News Analysis
European AMC to create 'positive feedback loop'
Further details have emerged about the EBA's proposed state-funded, pan-EU asset management company (AMC) (SCI 3 February). The initiative is expected to attract more investors to the European NPL market and by extension free up bank capital and spur more lending.
"The reduction of NPL ratios is a positive sign, but it is too slow," says Mario Quagliariello, head of risk analysis at the EBA. "An AMC can give impetus to the disposal of NPLs; data standardisation, for instance, would help investors access the market and allow them to deal with comparable information, reducing information asymmetries and increasing the price that they would be willing to buy. This would, in turn, free bank capital and spur more lending".
The idea here is that an AMC would create a positive feedback loop that would bring prices up. "The current market price does not reflect the real economic value," Quagliariello adds.
The AMC will deal with this problem by buying the loans at this value, otherwise called the future efficient clearing price. Quagliariello states that there is a three-year timeline, where if the price at which the AMC is selling the NPLs is below its real economic value, losses would be realised by the banks and not the AMC. If the banks don't have the capital, they would be recapitalised by individual member states.
From the EBA's perspective, addressing the NPL problem means creating an efficient secondary market in NPLs to address existing market failures, such as information asymmetry, due to the absence of comparable and accessible data on loan debtor and collateral characteristics. Another issue is the intertemporal pricing problem, given the illiquidity and shallowness of European NPL markets.
The goal of an AMC would be threefold: addressing incentives for banks to take action on NPLs; improving price discovery by improving the quality and comparability of data; and standardising existing legal contracts. The intertemporal pricing problem is dealt with by buying the loans at their real economic value, with a view to selling into a deeper and more liquid market at a later time.
According to the EBA's proposal, the solution must be in line with BRRD and state aid rules, while avoiding any risk mutualisation of legacy assets. Consistency with BRRD rules here refers to the concept of precautionary recapitalisation, whereby banks are recapitalised without resolution if some specific criteria are met. For Quagliariello, it is this feature of the EBA's proposal that allows the AMC to work within the flexibility of the current legislation.
The proposal involves stress tests to identify the 'theoretical amount' of aid that would be permitted for each bank's precautionary recapitalisation. This would in turn determine how much state aid could be used to facilitate the transfer of NPLs, which would be equal to the difference between current market prices and real economic value.
An assessment of real economic value versus current market prices would then be carried out, with banks transferring some agreed portions of their NPL portfolios to the AMC at the real economic value, with due diligence from the AMC and accompanied by full data sets available to potential investors. The transfer of assets to the AMC would first hit the existing shareholders to the extent that the net book value of NPLs is above the transfer price to the AMC. This may coincide with a liability management exercise and some bail in of junior debt to equity, as determined by state aid rules.
To avoid moral hazard issues, equity warrants issued to national governments at the time of the asset sale to the AMC would be triggered if the final sale price is lower than the real economic value. The assets would be transferred to the AMC at the point of sale.
The AMC would set a timetable to offload the assets at the real economic value. If that value is not achieved, the bank must take the full market price hit, covered if necessary by warrants exercised by the national government as state aid.
Mainly due to the standardisation and the due diligence undertaken by the EBA, Quagliariello is optimistic that the AMC would increase the number of investors in the NPL market. "Having a single stop at the AMC would help increase the number of investors, due to the standardisation, the due diligence that would be carried out by the AMC and the diversified portfolios that investors would have access to."
Other benefits, he says, include a "tranching system" - although he qualifies that it is too early to say whether securitisation will be part of the proposal.
Questions, however, remain over whether the real economic value can be achieved. Quagliariello is nevertheless emphatic: "While the difference between the real economic value and current market prices is to be tested on the field, even relatively minor improvements in transfer prices would make a great difference for banks."
14/03/2017 17:07:31
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