9.2.2 Types of asset relief measures

Although asset relief measures can take several forms – asset purchase, asset insurance, asset swap or some hybrid form1 – annex II of the IAC distinguishes between two broad approaches: i) the segregation of impaired assets from good assets, and ii) an asset insurance scheme. Also in the literature, two main types of asset relief measures are usually distinguished: asset purchases and asset guarantees.2

An asset purchase means that the State effectively purchases the impaired assets from the bank. Usually, the State does not purchase the impaired assets itself. Rather, a special purpose vehicle (SPV) is created, which is fully or partially sponsored by the State. It is the SPV that purchases the impaired assets from the bank. The impaired assets are transferred to the SPV, usually referred to as Asset Management Company. In order to be able to pay for the impaired assets, the SPV needs funding. The SPV has to issue equity or debt to finance its purchase of impaired assets. The SPV is usually sponsored by the state, which means that the state injects capital or guarantees debt.

An asset guarantee is a form of insurance. The State commits to bear some or all of the losses on the impaired assets. Usually, the losses are divided into tranches. The first tranche of losses – sometimes referred to as “the first-loss position” – will be borne by the bank, while the second tranche of losses will be borne by the State. In exchange for this guarantee, the bank has to pay a fee.3

Asset guarantee measures can be structured in different ways. Sometimes, the second tranche of losses is entirely borne by the State; sometimes, the bank also has to bear part of the second tranche of losses. For instance, in the UK Asset Protection Scheme, the UK government committed to cover 90% of the losses in excess of the first-loss position, so 10% of the second tranche of losses would be borne by the bank.4

Sometimes, there are only two tranches; sometimes, there are three tranches (in which case the State only covers the second tranche; losses beyond the second tranche are covered by the bank).5

While asset purchases and asset guarantees are both asset relief measures, there are some important differences between them. The first difference concerns the upside potential. The market value of an impaired assets portfolio is not constant. On the one hand, there is a risk that the value of the portfolio will decrease. This is known as the downside risk.6 On the other hand, there is a chance that the value of the portfolio will increase. This is known as the upside potential. Asset purchase measures and asset guarantee measures have in common that the downside risk is (partially or fully) transferred to the State. But in the case of an asset guarantee, the impaired assets remain on the bank’s balance sheet. As a result, if the value of the impaired asset portfolio increases, then the bank will benefit. So the upside potential remains with the bank. From the viewpoint of the bank, this is an advantage, while from the viewpoint of the state, it is disadvantageous.

The second difference concerns the payment. An asset purchase implies that the SPV has to pay for the impaired assets. This constitutes an advantage for the bank (who receives cash or receivables), and a disadvantage for the State (who has to make an upfront investment).7 In the case of an asset guarantee, there is no need for such an upfront investment.8

To sum up: in the case of an asset purchase, the State has to make an upfront investment, but enjoys the upside potential. In the case of an asset guarantee, the State does not have to make an upfront investment, but it does not enjoy the upside potential.