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Securitization is the technique, which synthetically converts debts into securities and securities into liquidity. In this process, assets are removed from the balance sheet of the originator and resold to the investors in the form of securities. These securities are negotiable and in this way provide liquidity to the market.
This technique gained popularity when banks of industrialized countries lost their credit rating and were in trouble due to their excessive exposure to less developing countries. The environmental debt crisis coupled with the economic recession in most industrialized countries weakened the banks. Most of the banks lost their credit AAA ratings and in some cases their rating was even below the ratings of their corporate multinational clients. The multinational companies (MNCs) taking advantage of the situation raised funds direct from capital market. They succeeded in commanding better rates than their banks owing to their better ratings than their respective banks.
The situation of public sector banks in Pakistan’s financial sector is asking for some doctrine. The non-performing loans (NPLs) are increasing despite all out efforts by the regulators and the banks. Market factors can be blamed for that, bankers may be held for inefficiency, ministerial corridors may be reminded of their inconsistent fiscal policies, the parliamentarians may be accused of all the political pressure exerted leading to imprudent decisions, the fact remains the same.The whirling snake of NPLs could not be arrested.
It is biting the banking sector from both end, hurting deposit rates downward to the investors and raising interest rates to the borrowers. The issue of NPL is discussed in each high level meeting of the finance ministry and the central bank. The central bank since assuming autonomy has come up with two schemes envisaging substantial write-offs leading to the recovery of long due defaulted loans.
Overdue loans: During last decade 1993-03, there were three major attempts to recover the long overdue loans:
i) In 1997, a scheme was introduced for loans default recovery (vide SBP circular no.19 dated 5th June 1997).The scheme offered incentives to all loan defaulters in the settlement of nationalized banks and DFIs. The cash recovery from 1st July 1998 to 30th June 1999 amounted to Rs16.2 billion and restructuring at Rs.18.0 billion. ii) Then under the Chief Executive’s drive, the defaulters were advised “to settle / clear their defaulted amount with respective financial institutions latest by 16 November 1999. Those who fail to arrive at negotiated settlement by due date would face swift and strong action for full recovery of the defaulted amount.” An amount of Rs.11.7 billion was recovered latest by 31st Dec 1999 under this drive encompassing only a period of 30 days.
iii) The Corporate and Industrial Restructuring Corporation (CIRC) was formed to” provide for expeditious legal remedies for matters relating to non-performing assets and recovery of outstanding amounts payable to banks and financial institutions to make attractive for privatization and to promote the revitalization of nation’s economy and rehabilitation and restructuring of industrial undertakings”. CICR has acquired cases of Rs 55 billion and made sales of only Rs2 billion. The time it will take to revitalize the financial sector even with a powerful charter to overcome legal issues, is any body’s guess.
iv) Guidelines for write-off were issued by the SBP on 15th October 2002 to recover the defaulted loans. These loans amounted to Rs157.7 billion as on 31 Dec 2002.
The SBP efforts for recovery of NPLs by charming defaulters to pay in order to avail substantial write-offs and its long-term effects on the values of banking culture and bank customer relationship will b discussed separately.
Present scenario: During 2003 when the amount of defaulted loans of financial institutions above one million as on 31 Dec 2002, stood at Rs157.7 billion, there are two options available to the banks for out of court settlement.
1) CIRC; 2) SBP guidelines.
CIRC: CIRC takes assets at the purchase price determined by it as per its charter. The prudent the provisioning, the less would be the purchase price of the CIRC. Further the purchase price will be in the shape of bonds payable to the bank in three years. So the banks have to make substantial write-off to cleanse their balance sheet now, with cash flow to be received within a period of three years.
However the good thing about CIRC is that the management of project changes under section 296. Some defaulters settle with the banks in order to avoid CIRC, as they do not want to loose their projects.
SBP guidelines: Keeping aside the debate on the incentives offered to defaulters and message this circular is transmitting to regular borrowers, again the amount against defaulted loans will be received within a period of three years without interest.
The bottom line is that in case of CIRC and SBP both the bank will get the recovery over a period of three years.
Alternate suggestion: Banks are making use of this novel technique to solve their long lasting problem of NPLs beside using securitization to enhance their profits and to monetize their previously illiquid assets. The loans are recycled to be invested in further receivables and expand the volume of business without corresponding increase in equity, thus avoiding capital adequacy restrictions.
Given the present mind frame of the central bank, to eliminate NPLs from the banks balance sheet at any cost, we can explore the alternative to the presently available options. It can be inferred from the Governor’s statement that SBP is ready to go to the extent of writing off 75 per cent of the NPLs to release banks from their grip, the option to use market solution can be looked into.
The NPLs as on Dec, 2002 stood at Rs157.7 billion. The NPLs at fairly discounted price can be transferred to an SPV. These should be discounted keeping into account the assets mortgaged against these NPLs and the future cash flows that could be realised through them. After discounting, say, the NPLs will be transferred to SPV at Rs70 billion. The SPV will get the ratting; credit enhancement may come from SBP in the shape of collar, with a pre-specified floor.
The credit risk of the securities to be issued by the SPV is taken care of. After the credit enhancement and rating, SPV will issue the securities in the form of TFCs. The proceeds of the TFCs will go to the originating bank and the bank will adjust NPLs against that proceeds. Thus receiving money against NPLS much earlier than in the available options.
The question may arise, by any public sector Pakistani bank chief executive” why to go into such a long exercise , which too is so complicated?
The humble answer to it is the request to please open your eyes. The information technology and synthetic solutions have been driving the banking industry faster than any other service industry. With the long term financing dying down, and capital market solutions taking the place of traditional banking, we have to find a place for banks in the changing world. The capital market development may be used to enhance the banks profitability and to its other advantage if could be.
Instead of charming the defaulters at the expense of regular borrowers, beside taking heavy write off on our balance sheet, why not securitize the NPLs.?
Even at discounted value to be determined on the basis of assets and future cash flows, the bank will receive the amount much earlier as compared to CIRC and SBP cir, 29. Further, after the Circular 29, the borrowers are trying to prove that they had been defaulter for six years or so, instead of claiming that they are circumstantial default and had been regular for so long and paid till recently.
The regular borrowers busy calculating how much they had paid and how much still to be paid with no eligibility for relief as they had been not a defaulter for long. They regular envying the defaulters who can get back the documents of collateral at reduced price instead of what they owe as per the financing agreements signed by them. And that too in 3 years without any interest to be paid .
The direct and indirect benefits of NPL securitization:
Banks: The direct benefits to the banks will be that they may get the proceeds out of sale of NPLs much faster than they are getting through circ and by implementing SBP guideline 29. The funds can be recycled in much better investment options.
Industry: The industry will benefit as there will be new clients running the projects which are not that debt heavy and more creditworthy than the defaulters. They may get cheaper funds due to their better credit ratting.
Overall economy: The excess liquidity in the market will find its way in the TFCs floated by special purpose vehicle (SPV). The stuck up projects will revive with the change in management. The collection and monitoring system will be more transparent. New job opportunities will be created. The investment atmosphere will improve.
Model for securitization of NPLs at Pakistani banking sector.
* Banks will sell NPls of Rs157.7 billion at fair price, say Rs70 billion to SPV.
* SPV will purchase NPLs at Rs 70 billion subject to term and conditions set forth in the sale and purchase Agreement.
* SPV will raise the finance for sale price by issuing TFCs to various investors.
* The proceeds of TFCs will be utilised by SPV to purchase the specified assets. * The cash flow generated through assets will be routed through the collection agent. * The collection agent pass the proceeds to SPV account, at quarter end to make payment towards TFCs holders.
Through securitization the banks may have to make the write off but the projects will not go to the defaulters. Some new people will be running the show. Further banks will receive the proceed much earlier enabling them to use it for further financing. But be careful this time Mr Bank President, don’t receive calls from Islamabad before undertaking further financing.
