Brussels’ plan for bad loans is a second bailout for the banks

Clancy-1

Barely a word has been said in the Irish media to date about an extremely important new proposal from the European Union (EU) Commission – to develop a so-called ‘secondary market’ for non-performing loans. If implemented, this package of policies will directly cause an increase in evictions and homelessness, enable the harassment of mortgage-holders by debt collectors, and generate massive new risks to financial stability.

This proposed EU Directive on credit servicers, credit purchasers and the recovery of collateral will jettison even the (extremely) limited progress the Irish state has made on regulating vulture funds.

“Credit purchasers” refers to vulture funds and securitisation institutions, “credit servicers” means debt collection agencies, and the proposal for the “recovery of collateral” is for accelerated out-of-court enforcement of loans secured by collateral – meaning banks will be able to seize their customers’ property without going through the courts.

In short, it will let the EU’s banks carry out a mass sell-off of bad loans to US vulture funds; shift almost a trillion euros of bad debt off the banks’ balance sheets into the opaque and unregulated shadow banking sector through the same instruments that caused the 2008 crisis; implement rules that mean the vultures cannot be regulated in any way within the EU and can operate across borders without any restrictions; and add nothing whatsoever to the existing level of consumer protection to borrowers and homeowners in the EU.

A toxic debt mountain

Non-performing loans (NPLs) are bank loans that are subject to late repayment or are unlikely to be repaid by the borrower. EU standards now generally require banks to classify loans as non-performing if they are more than 90 days in arrears. The ability of borrowers to pay back their loans deteriorated significantly during the financial crisis and the subsequent double-dip recession. As a result, many banks saw a build-up of NPLs on their books, particularly in the countries worst affected by the crisis.

Euro-area banks held just over €1 trillion in NPLs in 2016, the equivalent of around nine per cent of the Eurozone’s GDP, and amounting to around 6.4 per cent of total loans in the Eurozone. The level of NPLs differs dramatically across the euro area, with almost half bank loans in Greece and Cyprus classified as NPLs, and Italy, Ireland, Portugal and Slovenia all holding NPLs at rates of 10-20 per cent. While the average ratio of NPLs in the EU has decreased by more than one-third since 2014, the total volume of NPLs remains high, at around €820 billion as of December 2018.

The proposed EU Directive is touted by the Commission as having one main aim: to free up banks to lend to consumers and small businesses again by reducing the high levels of bad loans on their balance sheets.

But even a cursory glance at the lending statistics across the Eurozone and the EU demonstrate clearly that the lower level of lending by banks is not caused by a lack of willingness by banks to provide credit, but rather by a lack of demand for credit from SMEs, companies and households.

In reality the proposal has three key aims:

  • To encourage EU banks to reduce their stocks of sour loans by any means necessary so they can return to pre-crisis profitability levels and compete once more with US banks;
  • To take away the right of EU member states to place regulations and restrictions on vulture funds and debt collectors that may impede their ability to enter the EU and operate freely across borders; and
  • To give the banks and vulture funds new powers to seize their customers property if they fall behind in repayments of debt – without having to bother with the irritating process of actually claiming this collateral through a court in which the judge is legally obliged to consider the rights of the consumer.

Replicating the Irish model across the EU

The European Commission has looked at the post-crisis process in the Irish state where banks have reduced their stocks of non-performing loans significantly, decided it is a glorious success story, and resolved to replicate this process across the entire EU.

The key components of this ‘success’ story in Ireland were the creation of the National Asset Management Agency (NAMA), which used public funds to take bad loans off the balance sheets of the bailed-out Irish banks; the grovelling invitation to US vulture funds to enter the Irish market by former Finance Minister Michael Noonan; and the eagerness of the Irish banks to engage in the mass sell-off of their customers’ mortgages and loans to these debt vultures at a fraction of their value.

Following this logic of trying to replicate the Irish model across the EU, the Commission made a legislative proposal in March 2018 based on four key aspects:

  • Provisioning by banks – a Regulation to require banks to put aside their own capital to cover the loss of a bad loan;
  • A Directive on developing a secondary market for NPLs – promoting the sale of bad loans to vulture funds, and promoting securitisation;
  • The same Directive to cover debt recovery – giving banks more power to enforce the collection of collateral through out of court recovery; and
  • Non-binding guidance for Member States on how to establish a national Asset Management Company – a NAMA-style bad bank, including possibly using public funds.

In fact, the Commission has proposed that all credit agreements – i.e., even performing loan agreements in which the customer has fulfilled every obligation required of them – should be within the scope of this Directive and therefore able to be sold on to a third party.

ECB Guidance on reducing non-performing loans (2017)

The Commission proposal of March 2018 was preceded by rules issued by the ECB, which published its Guidance to banks on NPLs in March 2017, setting out the manner in which it expected banks to reduce their existing stocks of NPLs. This Guidance is non-binding but subject to a comply-or-explain type system in which supervised banks must explain deviations upon supervisory request, and in which non-compliance may trigger supervisory measures.

The Guidance only applies to the largest banks in the EU, which are supervised by the ECB’s Single Supervisory Mechanism. It states that each bank with elevated levels of NPLs is expected to develop portfolio-level reduction targets with a view to reducing the level of non-performing exposures on its balance sheet in a timely manner. The Addendum to the Guidelines calls for these banks to enact a reduction plan if their level of NPLs passes a threshold of five per cent of their overall balance sheet.

This Guidance has been used by banks in several member states – and particularly by Irish banks – to prompt and justify their mass sell-offs of mortgages to vulture funds. Irish banks constantly point the finger at the ECB when selling mortgages to vulture funds, claiming the ECB forced them to. But this is simply not true.

The ECB “has not expressed a preference for certain NPL reduction tools over others” in its non-binding Guidance, and has clearly stated that the combination of tools or strategy reduction drivers for a given bank is the responsibility of, and chosen at the discretion of, its management, which could include debt restructuring, debt forgiveness and many other measures that don’t involve vulture sales.

No doubt the ECB has applied pressure to banks to reduce their bad debt levels, but it has no legal mechanism to force banks to sell loans to vultures and it explicitly denies doing so.

Having said this, the role of the ECB has been one of consistently undermining the rights of homeowners and borrowers, to the benefit of the banks and vulture funds. Every attempt to regulate the debt vultures that we have seen in the Irish state in recent years – every draft piece of domestic legislation – has been referred to the ECB for its ‘opinion’. The ECB’s opinion always seems to be that the banks should be allowed to get rid of their bad loans by any means necessary.

The Commission’s proposed Regulation on banks covering NPL losses is similar to the ECB Guidance except it applies only to future NPLs and not the existing stock; it provides a slightly more lenient time frame for banks to set aside their own funds to cover future NPL losses; it is legally binding; and it applies to all banks and not only the largest ones that are under the direct supervision of the ECB.

In theory, the proposal for a Regulation to require banks to put aside their own capital to cover the loss of future NPLs is sensible from a financial stability point of view in that it will encourage banks to engage in more responsible lending behaviour, and reduce the likelihood of the need for public bailouts of banks in future.

The Commission’s proposal could have encouraged banks to work through future non-performing loans with their customers on a case-by-base basis; and provide concessions to their customers including extensions of repayment periods, lower interest rates, debt forgiveness or many other options.

But taken in combination with the Directive on developing a ‘secondary market’ for bad debt, in reality it instead encourages the banks to take no responsibility for their predatory lending practices and dump their toxic debt into the shadow banking sector, or worse, taxpayer-funded ‘bad banks’.

We cannot apply a one-size-fits-all reduction target that will incentivise banks to offload their loans onto the secondary market. Banks should be required to keep their NPLs on their book and to work through them with their customers by writing down, restructuring or forgiving the debt, particularly in cases of residential loans.

Wtf is securitisation?

As well as giving free rein to debt vultures, this Directive also aims to promote the use of securitisation vehicles to ‘refinance’ bad loans, or to move this bad debt off the banks’ balance sheets and into opaque and unregulated hedge funds.

Mortgage-backed securitisation vehicles are created when individual mortgages are sliced up and bundled together into packages that can be traded on – gambled on – by investors. The idea is that betting on the return of the bundled, securitised vehicle is supposedly less risky than betting on a single mortgage.

The main investment vehicles that held mortgage-backed securities in the 2000s were collateralised debt obligations (CDOs). CDOs were instruments that included slices of different bank loans, each with a different level of risk and a different interest rate. The rationale behind CDOs was that by pooling together risky loans with less risky assets, the overall risk profile would be lowered – the CDO would be able to gain a higher credit rating – and they would be more profitable for investors. But if one slice defaulted, it increased the risk of a default by the next slice in the bundle. The bad loans infected the rest of the sector until major investment banks could no longer put a price on certain securitisation vehicles.

The moment that marked the onset of the global financial crisis was not actually the collapse of Lehman Brothers in September 2008, but rather the moment in July 2007 when Bear Stearns found that it couldn’t put a value on a number of hedge funds that were contaminated with CDOs that included subprime mortgages in them. One of these hedge funds lost 90 per cent of its value overnight; another lost its entire value.

It is almost beyond comprehension that, just a decade on from the global financial crisis, mortgage-backed securities – and non-performing ones at that – are being posed by the Commission as a solution to a toxic debt crisis that is the legacy of the 2007-08 crisis, which these instruments literally caused.

Moving almost a trillion euros out of the regulated and relatively transparent banking sector into the opaque and almost totally unregulated shadow banking sector (by the existing ECB Guidance alone) is incredibly misguided and will pose massive new risks to financial stability in the EU and internationally. Expanding this process under the Directive for all future bad debt is incomphrehensible. How exactly does moving billions of euros of bad debt into the wild west of finance improve financial stability?

‘Buy when there’s blood in the streets’: enter the vultures

The Commission wants to move the toxic debt off the balance sheets of the EU’s banks so they appear healthy and well-functioning, and can compete internationally, particularly with US banks.

An 18th century banker is credited with coining the phrase that best defines the “contrarian” investor’s guide to make a killing in a financial crisis: “The time to buy is when there’s blood in the streets.” This principle underpins the strategy of the private equity funds referred to as vulture funds. You buy when the price is at rock-bottom and make a profit in the shortest possible time frame by any means necessary.

In the Ireland of today this means buying non-performing loans from banks at a fraction of their worth, and securing the underlying asset (usually people’s homes) as quickly as possible through making some sort of dodgy deal with the person who owes the debt, or simply throwing them out on the street.

The red-carpet treatment the Fine Gael-led government has provided to the vulture funds over the past five years – through open-door lobbying access, a virtually tax-free environment for most of the past five years, and consistent government opposition to attempts to rein them in through regulation – has made Dublin a favoured spot for US vulture funds to set up shop in.

Under the proposed EU Directive virtually all restrictions on “credit purchasers” (vulture funds) registered within the EU to operate across borders will be removed, and the fund will be bound only by the regulations of the EU member state in which it is registered. So the light-touch regulation of the Central Bank of Ireland may soon be the only line of defence against vulture funds preying on millions of indebted and impoverished borrowers across the EU.

Third-country credit purchasers – say a US vulture fund that has not set up a subsidiary in an EU member state at all – will simply have to designate a “credit servicer” (a debt collector) to enforce the credit agreement and not even bother with registering in the EU. Only the credit servicer and not the vulture fund itself will be regulated in any way under EU law.

This is precisely the political debate that has played out in the Irish state over the past three or four years. The owners of the credit agreement – the vulture funds – are the ones who make the key decisions regarding the distressed loan, including the setting of interest rates, whether to restructure a loan, and the enforcement of the loan. So it is crucial that the credit purchaser – and not only the credit servicer that acts as an intermediary – is authorised and regulated in the EU, and subject to supervision, investigation and sanctions by the national competent authorities in the member state in which it operates,.

Jettisoning the minor progress made in Ireland

In an Irish context, we have made only limited progress to date in terms of regulating vulture funds and protecting consumers and mortgage-holders. Yet even this modest progress made in the Dáil – usually in spite of Fine Gael opposition – will now be under threat by this EU Directive.

For years Irish campaigners for the rights of mortgage-holders have demanded that the vulture funds themselves, and not only the middlemen must be directly regulated by the Central Bank. Ireland’s Consumer Protection (Regulation of Credit Servicing Firms) Act 2018, which came into effect in January, is a positive step forward in that it allows the Central Bank for the first time to regulate, investigate and sanction the owners of the credit agreements and not just their designated debt collectors.

This modest but significant step forward in our framework for regulating vulture funds is now under threat by the EU Directive, as described above. The Irish government must defend our right to maintain this important piece of legislation in the European Council when negotiating this Directive, and all Irish MEPs in the European Parliament must also defend this position.

The second substantial potential piece of Irish legislation that must be defended from the EU is TD Pearse Doherty’s ‘no consent, no sale’ bill requiring banks to gain the written consent of their customers before selling their mortgage to a vulture fund; if this bill becomes law based on the will of our elected representatives in Dáil, it will be simply overruled by the EU through this Directive.

Campaigning for the Directive to be withdrawn

Leftists in the European Parliament have tabled amendments to the Parliament’s report on the Directive demanding the direct regulation of the vulture funds and not only their intermediaries; the need for banks to obtain the written consent of their customer before selling their loans on to a third party; a debt buy-back scheme for customers to have the right to purchase their own debt at the same reduced price that their bank would sell the loan to a vulture for; and for a range of additional consumer protection improvements to the Directive.

But these amendments are not enough. This Directive is a second bailout for the banks that gives free rein to the vultures and allows the banks to throw their customers under the bus. Minor improvements here and there won’t cut it. It needs to be scrapped in its entirety – and consumer rights groups, housing campaigners, human rights organisations and a range of political forces from across the EU will be organising a campaign in the coming weeks and months demanding this Directive be withdrawn .

Originally posted on Irish Broad Left

 

 

 

Sounding the alarm on the EU’s proposed Directive on non-performing loans

screen shot 2019-01-11 at 21.35.02

Below is a letter to trade unions, farmers organisations, housing campaigners and others from Matt Carthy MEP raising alarm over the EU’s new proposed Directive on non-performing loans

10 January 2019

I am writing to inform you of a serious threat to the rights of borrowers and consumers arising from a proposed new EU Directive, which aims to develop a secondary market for non-performing loans. (Proposal for an EU Directive on credit servicers, credit purchasers and the recovery of collateral).

This proposed EU Directive is designed to promote the use of vulture funds and securitisation vehicles in order to move this bad debt off the banks’ balance sheets and into the opaque and unregulated shadow banking sector.

This proposal will also empower banks to seize their customers’ collateral through an out-of-court recovery mechanism, and will result in borrowers, including mortgage-holders, being pursued more aggressively by vulture funds and debt collectors.

1. Background

Non-performing loans (NPLs) are bank loans that are subject to late repayment or are unlikely to be repaid by the borrower. EU standards now generally require banks to classify loans as non-performing if they are more than 90 days in arrears. The ability of borrowers to pay back their loans deteriorated significantly during the financial crisis and the subsequent double-dip recession.

As a result, many banks saw a build-up of NPLs on their books, particularly in the countries worst affected by the crisis. While the average ratio of NPLs in the EU has decreased by more than one-third since 2014, the total volume of NPLs remains high, at around 900 billion euros.

Unfortunately the role of the EU institutions has been one of undermining the rights of homeowners and borrowers, to the benefit of the banks and vulture funds. Every attempt to regulate the debt vultures that we’ve seen in the Irish state in recent years – every draft piece of domestic legislation – has been referred to the European Central Bank for its ‘opinion’. The ECB’s opinion always seems to be that the banks should be allowed to get rid of their bad loans by any means necessary.

2. ECB Guidance to banks on NPLs (March 2017)

The ECB published its Guidance to banks on NPLs in March 2017, setting out the manner in which it expects banks to manage their NPLs. This Guidance is non-binding but subject to a comply-or-explain system in which supervised banks must explain deviations upon supervisory request, and in which non-compliance may trigger supervisory measures.

The Guidance only applies to the largest banks in the EU, which are supervised by the ECB’s Single Supervisory Mechanism. The Guidance states that each bank with elevated levels of NPLs is expected to develop portfolio-level reduction targets with a view to reducing the level of non-performing exposures on its balance sheet in a timely manner. The Addendum to the Guidance calls for these banks to enact a reduction plan if their level of NPLs passes a threshold of 5% of their overall balance sheet.

The ECB Guidance has been used by banks in the Irish state to prompt and justify their mass sell-offs of mortgages to vulture funds. However, the ECB has repeatedly stated that it “has not expressed a preference for certain NPL reduction tools over others”, and that the combination of tools or strategy reduction drivers for a given bank is the responsibility of, and chosen at the discretion of, its management.

3. Commission proposal on NPL package (March 2018)

In March 2018, the Commission made a specific legislative proposal based on four key aspects:

  • Provisioning by banks (banks putting aside their own capital to cover the loss of a bad loan);
  • Developing a secondary market for NPLs (promoting the sale of bad loans to vulture funds, and promoting securitisation);
  • Debt recovery (giving banks more power to enforce the collection of collateral through out-of-court recovery); and
  • Non-binding guidance for Member States on how to establish a national Asset Management Company (a bad bank, including possibly using public funds).

Unlike the ECB Guidelines, the Commission proposal applies only to future NPLs, not the existing stock. It is mandatory instead of non-binding and applies to all credit institutions, not only the biggest banks under ECB supervision.

The package consists of three different proposals from the Commission: a Regulation (on provisioning), a Directive (on developing the secondary market) and a non-legislative blueprint (on setting up national Asset Management Companies).

4. Analysis of the proposed package

On the proposed Regulation, I am generally in favour of the idea that banks should be required to put aside their own capital to cover the losses they incur when the loans on their balance sheets turn non- performing. This would incentivise banks to adopt more prudent lending standards. It would increase financial stability and lessen the likelihood of future public bailouts being necessary.

However, we cannot apply a one-size-fits-all reduction target that will incentivise banks to offload their loans onto the secondary market. My view is that banks should be required to keep their NPLs on their book and to work through them with their customers by writing down, restructuring or forgiving the debt, particularly in cases of residential loans.

i) Promoting securitisation

I am extremely concerned by the proposed Directive on credit purchasers, credit servicers and recovery of collateral. “Credit purchasers” refers to vulture funds and securitisation institutions, “credit servicers” means debt collection agencies, and the proposal for “debt recovery” is for accelerated out-of-court enforcement of loans secured by collateral (though consumer loans are excluded from this aspect of the proposal), meaning banks will be able to seize their customers’ property without going through the courts.

The Directive aims to promote the use of vulture funds and securitisation vehicles in order to move this bad debt off the banks’ balance sheets and into the opaque and unregulated shadow banking sector.

Moving hundreds of billions of euros of bad debt into the shadow banking sector through the securitisation of non-performing loans is incredibly misguided, and will cause major new risks to financial stability. Mortgage-backed securities in particular played the key role in the 2007-2008 crisis.

ii) Giving free rein to debt vultures

It seems to me that the Commission is trying to replicate the Irish model in reducing non-performing loans and impose this model across the EU. That’s why it is so important for Irish campaigners to highlight the massive problems that we have experienced – from the NAMA debacle to the mass sell- off of distressed loans to unregulated vulture funds. It is not a model to follow but a lesson in what to avoid.

The debt vultures will be encouraged to spread their wings and move from just operating in Ireland and Spain to operating across the EU, while securitisation will be promoted as a so-called solution to the non-performing loan problem.

A private equity fund will be able to register in one member state and get a “passport” to operate in any EU state, while only being bound by the regulations in place in the state where it is registered.

iii) A second bailout for the banks

This EU proposal is nothing less than a second bailout for the banks. The non-performing loan problem is a legacy of the 2008 financial crisis. This problem was not caused by ordinary people and they should not be forced to bear the brunt of resolving it.

The Commission says the new Directive is necessary in order to allow banks to lend to small businesses once again. But all of the evidence shows that the ongoing economic problems in the EU are not caused by a lack of lending, but a lack of demand in the economy. The only way to boost demand is to increase public investment and foster real wage growth.

The real goal of this proposal is not to ensure banks lend again but to ensure they return to making massive profits again.

iv) Directive will tie our hands on future regulation of vulture funds

Suggesting that the Irish model is a success story that should be replicated across the EU is bad news for borrowers in the rest of Europe.

But the worst part of this proposal is that it will put major restrictions on all future attempts to regulate vulture funds at the Irish level. Our hands will be tied behind our banks.

Say, for example, that public pressure forces the government to finally act to put in place measures to regulate the vultures in a meaningful way.

Unless these laws comply with the EU Directive – which, let’s not forget, is designed to promote the sale of debt to vulture funds – the legislation will be struck down because it will amount to an infringement of the “right of establishment” or “right to provide services” of these private equity funds.

5. Campaigning for the Directive to be withdrawn

I have been heavily involved in trying to shape this package of proposals in the European Parliament and will be very much focused on this in the coming months. The Commission has clearly not taken consumer protection issues or fundamental rights into consideration when conducting its impact assessment for this proposed Directive.

The Directive should be withdrawn, and I am investigating possibilities for legal action in this regard. The European Parliament must block this proposal from becoming law.

Sinn Fein will be organising an EU-wide campaign against this Directive in the coming months, together with other progressive forces and consumer protection organisations.

If the Directive is not withdrawn, we will attempt to insert the strongest possible protection of borrowers’ rights into this package, to ensure this proposal does not give free rein to vulture funds across the EU. Ensuring that strong protection for borrowers is included in this legislation is absolutely crucial.

Specific policy proposals we will campaign for if the Directive is not withdrawn include:

  • Banks must include a mandatory clause in their residential loan contracts that provide the customer with the option of denying the bank the ability to sell on their loan to a third party (no consent, no sale).
  • Banks must provide their customers with the option of purchasing their own debt at a reduced rate – rather than the bank selling this debt to a vulture fund at this same reduced rate.
  • Vulture funds and debt collectors operating in the EU cannot be given a “passport” to operate in one state but be bound only by the regulatory framework of the state in which they are registered.

I hope that all those campaigning here in Ireland for better protections for homeowners and farmers against evictions and the sale of their loans to vulture funds will also get involved in this campaign at the EU level. We need your voices to be heard by the European Parliament and Commission, and in particular, we need to force our own government to oppose this proposal at the Council level.