Capitalising on the evolving investment opportunities opened up by bank restructuring

Restructuring continues to be at the top of banks’ agendas as they seek solutions for ongoing provisioning, capital, regulatory and macro-economic challenges.

Yet this is an evolving arena. Discussions at the European Banking Transformation and M&A Conference we hosted in March highlighted that the opportunity today is not just about distressed loan transactions and includes a much wider spectrum of transactions and in particular long dated performing loan portfolios..

We’re also seeing the rise of forward flow as manufacturers of lending products look to secure the right type of funding and risk adjusted-return. Investors are responding by developing long-term partnerships with banks.

Further developments include investment structures that synthetically transfer credit risk allowing banks to reduce their risk-weighted assets, while retaining the economic interest in the portfolio.Investors in these transactions have a strong appetite for European SME and corporate risk transfer but increasingly these structures are being deployed against other more specialised lending assets.

Opportunities ahead

So how do we see the interactions between banks and investors developing and what opportunities does this open up?

For the back books, we expect to see a further increase in activity in LDA transactions, leading to continued opportunities for institutional investors in both financing and acquiring these assets. A key feature of these deals has been a growing number of bilateral transactions rather than the auction processes that have been more common in recent years.

For new lending, institutional investors may go direct in some cases, but in the short- to medium-term many are partnering with bank and non-bank lenders to gain access to customers and deploy capital for new loans across a range of asset classes. These partnerships can be successful, but are complex to set up and manage. It is therefore important to create an alignment of interests.

Aligning interests

In our experience, creating successful partnership structures for forward flow and structured transactions requires:

1. Alignment of economic interests: Institutional investors are searching for yield, scale and diversification but want to ensure the originator in a forward flow has “skin in the game” so retaining a percentage of what is originated is an important feature that often comes up but it can be structured in other ways.
2. Alignment of non-economic interests: Key features include how the assets are managed particularly regulated lending, who owns the customer relationship, branding of products, what happens if contracts are terminated and how to manage reputational risk.

Does the increase in institutional money in the lending market put banks at risk of outright disintermediation? For now, we anticipate more partnership arrangements with banks, but there will be areas of traditional banking which could be carried out entirely by institutional investors or by non-banks partnering with institutional investors. Examples already include equity release mortgages in the UK, where insurers originate and fund such loans directly.

Set up to succeed

So, banks’ embedded origination expertise will remain a core part of their offering. But this is going to be a broader and more complex credit ecosystem, marked out by increased partnership and more varied sources of funding if they are going to be successful.