Sunday, June 5, 2016

Non-Performance Regarding Non-Performing Loans

The question of how to deal with the major Greek banks' non-performing loans is almost as old as the crisis itself. Essentially, there are two levels at which the consequences of any solution will be felt: at the level of the banks' borrowers and at the level of the banks' owners.

Once loans are explicitly put on a liquidation basis, life becomes extremely tough for the borrowers because they no longer have a banker to discuss their situation with. Instead, they face a liquidator who is only interested in one thing: liquidate the asset as quickly as possible. Even if a 10-year restructuring plan might eventually yield more return for the liquidator, the liquidator is not interested in what happens in 10 years from now. He wants to see cash now. My understanding is that certain borrowers (i. e. small mortgage borrowers) are legally protected from the excesses of liquidators but all others will feel pure pain.

What matters to the banks' owners is the price at which NPL are sold to liquidators. At the price which the owners desire they may not find a buyer. At the price which liquidators offer, the owners will suffer financially.

It is these two aspects which make the proper treatment of NPL so difficult and which are probably the reason why there has not been a solution to date. The Ekathimerini now reports on a new plan which might be a good solution: "Banks mulling special NPL vehicles".

Under this idea, the NPL would be spun off to existing shareholders in a separate special purpose vehicle. At the end of this exercise, the existing owners would own two companies instead of only one. One would be the former bank but now without undue NPL (and presumably operating quite profitably). The other one would be the NPL-SPV. Those owners who feel that they can work out the NPL much more successfully than any liquidator simply hold on to their shares in the SPV. Those who don't can sell their shares in the SPV at (very low) market values.

The principle point is that risk diversification takes place at the level of the owners and not at the level of the bank.

NPL are definitely not only a financial issue for banks. The ultimate success of a bank depends on what management spends it time on. In a bank where NPL approach 50% of the total loan portfolio, managements' time will be locked-up in that area. And only few managers are prepared to embark on a new lending strategy when they spend much of their time working out bad loans.

1 comment:

  1. I'm wondering, are there a lot of hidden legal obstacles on the whole NPL issue in Greece? Such that trying to liquidate the loans to recover the collateral via foreclosure becomes impossible, even if theoretically legal?

    That has been the case in Cyprus, where NPLs were even higher. One of the big issue in the Cypriot MoU was reform of the banking and legal system allowed foreclosure in some period of time under two decades and at something less than prohibitive cost.

    Background here: