This crisis presents a major dilemma for banks. Many borrowers who are facing difficulties in paying their loans on time, ask banks for forbearance on current due payments. During the government forbearance programs, banks routinely granted such requests. Absent government programs, granting forbearance leads to a reclassification of a loan as a Non-Performing-Loan (NPL), thereby requiring an increase in the reserve set aside for potential losses. Indeed, the expected trend in the upcoming NPLs is clearly shown through the data already coming out of the CMBS market. Moreover, even during the government programs, the top-three banks’ most recent financial reports show a massive increase in reserves.
With government forbearance programs ending, banks need to decide what to do today. Banks that believe we are heading into a year-long recession, despite government assistance to borrowers, need to act now. In the coming months, there will be a surge in the number of NPLs. Many banks and other lenders will want to sell them. And with high supply, the discount on these loans will increase. Indeed, an important lesson from the 2008 crisis, is that the longer a bank waited to sell its NPLs the deeper was the discount.
Currently, there are more buyers looking for NPLs than sellers. To take advantage of this higher demand banks need to sell their potential NPLs today. Depending on the type of business – hospitality, retail, or office – and the strength of the client’s balance sheet, it is possible to estimate the likelihood of a recovery or the soundness of a foreclosure. Selling now the loans with the higher likelihood to fail, will hedge the risk of banks against the deeper discount expected in the future.
However, although selling NPLs is inevitable, banks prefer to postpone this action because of potential reputation effects vis-s-vis clients, peers, and investors. Thus, despite the expected high discounts, delaying the sale of loans together with many other banks does not seem to carry the same reputation risk.
But banks can be creative in using technology, such as Metechi, to confidentially and competitively sell NPLs now at a low 1% fee.
Instead of accepting deep discounts to avoid the reputation risk, banks can manage a confidential competitive sale process. The selling bank can run an anonymous auction among the potential bidders, and reveal its identity only to the winning bidder subject to NDA. This process can be used even by banks wishing to sell only part of an NPL, because of a contractual commitment not to sell the whole loan.