There’s only one way forward for Greek NPLs
As investors and service providers pour into the market for Greek non-performing loans, authorities in the country have proposed two schemes to help the country's banks meet their ambitious targets for selling off these assets and cleaning up their balance sheets. Only one of them deserves serious consideration.
Looking at Greek banks’ balance sheets is unnerving — and looking at their ambitious plans for selling NPLs is even more so. The big banks started 2018 with NPL ratios between 35% and 50%, and a total stock of over €100bn. The European Central Bank (ECB), in its supervisory capacity, is pushing them to get below 35.2%, or €65bn, by the end of 2019.
Last year saw around €11bn traded, according to Deloitte’s Deleveraging Europe report, with a further €5bn in the pipeline, while service providers are clustering around the market, hoping for a slice of the pie. In mid-2017, just seven loan servicers were operating in Greece. Now there are 15, and a further 11 are working on obtaining their licences.
But Greek banks are constrained in selling their assets, partly by the capital they have available. At Eurobank, by some measures the strongest of the four major firms, 76% of core capital is made up of deferred tax credits (DTC) — that is, offsettable tax losses which have been guaranteed by the government, rather than shareholder equity.
DTC ratios for the other banks range from 40%-60%, but the market values the Greek banks at such a level that you could buy the lot for €4.5bn and still have change for a souvlaki on the way to the airport.
This has led the Bank of Greece, the country’s central bank and prudential supervisor, to propose a cunning scheme to solve both problems at once, capitalising a special purpose vehicle (or several), using the DTCs, which, if you squint hard enough, looks a bit like a loan from the government. The DTCs would absorb the write-down on the assets sold into the SPVs, which can then be funded at market value, issuing notes to private sector investors through a securitization structure.
The scheme has several virtues, solving both problems at once, with the firepower to make sure that neither re-emerges. It is, essentially, a once-and-for-all solution which, if banks take full advantage, ought to solve the NPL problem entirely, leaving a smaller, but far cleaner banking system.
Time for Greece to pinch ideas from Italy
The other proposal on the table comes from the Hellenic Financial Stability Fund (HFSF) — and it is almost a straight lift from the successful Italian GACS (Garanzia Cartolarizzazione Sofferenze) guarantee scheme. In the HFSF proposal, as with GACS, banks and investors are free to structure securitizations according to ordinary market practice, which, if they can achieve an investment grade rating on the senior tranche, can in turn apply for a government guarantee. The guarantee, in Italy at least, is priced based on a basket of CDS spreads on Italian banks and companies.
The government guarantee in GACS is pretty weak. It’s a retrospective promise to make good realised losses, which means the state might only cough up decades down the road. But crucially, it gets the GACS tranche into 0% risk-weight territory for banks, and makes GACS tranches eligible repo collateral as well. Nearly every Italian bank to use the scheme (and around €45bn was traded using GACS last year) kept the guaranteed tranche, with UniCredit the notable exception.
The HFSF proposal is a lot less advanced, less comprehensive, and can only solve the NPL problem in a piecemeal fashion, while doing nothing at all to the DTCs still used as capital.
Nonetheless, it is by far the superior proposal. Knocking off the Italian plan might seem a little like cheating, but it has several benefits.
First off, the there's the European Commission to deal with. Any scheme where the state supports banks needs to navigate stringent state aid rules from the European Union. This might seem insane to some observers — the same Commission which with one hand is passing stringent NPL provisioning rules and pushing countries to clean up their banking systems, might actually prevent countries doing so with the other — but it is European politics.
A Greek version can’t be an exact carbon copy of the Italian version — for one thing, not enough Greek firms have active CDS markets on their debt to make a sensible “market price” for the guarantee — but Italy has already shown that a senior tranche guarantee can make it through state aid rules, hopefully with the minimum of delay.
The Commission has said it was “monitoring” the Bank of Greece proposal but supervisors have already bent over backwards to redraw the rules for deferred tax assets (which are contingent), allowing them to be converted in deferred tax certificates (which are guaranteed) and therefore counted as capital.
To step ahead and move these entirely outside the banks into separate SPVs means yet more supervisory fudging, and a harder state aid discussion; there simply isn’t the time. Greek banks need to make progress now, not after the Commission mandarins finish their chin-stroking.
The second consideration is the buyers, the banks and their advisers.
The Bank of Greece’s proposal is elegant, as a theoretical abstraction, but it’s untried, and means another layer of learning for everyone involved. The Greek bank treasury teams might be unfazed by this, given that it is their supervisor that is proposing it but portfolio advisory, investment banks, and, crucially, the private equity and hedge funds buying NPLs will face a steep learning curve, and complicated credit approvals.
Many of these players, however, are the same ones that have been enthusiastically picking over Italy’s NPL market for the past two or three years. Investment teams buying loan books look right across southern Europe, and the more market peculiarities are involved, the less interested they are. Banks offering NPL financing, too, have pan-European books with the majority of positions in Spain and Italy. The closer the Greek scheme to the Italian, the better for leverage providers.
NPL investments are not trivial at the best of times. They need extensive due diligence, months spent in a data room, and boots on the ground, in the form of local servicers and legal representation. The structure of any NPL leverage, through a securitization or a guarantee, ought to be the simplest part — and it would be, using the HFSF scheme. Opting for the Bank of Greece, though, means a longer, slower journey, and Greece doesn’t have the time to waste.
It might be uglier, it might be an Italian knock-off, but the HFSF’s approach is the right one. To solve a problem like Greek NPLs, best to keep it simple.