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Shrinking Bank Balance Sheets as Five Year anniversary approaches

By Michael Bolton is Managing Director, Clayton Euro Risk

In Europe the start date of the Financial Crisis is generally acknowledged as August 9 2007 when BNP Paribas, France’s biggest bank, halted withdrawals from three investment funds because it couldn’t ‘fairly’ value their holdings after US subprime mortgage losses began to mount (and which the three funds were heavily exposed to).

Five years on nothing has really changed. In structured finance terms the market has yet to return and there is still no active trading in mortgage backed securities (MBS), excluding the handful of AAA issuers who are able to privately place.
So how have the Banks been able to shrink their balance sheets? There have been generally two types of losers among the Banks. The high profile casualties with insufficient capital to weather the storm and rescued by the taxpayer (Northern Rock, Bradford & Bingley, RBS etc), and to a lesser extent those Bank’s with sufficient capital (though having to raise additional or seek temporary aid from the taxpayer) whose main priority has been to sell asset and bring their balance sheet’s back under control.Michael Bolton

The market that has flourished, when buyer and seller can agree price of course, has been the whole loan market either by portfolio trades or M&A activity. Recent high profile examples in the media have included the Nationwide Building Society’s purchase of £1bn of Bank of Ireland UK mortgage portfolio, Yorkshire Building Society purchase of Citi’s Egg mortgage portfolio and Virgin Money purchase of NRAM mortgage portfolio. In these examples the legal ownership of entire mortgage portfolios have been transferred with mortgage borrowers being informed that there is a new owner of ‘their’ mortgage although often this is seen as positive.

It’s easy to see the winners and losers of the Crisis and why. In addition to the above high profile examples there is then the trade in ‘non-performing’ mortgage loans. This has generally been monopolised by the Hedge/Private Equity Funds with their greater ability to monetise their investment than the selling Banks.

The one common theme in the above is that during the process of selling thorough and exhaustive due diligence is performed by the buyer (typically because the seller is not prepared to offer unconditional reps and warranties and even if they are buyers do not want to end up with legal claims in the future). Or in other words buyer beware. There are firms that specialise in being the ‘eyes and ears’ of the buyer.

Such firms perform a range of due diligence requirements such as:

  • A review of each individual loan file (for example as a buyer they do not want to discover that a mortgage in one name, Mr Smith, actually has two legal owners, Mr & Mrs Smith, which could make the contract very difficult if not impossible to enforce)
  • Make appropriate title checks and investigations on each and every property in the portfolio (there are some European jurisdictions where the legal process has been notoriously slow/weak in this respect)
  • Re-value each and every property in the portfolio (this does not always have to mean an on-site re- inspection – in most jurisdictions a combination of desktop, drive-bys and property price index can do the job)
  • Any other evident risks in the loan file (such as undisclosed loan modifications and evidence of mis-selling of payment protection insurance)

While this list may sound daunting there are due diligence firms with the experience and knowledge to handle all of the above. This is not the work for trainee accountants to understand from one of the big audit firms but from a firm that employ ‘grey haired’ former Bank Underwriters and Internal Auditors who specialise in Credit and the related issues.

The market is not only active in the UK and Ireland but across most of the European jurisdictions. In fact not unsurprisingly those countries that have seen their Banking sector under pressure. Not only is the market pan-European but support firms such as Clayton Euro Risk have dedicated, specialist teams in most of these countries, supporting a market trying to help resolve the current downsizing of the Banking Sector.