Transfers Of Non-Performing Loan Portfolios

Article by Gabriel Gotlib,* Guillermo Burman** and Jeffrey Hoberman***

In recent years, Argentina and other Latin American countries have faced some significant macro-economic and financial crises. These crises generated related losses, but also notable business opportunities. This article considers the acquisition of a large portfolio of distressed debt, particularly certain legal, tax and accounting issues. The recent worldwide financial crisis may generate similar opportunities, and the experience noted in this article may be useful for potential investors and sellers.

1. Analysis of Business Issues

   1.1 Advantages of transfers of non-performing loans

   Traditionally, procedures for the recovery of loans are not carried out by the originators of the loans (mainly banks) in an efficient manner. Employees in charge of these assignments deal with too many matters and their compensation is not tied to the success of their actions. As a matter of fact, banks do not assign their most talented staff to deal with the recovery of defaulted loans. Banks are more concerned in complying with internal procedures (taxes to discourage opportunistic conduct) and with regulatory laws than in collecting defaulted loans. This "one size fits all" approach carried out by banks, impedes the creation of recovery policies specifically tailored based on the unique characteristics of each class of debtor or loan.

   Facing this inefficiency, a first option employed by banks for the management of their "defaults portfolio" was the creation of subsidiaries exclusively dedicated to the collection of loans. This would allow banks to maintain control over the collection policies applied (and therefore to protect the client relationship) and to retain key information regarding the reasons for default. Nevertheless, these measures were not an effective way to purge the balance sheet, nor to eliminate the contingencies arising from judicial and extra-judicial collections.

   Alternatively, banks sought to direct their collection procedures towards the hiring of third parties through law firms (for those non-performing loans which were already at a judicial stage) and collection agencies (for those non-performing loans in respect of which no judicial claims had yet been made). This approach was not successful either, as similar inefficiencies occurred when attempting to control these external actors.

   The procedures of buyers of non-performing loans differ from procedures performed by banks in the following regards:

   buyers do not have any obligation to treat all similar debtors in an identical manner. The buyer possesses absolute flexibility to extract value from the acquired assets. The only limit is compliance with applicable law; at some point, financial entities have their hands tied with regard to collecting their defaulted loans for the following reasons: moral hazard concerns in extra-judicial collection procedures (e.g. difficulty of monitoring, problems of agency between a bank and its officers); collection of defaulted loans is not the core-business of banks. Banks know how to lend and invest, but they are inefficient when it comes to collection; the relationship of banks with their clients, far from being a one-off interaction, is a lasting one. This means that it is not constructive for banks to show themselves as "unmerciful" in front of their clients, as would be the impression if it were to be publicized that a bank was to auction defaulted debtors of loans from mortgages granted for the construction of homes. On the other hand, a bank cannot present itself to its clients as being overly flexible. If this were so, performing debtors would find themselves extremely tempted to stand by the side of the non-performing debtors. In a nutshell, a bank cannot show itself to its clients as being either too aggressive or too permissive. Buyers of non-performing loans do not experience any of these constraints; banks are subject to regulatory restrictions with regard to granting offers for lower payments; and there is a broad discretion with regard to choosing the destination of payments. For example if there is a renegotiation, the first payments received may be deducted as expenses and capital, and once these have been paid, they may be deducted as interest, thereby minimizing the impact of VAT and income tax. As a matter of fact, none of the alternatives pursued by banks for the handling of a default portfolio seems to be effective. It is in this context that the sale of non-performing loan portfolios to professionals exclusively devoted to their recovery appears as an alternative that promises...