Carving out legacy assets: A successful tool for bank ... · GR CY HR IT PT IE SI BG HU RO. Market failures NPLs 4 •Inefficient judicial systems •Information asymmetry (buyers

1

Carving out legacy assets: A successful tool for bank restructuring?

Willem Pieter de Groen

Centre for European Policy Studies (CEPS)

Lisbon University of Law8 May 2017

2Non-performing loans (NPLs) potential threat for EU banks

47% 47%

20%16% 16%

14% 13% 13%11% 11%

7% 6% 5% 5% 5% 4% 4% 4% 3% 3% 3% 3% 3% 2% 2% 1% 1% 1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

GR CY PT IT SI IE BG HU RO HR PL ES AT SK MT LT FR LV BE DK DE NL CZ UK FI EE LU SE

NPL Ratio Coverage ratio of NPLs

EU banks are facing € >1 trillion NPLs

Source: EBA (Sept-2016)

3Non-performing loans (NPLs) potential threat for EU banks

Source: ECB

0

10

20

30

40

50

2007 2008 2009 2010 2011 2012 2013 2014 2015

GR

CY

HR

IT

PT

IE

SI

BG

HU

RO

4

Market failures NPLs

• Inefficient judicial systems

• Information asymmetry (buyers and sellers)

• Pricing problem (inefficient markets)

• Incentives for banks to postpone loss taking

Management costs Market value

Loss provisions

Economic value

Book valueCost of

capital, etc.

Market failures

Resolution tools

NPLs

5

Secondary market NPLs

17,3

40,3

22,914

5,3 2,2 2,1 1,6 0

36

13

13

13,3

7,5 11,86,4 2,3

0

39,7

19,1

0,4

2,3 0,34,2

3,11,30

10

20

30

40

50

60

70

80

90

100

IT UK IE ES DE NL AT & CEE PT GR

Ongoing

2016

2015

Loan sales in Europe 2015/2016

Source: Deloitte

Secondary market for loans is relatively small in the EU (€ 280bn).

6

Policy responses• Enhance bank supervision

• Proper accounting of NPLs• Harmonization of NPL definitions (EBA)• Enhanced disclosure on exposures

• Guidance for banks to develop NPL strategy (ECB)

• Improving the legislation and procedures• Reforms of insolvency law and procedures

• Shorten time between financial distress and liquidation• Tax reforms to encourage banks to recognize losses sooner

• Carving the NPLs out of the banks’ books• Creating secondary market

• Set-up asset management company, corporate restructuring and securitization

7

Data description

• Sample• 79 euro area banks• All received capital support from

government• 2007-2016• Data sources:

• State aid: DG Competition decisions• Financial: Annual reports

8

Main causes capital shortfalls?

Financial assets - Loans

(52%)Financial assets -

Loans/Securities (17%)

Financial assets -

Securities (23%)

Non-financial assets (6%)

Operational (1%)

Legacy assets incl. NPLs main issue during sample period

9

Resolution tools used

Sale of business

(part) (24)

Bridge bank (15)

A

sset

separ

atio

n

(28)

Other (9) 3

3

1

1

1

Sale of business

(entire) (12) 8

1

3

11

6

1

1 1

10

11

None (

17)

Total: 79 Aided banks

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Effectiveness: Long-term viability

Return on risk-weighted assets after first intervention (2007-15)

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

T0 T1 T2 T3 T4 T5 T6 T7 T8

None Sale of business (entire) Other (Guarantees)

Sale of business (part) Bridge bank Asset separation

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Effectiveness: Financial and economic stability

Loan growth after first intervention (2007-15)

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

T0 T1 T2 T3 T4 T5 T6 T7 T8

None Sale of business (entire) Other (Guarantees)

Sale of business (part) Bridge bank Asset separation

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Effectiveness: Cost of measures

Costs and capital consumption (2007-15)

-40%

-30%

-20%

-10%

0%

10%

20%

30%

None Sale ofbusiness(entire)

Other(Guarantees)

Sale ofbusiness

(part)

Bridge bank Assetseparation

On balance sheet Carve-out

Ris

k w

eigh

ted

ass

ets

Capital injection

Regulatory capital beforeinjection

Cumulative losses (peak)

Net value

Immediate deleveraging(T0-2)

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Effectiveness of resolution tools

On-balance sheet Carve-out

None

Sale of

business

(entire)

Other

(Guarantees)

Sale of

business (part)Bridge bank

Asset

separation

Transfer value Book Market Economic Market Book Economic

Long-term

viabilityUnchanged Improves Improves Improves Improves Improves

Economic and

financial stabilityUnchanged Improves

Improves/

DeterioratesImproves Improves

Improves/

Deteriorates

Loss Low High Medium High Low Medium

Capital required Yes No No No Yes No

Liquidity Bank Bank Bank No Bank Non-bank

Management

- strategy Internal Mixed Internal Mixed Internal External

- accounting Annually Up front Annually Up front Annually Up front

Moral hazard No No Yes No No No

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Conclusions & policy remarks• NPLs risk for banks in several EA countries

• Bail-in makes it even more important to minimize the the total losses

• Avoid direct sales (sale of business [part or entire]), which have the highest expected losses

• No resolution tools option for small portfolios of NPLs and sufficient margins

• Other tools option for effective resolution, though all have some disadvantages (guarantees [moral hazard], bridge bank [capital], asset separation [liquidity])

• Remaining questions on impact of internal or external managementof legacy assets

• Liquidity facility needed for some resolution tools (e.g. asset separation)

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References: Groen, W.P. (2017), “Carving out legacy assets: a successful tool for bank restructuring?”, In-Depth Analysis, European Parliament, Brussels.

Contacts: Willem Pieter de Groen(+32)2 229 39 57 [email protected]@hec.ca

Disclaimer: Unless otherwise indicated, the views expressed are attributable only to the author in a personal capacity and not to any institution with which he is associated.

© CEPS 2017 - Willem Pieter de Groen.