MARKET DESIGN PRINCIPLES FOR THE SECURITISATION OF NON-PERFORMING LOANS

In a world where the problem of non-performing loans (NPLs) is all but ubiquitous, and success stories of markets of distressed debt are rare, the paper establishes design principles for the creation of such markets. It does so by creating a theoretical model for gains to trade between banks, the sellers of NPLs, and asset reconstruction companies (ARCs), in a context when buyers can pay using a combination of cash and securities issued against the NPL. The results include: 1) Identification of combinations of: a) deal values and b) cash proportions used in transactions that are consistent with mutual gains to trade 2) Demonstration that feasible set includes points at which the cash proportions as well as the deal values are low, points with high cash proportions and deal values even lower than bankruptcy proceeds, and points with low cash proportions and deal values much higher than the true value 3) Determination of levels of securitisation consistent with the discovery of the  “true value” of NPLs 4) Proposal for a new design for NPL auctions, including a  “conversion function” to convert a two-parameter bid into a cash equivalent.