage the underlying loans on a daily basis with a fee structure that incentivises them to maximise recoveries on the underlying loans.
The use of securitisation makes a lot of sense. This technology has the capacity to enable a significant volume of NPLs to be removed from the banks in one fell swoop. Given the only limitation in sizing a transaction is the magnitude of the universe of investors that can competitively price and absorb an issuance, then we could be talking about pretty hefty deals. The opportunity afforded by securitisation of offloading NPLs in either one large deal or a series of large transactions is infinitely more appealing than the alternate scenario that we have witnessed to date of a protracted period of auction processes.
Securitisation technology also counteracts one of the major stumbling blocks that has traditionally made banks reticent about off-loading NPLs: the pricing. Although NPL securitisation cannot guarantee decent pricing, it does possess a number of features that load the dice in favour of the banks when it comes to trying to achieve the best possible return.
Whereas an auction process will involve just a small handful of investors, debt securities issued by a securitisation can be mopped up by a whole range of investors of varying size and different risk appetites whilst at the same time not having to incur prohibitive levels of due diligence costs. In other words, securitisation expands the universe of investors and, by doing so, will create a greater level of competition which the banks will be able to reap the benefit from through better pricing on issued NPL securities. At a time when central banks are keen to stimulate the economy through increased quantitative easing, whilst at the same time interest rates remain painfully low, then the chances are that there is likely to be plenty of appetite for the product.
By their very nature securitisations are highly bespoke structures and can be tailored in such a way to put a bank’s best foot forward to achieve their desired pricing. An example of this is the inclusion of credit enhancement measures (tranching, credit lines, derivatives) in the structure. Through this structuring, risks can be mitigated which in turn will be reflected with improved pricing. Similarly, if a day one discount for the bank is proving to be a tough pill to swallow, then it is quite possible to structure a transaction in such a way to ensure that the bank could benefit from certain performance hurdles being met in the form of receiving some deferred consideration.
Potential stumbling blocks of NPL securitisation
NPL securitisations do come with their own shortcomings. Indeed, in the aftermath of the GFC one of the major criticisms of securitisation was the profound complexity of many of the structures. These concerns were well-founded and accordingly have not only been addressed in post GFC issuances but the European regulators have actively encouraged such a shift through regulatory measures (such as the European Securitisation Regulation) which actively encourages structures to be simple, transparent and standardized (STS). Although some of these STS aspects certainly hold true for an NPL securitisation, the stark reality is that NPL securitisation structures by their very nature are the complete antithesis of this, with the underlying collateral comprising a massive portfolio of NPLs without a steady payment stream.
The complexity of an NPL securitisation arises from the presence of multiple distressed loans. Given these loans are non-performing and have not been specifically originated for the purpose of a securitisation, it is likely that many of their key payment terms (amortisation profile, payment dates, interest rate provisions and even currency) will vary and therefore have to be harmonised as part of any transaction. In addition, the terms and conditions of the debt securities are likely to feature complex redemption conditions as well as other structural features to cater for varying payment profiles as well as the non-performing nature of the underlying loans.
Without question, securitisation does have the potential to enable significant volumes of NPL’s to be removed from the balance sheets of banks on an extremely timely basis through the employment of certain structures to achieve the best possible pricing. As for the reservations surrounding NPL securitisations, then none of these are insurmountable and therefore there is no apparent reason why NPL securitisation should not only be actively embraced but should, in fact, positively flourish.
Reaping the benefits
There is also strong precedent that NPL securitisation has been successful in aiding the banks with their NPLs. In Europe through “GACS” (“Garanzia Cartolarizzazione Sofferenze”) and “HAPS” (“Hellenic Asset Protection Scheme”), the Italians and Greeks have already successfully harnessed this technology to address those NPLs that have been hampering their banks. We have also witnessed a number of NPL investors successfully utilise securitisation technology as a form of leverage to maximize returns on NPL portfolios that they have acquired. Similarly, if you turn to the United States, there is a strong precedent for this following the establishment of the Resolution Trust Corporation (RTC) in 1989 to liquidate assets once owned by the savings and loans associations. Although the RTC used a range of disposal methods, securitisation technology played a key role in connection with this.
The widespread use of NPL securitisation technology as a means of mopping up NPLs residing in the banking sector certainly makes a lot of sense and the fact that there is strong precedent for this, is living proof that it certainly has a role to play in addressing NPLs. On account of its structural flaws as well as the widespread stigmatization of securitisation, it was inevitable that it had no role to play in the immediate wake of the GFC as a method of offloading NPLs. Just as the banks have gone through a period of rehabilitation, securitisation has also evolved and adapted so that it is stronger, more robust and has already demonstrated that it has a role to play in healing the banks.
Ultimately, time will only tell whether widespread NPL securitisation will be deployed as a weapon to resolve the woes of the banking sector, and with it provide a much-needed boost to the economies that they serve. One thing that is clear, is that the banking sector have a new and enhanced tool to their armory which was not available in the immediate aftermath of the GFC. Given its huge latent potential, and the fact that it has a proven track record as well as the ability to deliver immediate pain relief, then banks risk ignoring this technology at their peril. Securitisation could provide the answer to their woes.
About the Author
Iain Balkwill is a partner in international law firm Reed Smith’s structured finance team. His practice covers the restructuring, enforcement and securitisation of debt secured by commercial real estate (CRE). Iain has also been heavily involved in acting for sellers and investors in relation to the acquisition of non-performing CRE loan portfolios. Iain is a strong advocate for the establishment of a fully functioning European CMBS market as a means of financing European CRE, but also the deployment of this technology as a mechanism for banks to off-load significant volumes of non-performing loans.
Venezuela – A Tribute for Her Endless Pursuit of Democracy
By Peter Koenig
Venezuela is again the shining light of Democracy – pushing ahead with the 6 December 2020 National Assembly (NA) elections – despite the endless challenges of covid – of sanctions, of embargos, of confiscation of foreign assets, and even of a totally illicit blockage of reserve currencies – Venezuela’s gold – naturally in the world’s protectorate of international financial fraud, The City of London.
This unique drive for democracy against all odds succeeds to a great degree thanks to President Maduro, who relentlessly resists not only the attempts against his life, but the lies and vilifications about Venezuela from most of the western world, led, of course, by the United States, followed closely by the European Union which, it seems, dominated by NATO, can’t break loose from being at Washington’s bidding.
It is sad to see European states – hands and minds still dripping of colonial blood, not being able to break the stranglehold of their genocidal past – and step onto a new plate, into a new history – fighting for justice and human rights. An example how far from this eye-opening conscientious awakening Europe is, was again demonstrated today by the EU Commission’s call to “sanction” Russia for the totally unproven Navalny poisoning, by stopping the almost completed Nord Stream 2 German-Russian gas pipeline project.
Never mind the absurdity, that Germany and the EU are punishing themselves, not only because alternative badly needed gas supplies will be considerably more expensive – and god forbid – may be coming from US fracking sources. In other words, the EU would approve of an environmental disaster. Many of EU member countries are by their Constitution barred from using fracking gas or oil.
And again, the EU vassalhood – to call it what it is – refused President Maduro’s invitation to observe the December 6 elections. Mr. Maduro went out of his way to invite all the important opinion makers to come and observe the fairness of the elections, including the UN and the Europeans. The latter prefer not to see the correctness with their own eyes, but being able to criticize what they have not seen. There is no darker blindness than that emanating from not wanting to see.
And that of course only, because the European leaders (sic) – all shoe-ins by an international deep state elite – will do whatever it takes to preserve as long as possible the unsustainable – an unfettered, neoliberal no holds barred capitalism. The WEF (World Economic Forum) calls it best: The Great Reset – the upwards reorganization of assets. After the very elite-made global covid hoax has destroyed and continues to devastate most of what was the world economy, what gave work and food to billions of people – people are dwelling in the gutters with nothing left – no health care, no shelter, no food – no hope. The latter is the killer.
Venezuela is the antidote to this western usurping approach to civilization – what’s left of it. Venezuela pursues justice and fights for equality. By the way, Venezuela is in the honorable company of Cuba, Syria, Iran, Russia and China. The US, alias the west, cannot tolerate an example of ethics in its hegemonic orbit. Western allies – united under the boots of NATO – pretend freedom is their cause, while their own people suffer from unfathomable injustice every day – poverty and famine of children is skyrocketing in the Global North, the so-called developed or industrialized world – the bankers world, the world of those who indebt the Global South into dependence, into the Global North’s neo-colonies.
Venezuela, on the contrary, aims at eradicating poverty famine and misery – and that despite her constant strangulation by Washington and their western allies, and even by some of what should be their Latin Brothers, the Lima Group, formed in August 2017 in Lima, Peru (12 members as of December 2019: Argentina, Bolivia, Brazil, Canada, Chile, Colombia, Costa Rica, Guatemala, Haiti, Honduras, Mexico, Panama, Paraguay, Peru, Guyana, Saint Lucia, Bolivia and Haiti).
Imagine – how much pressure these Lima Group countries are under to accuse, boycott, denigrate and speak out in international fora against their fellow Latin Americans of Venezuela. Once upon a time there was a United Latin America – united under the leadership of Venezuela’s Simon Bolivar. With the onset of the British Empire’s transatlantic move of its power center to become the United States of America, the southern part of the America’s became what recent US Presidents called “our backyard” – ready to be usurped in any way possible, mostly in the form of military dictatorships and lately by Washington-induced coups against democratically elected heads of states.
However, the spirit of Simon Bolivar, El Libertador, lives on. Together with Nicolas Maduro’s tenacious will for freedom, for autonomy, for full sovereignty for Venezuelans, their use and destiny over natural resources, may prevail and influence upcoming elections in Bolivia (October 2020), Chile (October 2020 referendum on whether a new Constitution ought to be drafted, replacing the one dating back to Pinochet), Brazil (municipal election in November 2020) and Ecuador (general elections in February 2021).
Venezuela’s overarching strength by solidarity and endless fight for justice and Human Rights, brought the opposition to its knees. The right-wing Washington supported opposition, led by self-nominated “president” Juan Guaidó, boycotted past elections, so as not to show their weakness vis-à-vis the rest of the world. Now, perhaps the real head of opposition, Henrique Capriles, is changing tactics. Realizing that the only way to have any say in the political arena of Venezuela is by participating in it, he is calling for participation in the 6 December National Assembly elections.
President Maduro has always encouraged and invited participation of the opposition in elections and will welcome their presence for the December 2020 NA elections too. Because Democracy is at the heart of Chavismo, the very socialist thought being carried forward – steadily, without wavering, by President Maduro and his Government. – Viva! Venezuela’s Democracy – a shining light for the Americas and for the world.
About the Author