Greek Business File, January-February-March 2020, No 124
By Dimitris Kontogiannis
Local banks have started preparing their bad loan portfolios to be securitized under the newly legislated Hercules Asset Protection Scheme. However, their biggest challenge will be to single out the strategic defaulters among their delinquent borrowers. A US academic paper estimates conservatively the strategic delinquencies at about 37 percent or over 7 billion euro in the Greek mortgage market.
Greek banks count on a stronger economy to provide more loans to financially healthy companies and households and make a profit and a firmer real estate market to turn some problematic loans into current while propping up the value of their house collateral in their books. The reduction of delinquencies is one way street but banks can also benefit immensely by identifying the borrowers who can service their loans but chose not to do as a US academic research paper puts the so called strategic delinquencies at about 37 percent of the total.
A new academic paper
The disposal of bad loans by Greek banks via the Hercules Asset Protection Scheme has started slowly but it is expected to pick up steam in the next few months and definitely in the second half of the year as witnessed in Italy where a similar model was applied. Nevertheless, the poor payment culture may be a bigger problem than admitted by local officials. A new academic paper based on non-performing loan data provided by a systemic Greek bank estimates that 37% of delinquencies at end-2013 could pay interest and capital on their loans but chose against doing it.
The Greek parliament approved in December 2019 the so called Hercules Asset Protection Scheme (HAPS) in order to dispose of non-performing exposures of about 30 billion euro until 2021. It was preceded by the decision of the DG COMP that the Hercules scheme was not classified as state aid.
The scheme, which is based on the Italian model (GACS), aims at helping Greek banks reduce their NPEs significantly and deleverage. The structure of HAPS foresees that bad loans will be securitized in senior, mezzanine and junior tranches. The Greek state guarantees only the senior tranche.
The rating of the senior tranche of the securitized loans at its inception should be at least “BB-“ and the bank must have sold at least 50 percent plus one share of the junior tranche and an amount of the mezzanine notes for the state guarantee to be activated.
The rating should be provided by an external assessment institution. If there are multiple ratings, the lowest counts. To ensure the attainment of the minimum level of rating, the securitization will have a liquidity buffer whose amount will be proportional to the outstanding nominal value of the notes.
The senior and mezzanine notes will feature a floating coupon with a payment frequency based on the contractual terms, i.e. annual, semi-annual, quarterly.
The loans are sold to the SPV (Special Purpose Vehicle) at the gross book value minus current provisioning (NBV) or lower. Upon securitization, the SPV will appoint an independent servicer to work-out the bad loans of the securitization. The initial NPE servicer could be replaced by another one if the state guarantee is called upon and the servicer has cumulatively recovered less than the cumulative NPE recoveries cited in the business plan as assessed by the credit rating agency. The servicing fees are conditional upon performance targets.
The servicer should be independent to avoid conflicts of interest between banks and investors. The Greek market of NPEs has some 22 authorized servicers but only half have assets under management and are active. The biggest ones are NewCo, FPS, Cepal and Quant.
Some core banks have either sold or plan to sell their internal recovery units to external investors. Piraeus Bank and Sweden’s Intrum set up a new servicing platform, NewCo, with underlying assets of 27 billion in a deal worth 410 million euro for 10 years of exclusive servicing contract last year. Also, Eurobank approved the sale of an 80 percent stake in the bank’s loan servicing unit FPS to Italy’s biggest loan recovery firm doValue.
Speed up auctions
In addition to the securitization of bad loans, the banks plan to speed up auctions of real estate assets in a bid to conform with the instructions of the Single Supervisory Mechanism (SSM) and put more pressure on borrowers who can service their loans but had chosen not to do it. Strategic defaulters have evaded bank efforts to identify them for years.
It is interesting that a research paper titled “Collateral Enforcement and Strategic Behavior: Evidence from a Foreclosure Moratorium in Greece” co-authored by Nikolaos Artavanis of the Virginia Polytechnic Institute & State University and Ioannis Spyridopoulos of the American University conservatively estimated that 37 percent of delinquencies were strategic at the end of 2013. This amounts to over 7 billion euro or 4 percent of Greek Gross Domestic Product(GDP) and the cost was passed on to the greater public through recapitalizations that increased public debt and depleted government holdings in Greek banks.
They used data provided by a systemic Greek bank and found, among other things, that “borrowers with lower credit scores, higher loan amounts, and higher combined CLTV (Loan-to-Value) ratios are more likely to become delinquent. Furthermore, we show that delinquencies by mortgagors with higher credit scores, higher income, and lower CLTVs are more likely to be strategic. Taken together, these results are consistent with the idea that strategic defaulters have greater ability to pay than their non-strategic peers.”
Moreover, the authors found that household sophistication, assessed from professional specialization in conjunction with education, plays an important role on strategic behavior.
“Among high-profile professions that typically require a college degree, borrowers working in law and finance are 23% and 14% more likely to act strategically, respectively. These professionals have a better understanding of the legal and financial ramifications of the moratorium, which facilitates the identification of strategic opportunities. Furthermore, the aversion of law professionals towards filing a false court claim, and the stronger reaction of finance professionals to the presence of negative equity suggest that the two groups process different types of information: legal and financial, respectively. On the other hand, the military exhibits remarkably low strategic delinquency rates, consistent with the view that military service inculcates a stronger sense of ethics and social consciousness,” they said.
The paper also points out that self-employed professionals have a much higher propensity to act strategically compared to wage-workers (given the ability to pay) and attributes it to tax evasion which is another prominent characteristic of self-employment status in Greece.