Asset management at EAA – No premature sales at unfavourable prices
EAA looks back on a very successful 2017. The management of non-performing loans has revealed itself to be a key factor in success.
Over the past year 2017, EAA completed the protracted restructuring of often very complex loans in numerous cases. Sales opportunities which arose on account of the positive market environment were used consistently. This made it possible, for instance, to reverse risk provisions established previously with a positive effect for the annual result. Sustainable strict management of non-performing loans is a fundamental component of the EAA strategy for the minimisation of losses and to leverage value recovery potential.
One of the key advantages in the resolution model adopted by EAA is in the time factor. In contrast to commercial banks which manage their NPL portfolio within the framework of continued business or in a separate business unit, EAA is not under pressure to sell a NPL immediately. Accounting in accordance with the German Commercial Code (HGB) under which temporary fluctuations in the value of the investment do not have a direct impact on the profit and loss account in any year; the exemption from provisions on equity and liquidity as set down in the German Banking Act and favourable refinancing are the key reasons.
EAA uses the framework conditions, in particular in NPL management, in order to avoid premature sales under pressure at unfavourable prices. Instead, it focuses its NPL management in particular on the restructuring of loans with the objective of increasing value. Subsequently, it’s a matter of either securing refinance or redemption, or an orderly sale.
The restructuring process begins for EAA significantly earlier than in a classic commercial bank. The divisions Performing Loans and Non-Performing Loans are more intricately connected. As soon as the first signs of deterioration in credit quality become apparent, experienced restructurers are incorporated into the asset management process. They make an assessment as to whether an immediate sale of the position is sensible or whether targeted restructuring measures promise a better recovery ratio.
The timely and flexible reaction demands well-coordinated processes which begin with the rapid formation of work-out teams which include further specialists, including lawyers. Work begins with an initial status assessment of the work-out situation. It allows the rapid analysis in view of the measures to be taken. This includes an assessment of existing contracts, collateral and specifics of the legal framework in the country in which the asset is located. It is to be clarified, for instance, what steps are legally enforceable. It must also be analysed how measures impact on the portfolio as a whole. This also includes clarification of whether EAA has all necessary specialist skills at its disposal or whether it must bring on board external specialists from the existing network. This is followed by the detailed determination of subsequent steps and milestones.
EAA has employees with long-standing experience, seniority and broad product expertise at its disposal. They collaborate with portfolio managers of Mountstreet Portfolio Advisors GmbH – up until 2017 a service subsidiary of EAA – which primarily ensures the necessary presence in foreign locations. This expertise and division of labour are key factors in success. As a result, the EAA is in a position to meet the rapidly changing challenges of a broadly diversified international portfolio which can, in practice, range from ailing aircraft finance, to the impact of subsequent modifications to subsidies for solar power plants in Southern Europe, to the question of the restructuring strategy for an oil exploration ship in South America.
In contrast to the NPL managers in a commercial bank, NPL managers at EAA enjoy a high degree of independence. Since EAA does not generate new business, the possible impact on the overall business relationship with a customer need not be taken into account. This often makes it possible to take a more active role in restructuring negotiations and opens up a broader spectrum of negotiations strategies. An example here is the hold-out strategy. In the case of syndicated finance, for instance, which requires unanimous decision-making by the banks involved, it offers an opportunities to push through its own negotiating position, for instance in demanding the premature redemption of its own share of the loan.
Rapid reduction of risk positionsmore
Key success factors for the rapid resolution of problem investments in summary:
- Active communication: Make contract partners aware of that fact that EAA is focused exclusively on the repayment of a loan and will use every opportunity to secure early repayment.
- Prioritisation and active management: Focus on exposure with high possible relevance for the profit and loss account for the year (e.g. Using an ABC analysis).
- Data availability and data assets: To respond quickly and immediately implement measures, all necessary data must be quickly available and of high quality. Standardised status reports help in providing a quick overview of the situation.
- Rapid use of external experts, where necessary, via a comprehensive network. Where necessary, active participation on steering committees in order to better be able to influence terms of restructuring.
- Clear position and targets across all those involved in the process.
The EAA model –
or: The option to wait
Even if EAA does not wish to fall back on liability commitments – and from today’s perspective no longer has to – they were nonetheless the basis of its success to date. Precisely this duty to offset losses makes it possible for EAA to raise money on capital markets on good terms.
EAA is independent both economically and in terms of its organisation, this means, amongst other things, that it plans its refinancing itself and implements it with its own issues on the capital market. As a result of the liability commitments it has obtained, EAA enjoys very high creditworthiness and top-notch ratings.
On this basis, it is able to secure funds on capital markets on better terms than private banks and in some cases even on terms better than many European states. This is a key benefit which EAA applies to its advantage in the resolution process. Sales experts know: “The profit is in the purchase”. As regards financial institutions, refinancing represents the purchasing level, loans and other financial products are on the sales side.
The refinancing strategy of EAA is risk-minimising. Its presence on capital markets is such that it can at all times expect to be able to raise necessary funds from institutional investors. This makes it possible, for instance, to implement management strategies for the long term and to hold risk positions for as long as required to secure an optimal market price. Those who have to refinance at great expense on financial markets do not enjoy such an “option to wait”.
Since the beginning of its operating activity, EAA has focused on making the best of its position on international capital markets. Means to an end: An issue programme which both meets the needs of relevant investors as well as includes flexibility in the management of EAA’s liquid funds. Liquidity management is a central instrument used to avoid having to fall back on liability commitments, which ultimately means protecting public budgets.
The investor basis
In order to achieve these targets, EAA has worked from the very beginning on ensuring its investor circle is as broad and sustainable as possible. Here, it was a matter of generating the greatest possible benefit. Today, various central banks and supra-national institutes are among the regular investors in EAA issues.
There are then the banks which acquire EAA bonds on account of their being zero risk-weighted. EAA bonds do not need capital backing.
Fund managers and other institutional investors also use EAA issues for low-risk strategies. In geographic terms, the investor base stretches from America to Europe and Africa and to Asia. EAA is today focused on large-volume bonds in EUR or USD with maturities of up to three years. EAA offers maturities of up to one year with its commercial paper programme in USD, EUR and GBP.
Supported by continued demand from investors in all corners of the world and the continuity of its issue programme, over the last financial year, EAA secured terms similar to those of the Federal State of NRW and thus not far away from those secured by Federal issuers on the market.
The reduction in costs for refinancing support EAA’s net interest income and helps to ensure a positive annual result, as was recently the case in 2017. At the same time, favourable refinancing was a pre-requisite in the restructuring of project finance or non-performing corporate loans over three or four years, which in 2017 made a crucial contribution towards a positive annual result.
At the end of 2017, EAA had outstanding medium and long-term issues of approx. EUR 15 billion on the market. Its annual issue volume in this segment currently stands at EUR 3 billion.