A wave of non-performing loans threatens the banking sector, the solution may come from an unexpected source.
As current fiscal stimulus measures are lifted and the true economic impact of the pandemic begins to bite, the road ahead looks rocky for the banking sector — and for many reasons that are similar to what challenged banking in the aftermath of the global financial crisis.
One of the major thorns in banks’ sides from the previous crisis was the presence of significant volumes of non-performing loans (NPLs), which now look set to multiply in the wake of the pandemic.
NPLs have caused a real drag on profitability and the absorption of valuable internal resources in managing problematic positions. The last thing the sector needs is for this to increase in coming years.
Concerns surrounding NPLs are not just confined to the banking sector. Governments and legislative bodies worry about them too, as they are too well aware of the stifling impact that NPLs have on lending and, therefore, the wider economy.
A different kind of medicine
The neutralisation of these impaired assets is a top priority for banks and, to date, the almost universally adopted solution has proven to be the disposal of portfolios of loans to distressed debt investors through competitive auction processes. If the current hallmarks are anything to go by, then the monopoly enjoyed by these processes is set to change, with securitisation assuming a more prominent role in alleviating the pain of the banks.
Contrary to what emerged during the global financial crisis, the use of securitisation makes a lot of sense now — and it is a much more solid instrument than what it was then. This technique has the capacity to enable a significant volume of NPLs to be removed from banks in one fell swoop, or alternatively it can be used as an extremely effective balance sheet management tool. Given the only limitation in sizing a transaction is the magnitude of the universe of investors that can competitively price and absorb an issuance, we could be talking about pretty hefty deals with an immediate derecognition impact on the balance sheet.
NPL securitisation is likely to play an increasingly integral role in the months and years ahead, as a tool for offloading significant volumes of NPLs
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: a protracted period of auction processes.
There is also strong precedent that NPL securitisation works exactly as intended. In Europe through GACS (the Italian programme titled Garanzia Cartolarizzazione Sofferenze) and HAPS (the Hellenic Asset Protection Scheme), Italy and Greece have already harnessed this technique to offload notable volumes of problematic loans. In fact, the success story of these transactions is not something that has been missed by the European legislator, which is currently in the midst of amending the Securitisation Regulation and the Capital Requirements Regulation to actively promote the use of NPL securitisation.
Given its many favourable attributes and the favourable regulatory tailwinds, NPL securitisation is likely to play an increasingly integral role in the months and years ahead, as a tool for offloading significant volumes of NPLs.
Changing fortunes
The emergence of securitisation in the NPL space is certainly significant and a remarkable rise to grace for a financial instrument that 10 years ago was very much in the doldrums, having been vilified as one of the chief assailants that precipitated the global financial crisis.
A decade later, securitisation can now be said to be a very different beast. Through the actions of investors, regulators and market participants, securitisation structures have now been finessed, structural shortcomings fixed and best practice adopted.
Only time will truly tell whether NPL securitisation will become the mainstream answer to addressing increasingly problematic NPLs. However, one unassailable fact is that these structures do enable banks to reduce, if not remove, the negative impact of NPLs on a timely basis. Banks risk ignoring this technique at their peril, and to the detriment of the economies they serve.
Iain Balkwill is a partner at law firm Reed Smith.
