Regulations that encourage banks to sell non-performing loans (NPLs) have unintended consequences for consumers and society.

Through Ben Marsh, Head of Business Development, Crane Financing

For more than two years, the Irish media have actively pursued a story which suggests that thousands of consumers are (or will be) disadvantaged by the sale of distressed Irish mortgage portfolios to Private Equity (PE) funds.

The tale is a familiar one: So-called “vulture funds” acquire non-performing loans to make a quick buck in as short a time as possible, without worrying or thinking about how the consumer is treated, or how. there is a chance that the client can be rehabilitated in the mainstream financial stream. Speaking in the Irish press of anything up to 40,000 left on the streets further fueled the fire. Such a negative characterization of the PE market is not fair – they are an easy target for media criticism – but the broader issues raised by the coverage merit further debate.

Ireland experienced a large real estate bubble and a subsequent crash, leading to the sale of large portions of NPL. However, the reason why so many NPL portfolios end up in the hands of private equity funds is a consequence of legislation passed after the global financial crisis. And what is happening in Ireland – and the media fury it has created – could very soon be happening here.

Reduce NPL ratios

Since the 2008/9 crisis, regulators have focused on reducing NPL ratios within banks, encouraging banks to sell customers with defaulted products. A key element of this legislation is the Prudential Backstop which prompts banks to sell or write off bad loans from their balance sheets by making them increasingly expensive to hold, with costs rising over time.

Regulators hope that by making bad debt too expensive to hold and resell, original banks can free up capital to lend to new customers. This has happened to a large extent: in the recent EBA NPL report, the total volume of NPLs in June 2019 was € 636 billion, but that is only half of the volume recorded four years earlier (1.152 billion euros). In the second quarter of 2020, the total absolute amount of NPL (gross value) for all banks in the EU stood at € 588 billion, although the steady decline seen before COVID now appears to have stopped and is not expected to maybe not resume until after the resume has started.

But regardless of the volumes of NPL available for purchase, what regulators seem to have failed to take into account is what happens to the customer whose debt is sold. And if they evoke the importance of a “deep and liquid” secondary market and the very need to encourage new entrants, they do not seem to have fully understood the differences between the various “buyers” already present in the secondary market. , nor their roles or motivations.

At one end of the scale are investment funds that tend to take a short-term view of every portfolio they buy, with little or no desire or ability to support a longer-term client or to offer new funding if they need it. In the middle are traditional buyers, full-fledged companies with the ability and appetite to support customers for the long haul. Specialized banks are on their own, who understand the customer’s position, and are willing and able to support them in difficult times and, like traditional buyers, over a much longer period, as their model is based on a stable model. and long term. yields as opposed to short-term cash flow. (Hoist Finance is an example of such specialist banks, licensed in banking since 1996. They have served clients for an average of 4.5 years and run a deposit business, using these funds to acquire performing loans and not productive.)

The problem is that these specialist banks inadvertently find themselves in a Catch 22: while they may wish to work with a client for the long term, and ultimately put that client back in good financial health with future access to credit, time is of the essence. . As banks, and therefore subject to the same regulations as selling banks, they are financially penalized for hanging on to the NPL portfolios they hold!

The early discharge of non-performing loans is likely to be to the detriment of the consumer, by excluding him from access to traditional credit. It could also lead to more portfolios being sold to those funds at the end of the scale with different motivations as the bank buyer is simply not in a position to compete financially.

The legislation has in effect meant that banks like Hoist Finance have been caught in friendly fire as assets continue to weigh more heavily on balance sheets, even after their purchase.

The customer journey

So what to do? Certainly, we believe that consumers are better served by specialized banks than by unregulated investment funds. In fairness of balance, in exploring and better understanding the default customer journey, there are pros and cons on all sides, both for the customer and for the company.

Selling to a fund often leads to a faster resolution of a debt problem and frees up capital for the original bank to create new loans. But there is little or no emphasis on rehabilitating clients and no ability to come up with new credit products, which means these clients contribute little in terms of societal benefits.

Selling to a specialist bank buyer means a proven customer focus and positive longer term results and rehabilitating those customers with continued access to credit, which in turn means continued contribution to society. The Prudential Backstop, however, creates what we describe as a “burning platform” and restrictions in terms of the ability to offer new credit and restructure loans.

The loans could, of course, stay with the original banks and not be sold at all. Initial lenders are actively encouraged to recognize and properly manage NPLs and identify vulnerabilities at a much earlier stage. But the urge to sell is not only motivated by regulation, but also by the fact that the relationship with their customer is broken. Issuing banks are often not configured to handle long-term NPL customers. An accumulation of bad debt also prevents them from lending more.

Banks of all stripes are more regulated than their counterparts, which leads to better treatment of customers in general. Current regulations and the need for banks to get rid of NPLs off their balance sheets could lead to what many are trying to avoid: a shift towards more sales to investment funds alone, perhaps to the detriment of consumers who are not. a time when the European Commission insists that all consumer protection obligations be met, regardless of how PNPs are resolved.

The secondary market, on the whole, is a good thing, and a healthy and diverse market is essential. There is definitely a place for PE, but as seen in Ireland, people in debt deserve a second chance – especially in a post-COVID world – and might not get it if they don’t. is by taking a short-term view. Investment funds often push clients down a legal path when it comes to securing collateral, perhaps without trying too hard to find an amicable solution. Judicial sale prices are inevitably lower than out-of-court sales, and the accumulation of such court sales is therefore more likely to lower house prices in the longer term. This in turn creates a greater debt burden for the next group of defaulting clients, as they see lower values ​​recovered when their own properties are sold. This is a significant problem in Ireland and France and could end up becoming a problem for UK homeowners and other borrowers, once the government’s safety net is removed and the true extent of the economic downturn kicks in.

The stand regulations need to be reconsidered, and this needs to be done urgently, as I very much doubt that they were designed to impact the customer the way they did, or to the extent where she could. This should not be an obstacle to a positive outcome for all parties involved.