Asset securitization offers access to cheaper liquidity

The global credit crisis and the worsening economic backdrop should have made Greek banks more prudent in their lending policies in order to guard against the possible emergence of bad loans over the next few quarters. However, banks’ quest for fresh funding via the securitization of loans and credit cards appears to have given them incentives to do just the opposite. Greek banks may not have toxic assets such as subprime debt and other derivatives on their books nor do they have to worry about the kind of write-offs taken by other US and European banks but they have felt the pinch of the crisis on the funding front. The fact that the large Greek banks have been relying heavily on fast credit growth to meet their ambitious profit targets in their multiyear business plans makes funding even more important to them. Without adequate funding, they would have to make fewer new loans to households and businesses in Greece and abroad and sharply lower their earnings targets, hurting their shares. With deposits growing slower than loans in the countries of Southeast Europe and international wholesale markets essentially being shut down, sources of additional funding are restricted to the Greek depositor base, money markets and the short-term debt market, such as commercial paper. Since their top management understands that historically banks have failed more due to a shortage of liquidity than for any other reason, the big local banks have used all possible means to keep billions of euros in contingency funding. But this has been an expensive operation, with banks paying interest rates in excess of 5 or 6 percent on time deposits and high rates to foreign institutional investors for the private placement of their bonds. Faced with the difficulties of accessing certain markets and the higher cost of funding, local banks have turned their attention to the securitization of their assets, namely credit cards, mortgage and other type of loans, to secure cheaper funding from the European Central Bank (ECB). The latter hopes to help them overcome the credit crunch and stop it from poisoning the real economy. Although this securitization involves the pooling and repackaging of loans and other bank assets, it is not accompanied by the sale of the securities to investors as took place in the good old days. The securities stay on the books of each bank, which uses them to raise cash from the ECB by pledging them as collateral or agreeing to buy them back at a later date. This is a very good proposition for Greek and other eurozone banks because they can borrow funds for 4.15 to 4.20 percent for two weeks from the ECB’s window, compared to around 5.0 percent on the money market for three months and close to 5.80 percent. The lower cost of funding can make the difference in their annual profitability if it concerns big sums. Of course, banks can sell these securities to investors when conditions on the international wholesale markets normalize but this does not seem probable over the next few months. But in securitizing their assets, Greek banks have also a greater incentive to hand out more of the popular loans featuring lower initial fixed interest rates, usually for a period of one to five years. Why? They will rush to make more new loans because the securitized loans are not included in the calculation of loan volume growth rates. This is embedded in their multiyear business plans. In addition, banks have an incentive toward new loans since the securitization reduces their so-called repricing gap. The latter refers to the mismatch in the duration between assets and liabilities. The gap is because deposits are repriced more often, usually every three months, than the loans with the one- to five-year initial lower fixed interest rate. At periods when the Euribor interest rate goes up, banks gain from the mismatch. So the securitization opens up a slot in their loan book and credit institutions have an incentive to fill it by aggressively marketing the loans with the initial low interest rates to their clients. All in all, the securitization of assets being pursued by more and more local banks for the purpose of obtaining cheaper liquidity from the ECB to fund their loan growth and boost their profits also leads to something precarious: It gives them an incentive to be aggressive in marketing these popular loans to their clients. This may be a dangerous game in a period of worsening economic conditions because it may lead to a record of loans in arrears over the next three quarters.