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Banning loan sales could spark ‘Big Short’ style derivatives trade


(stock photo)

(stock photo)

(stock photo)

Any slow down in sales of bad loans by banks would likely be replaced by an upswing in the pace of securitisation deals, according to rating agency Scope - including the kind of “synthetic deals dubbed “weapons of mass financial destruction” after the last crash.

The German rating agency says portfolio sales by Irish banks may slow significantly if concerns around mistreatment of customers continue to intensify - noting Sinn Fein’s proposed ‘No Consent No Sale’ law that would require lenders to get agreement from borrowers before selling their loan as a possible disruption to the market.

The alternative that would allow banks to cut their exposure to bad loans is securitisation - whereby lenders bundle up loans into an off-balance sheet vehicle and borrow against in the bond market. It is set to grow in importance in Ireland, Scope said.

Non-banks - including vulture funds - that have amassed billions of euro of non performing loan (NPL) portfolios are likely to securitise some of those loan either to lower their own financing costs or simply to raise cash, Scope said.

This trend already appears to be underway, with Scope noting a €419.8m deal by Lone Star in the third quarter of last year when it raised funds by borrowing against the value of portfolio of performing and non-performing loans.

The securitisation route is also expected to appeal to banks themselves, Scope said.

The massive bad-loan sales in recent years began with boom era commercial property and developer loans that have now largely been removed from bank balance sheet. Lenders here now have what the agency called “relatively granular NPL stock” mainly of SME loans and residential mortgages. These are significantly easier to securitise than CRE portfolios, and if the “No Consent, No Sale” bill became law, so called synthetic securitisation remains a viable risk-transfer mechanism. Synthetic securitisation involves banks buying complex financial derivatives to insure against the risk of borrower defaults. The market fell dramatically out of favour after the financial crisis when a boom era explosion in their use was blamed for driving down lending standards and storing up huge financial risks - the trade was heavily criticised in books and movies like The Big Short staring X and Y.

Scope says the regulatory framework in Ireland remains favourable for either mode of securitisation and that in the event of true sales being blocked or limited growth in synthetic mortgage-backed securitisations of Irish portfolios.

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