Why go for a Bad Bank when a EU GACs is possible?

Bad Bank is magic word for politicians and a wet dream for bankers and banks’ shareholders: it basically mean that taxpayers money will be used to foot banks’ losses.

There will always be proposals and research papers stating that this is not the case, well anytime you find them just ask few questions:

1- how will the transfer price be calculated and how can we check if the price is rigged?

2-who is going to pay recovery cost (legal, administrative, etc) and how can we check if them are inflated ?

3- provided that healthy markets for distressed assets do exist in Europe why do we need a public entity to interfere with them?

IFIS NPL Market watch Jan 2020

If you are not sure that taxpayers’money are going to be involved pls check Occam Razor: if a Bad Bank truly trades at market prices, why market players with better expertise, remarkable track record and risk appetite should not compete? If the price paid by bad bank is fair and causes relevant losses to the seller what is the benefit for the banks?

The common answer is that a public bad bank does not need to seek profits so can pay higher prices but the main fallacy is that this assumes a market liquidity that by definition is non existent when you deal with illiquid assets. It also does not take in consideration that the lack of technical skills in managing credit recovery can offset the margin granted by not working for profit.

Market price of illiquid assets is not only driven by current market conditions (interest rates, availability of funds etc) but also by the ability of asset manager to extract value from them: that is the weakest point in bad banks solution.

If the bad bank do not involve market players to extract value it is likely that it will get poor results.

If it do involve market players, what do we need its intermediation for?

IFIS NPL Market watch Jan 2020

These arguments can explain why in 2016 European Commission rejected the idea of a bad bank for Italy and agreed a different instrument aimed at mimic as much as possible market dynamics the GACS (Garanzia sugli Attivi Cartolarizzati) that so far have proved more efficient than any bad bank solution.

But the main reason why a Bad Bank should be considered an obsolete tool to handle EU Bad Loans is that a mechanism that proved far better is available and could be easyly applied out of italy.

My best guess is that on 25th september the most reasonable solution should be a guarantee scheme similar to GACS that could be applied at a EU wide level.

Most relevant benefits would be:

1. Banks allowed to derecognize bad assets as if they had sold by simply transferring (often at close to NBV values) them to securitization vehicles sparing immediate losses (and consequent need for public money or capital increase) caused by actual sale

2. Public intervention limited to a guarantee (that may even not be enforced if everything goes well) aimed at providing immediate relief to banks with very limited distortion of market processes

3. Wide involvement of market players (special servicers, rating agencies, debt purchasers etc) to ensure transparency and transfer values close to market equivalent

Focus on ItalyIFIS NPL Market watch Jan 2020

Recent Italian experience also shows that a secondary market for Non Performing Exposure in Europe do exist and can handle large volumes.

Therefore the most relevant reason why a a GACs like solution is better than a bad bank is that it would not replace market forces but use them to price illiquid assets as close as possible to open market equivalent values.

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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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