Is a Bad Bank the right solution for Euro zone?

The main problem with dealing with a Bad Bank is the proper assessment of distressed assets’ current value and how this is affected by estimation of expected cash flows. If the actual value is lower than trasfer price to the Asset Management Compay the gap need to be filled somehow. Futhermore it need to be considered that quality and Efficacy of management do matters and significanty affect the timing and amount finally collected.

As reported by Financial Times European Central Bank officials have held high-level talks with counterparts in Brussels about creating a eurozone bad bank to remove billions of euros in toxic debts from lenders’ balance sheets.

So far Senior EU officials have pushed back on the idea, arguing there are better ways to tackle toxic loans, but declined to give further details. The most relevant opposition to the idea stands within the European Commission, where officials are reluctant to waive EU rules requiring state aid for banks to be provided only after a resolution process imposes losses on their shareholders and bondholders.

However, people following the discussions inside the commission did not rule out their resuming at a later stage of the pandemic.

Charts showing how ratio of non-performing loans has decreased in Eurozone countries in recent years - the ECB is keen to accelerate the fight against toxic debt

In order to get a full picture of the situation the Financial Times recalls that in March, the commission adopted a temporary relaxation of state-aid rules and has since waved through billions of euros in emergency government relief measures. Brussels is also finalising plans alongside member states to allow countries to inject equity directly into struggling businesses, though in return they will be restricted from paying dividends or bonuses while in receipt of state aid.

I had made some skeptical comments on 2017 Bad Bank’s proposal made by Mr Enria when he was head of European Banking Authority: my main doubts we on how to calculate the transfer price of NPLS and who would be supposed to fill the gap between book values and market prices.

Recent news regarding Unicredit ready to sale some 3-3.5Bn of NPLs in order to stay on track with complete disposal of non core assets by 2021 can be considered an evidence to support the idea that a Bad Bank Solution may not be the best way to tackle NPL problem in Euro Area.

The main assumption with ECB proposal seem to be that regardless the timing, collections related to Bad Loans are going to be at least equal to current Net Book Value. If this is the case there is no need to fill a gap and the Bad Bank can be considered like a parking lot where NPL are stockpiled waiting for cash to come.

Unfortunately most of times this is not the case: debt collection process and forclosures need to be initiated and monitored, claims need to be submitted to bankrupcty receivers and so on. Also relevant decision need to be taken along the trade off between immediate discounted payoff vs future legal proceeds or multiple year payment plan.

It is still not clear how ECB proposal on Bad Bank would determine trasfer price of existing NPL portfolios and how the future credit collection activity will be run.

Based on current publicly available info the decision to reject the idea for the moment seem to be reasonable considering that most urgent priority should be try to avoid new corporate and household default rathern than subsidize banks relieving their balance sheets.

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About Massimo Famularo

Investment Manager and Blogger Focus on Distressed Assets and Non Performing Loans Interested in Politics, Economics,
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