Asset Management Companies: the Spanish example

In a severe banking crisis, the question of what to do with impaired assets is often raised. The most straightforward option, of selling the assets at a low price in a fire sale, can trigger an unnecessary destruction of value, with the banking framework aims to avoid. Governments have explored other options, and a relatively successful one has been the transfer of these assets to an Asset Management Company (AMC) with the goal of selling them in the long term. The advantage is that the impaired assets can be permanently removed from balance sheets and the transferring banks can focus on managing their core assets. However, it is only a recommended option when the number of assets and their average value is high, they are relatively homogeneous and the number of transferring banks is large.

Let us look at a 2012 example from Spain, SAREB (Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria) to explain key questions concerning the creation of an AMC.

What is the purpose of the AMC? The objective of SAREB was the immediate exit of real estate development-related assets from the balance sheets of Spanish credit institutions that required public assistance in 2012, for their orderly liquidation over a maximum period of 15 years.  This step was important for restoring the credibility and financing capacity of the Spanish financial system and achieving a solid and sustainable economic recovery.

The transferred assets were deconsolidated from the balance sheets of the transferring banks as the requirements set by the supervisor were met. These were: non-majority shareholding in SAREB's capital by those banks (in fact, their stake was zero); no compensatory guarantees from the transferring banks for any future SAREB losses; no asset buy-back agreements with the transferring banks; and limited ability of those banks to influence SAREB's decision-making (also zero).

What assets are transferred? In the Spanish case, financial assets (loans and majority shareholdings in real estate companies) and real assets (foreclosed real estate), both doubtful and normal (without having registered default), linked to real estate development, were transferred. To simplify both the process and cost of transferring the assets and their subsequent management, loans with a value of less than €250,000 and foreclosed assets of less than €100,000 were excluded. Around 39,000 loans and 60,000 foreclosed assets were excluded, representing, respectively, 30% and 58% of the number of loans and foreclosed assets, and only 2% and 14.5%, respectively, of their total net book value.

The impaired portfolios of small and medium-sized enterprises, consumer and retail mortgages were also excluded, as they had lower overall levels of delinquency. It was also felt that the banks would manage these loans better themselves, as they required proximity to customers. It was agreed to leave open the possibility of including significantly impaired portfolios or sub-portfolios at a later stage, but this never happened.

How is the transfer price calculated? For SAREB, the expected loss on loans in the baseline scenario of the stress test conducted by Oliver Wyman in 2012 was used as the starting point, with an additional haircut of 14%. For real estate, the starting point was the book value of these assets at 31 December 2011, with various haircuts applied[1]. An additional linear haircut of 7% was applied to the final value. In the end, assets with a gross book value of €107,121 million were transferred for an amount of €50,781 million, so that the average discount was 53% (it was different for completed housing, developments in progress and land).

What are the implications of a price that is too high or too low? Clearly, a higher price means less losses for the transferring banks and more potential losses for the AMC. The opposite is true if the price is lower. In the case of SAREB, it was intended to be a conservative price that would limit its future losses, without, however, reaching an excessively low price. This would have been inconsistent with the very essence of SAREB's constitution (to avoid unnecessary value destruction) and which, in turn, could have adversely affected healthy institutions in the Spanish financial system.

After almost 10 years, SAREB’s accumulated losses of the institution clearly indicate that the price was too high. But, we should remember that the choice in 2012 was a lower price (with a higher certain amount of the banking system bailout in 2012 to compensate for the higher losses of the transferring banks and, in some cases, to recapitalise them) versus a higher price (with higher potential losses of SAREB within 15 years). The second alternative was chosen.

It is worth recalling the economic situation in Spain at the time, with financial markets punishing public debt in a context of a euro credibility crisis that was not tackled conclusively by the European Central Bank until the end of July 2012.

How is an AMC financed?  SAREB's equity amounted to some €4.8 billion, 25% capital and 75% subordinated debt. These resources were provided by private partners (55%) and by the Spanish resolution authority, FROB (45%). In addition to this source of funding, SAREB issued senior debt guaranteed by the State, which was subscribed by the transferring banks (they obtained liquidity by discounting it at the ECB) and which was delivered in exchange for the assets transferred.

Is a public or private AMC better? It depends on the economic circumstances surrounding the creation of the AMC. The very negative economic situation that Spain was experiencing in 2012 explains why a mostly private company was designed, without its debt being consolidated with that of the State by meeting the requirements set by Eurostat[2]. Almost 10 years later and in view of SAREB's negative equity, Eurostat has required the classification of the entity's outstanding debt (some 35 billion euros) as public debt.

Should the assets being transferred be known in detail? Obviously, that is the ideal. In Spain, this was impossible, as the commitment reached by the Spanish government with the European authorities in the Memorandum of Understanding signed in 2012 required the transfer of most of the assets by 31 December of that year. So, there were five months to design the vehicle, set it up and transfer the assets, which prevented the necessary due diligence from being carried out before the transfer. SAREB subsequently launched a comprehensive due diligence process of its assets, which was completed in 2014. In light of this exercise, the AMC revised its business plan.

Should the success or failure of an AMC be assessed only in the light of its financial performance? Although it is clear that SAREB's business plan has not been fulfilled, the assessment of its creation must be framed within the roadmap for bank restructuring and the Spanish economic recovery, of which it was a part. It is clear that SAREB contributed to restoring confidence in the Spanish financial system, laying the foundations for economic recovery and enabling a very significant reduction in Spain's risk premium. Probably, we can extend this idea to other AMCs: the lack of direct profitability must be balanced against other indirect benefits of these tools.

A version of this blog was first published in Expansión.