Asset Protection Scheme ‘could spur defaults’

The UK government’s Asset Protection Scheme, which provides banks with a form of insurance for assets such as leveraged loans, could make financial restructurings harder and encourage more corporate defaults, according to industry insiders.

Participating banks may be incentivised to let borrowers make a payment default or to go into a bankruptcy procedure, because these are the conditions under which the bank receives the government payout, Corinna Mitchell, a London-based partner at law firm Dechert, said in an interview.

“Where debt has been placed into the scheme, there is a chance that lenders might prefer a payment default or bankruptcy to a restructuring or refinancing solution,” Mitchell said

The scheme, which is designed to promote stability by giving banks confidence in the value of their assets, already includes around £300 billion-worth of assets from The Royal Bank of Scotland’s portfolio, including corporate and leveraged loans, commercial and residential property loans and structured credit assets. Lloyds TSB has placed approximately £250 billion in the system, which includes around £150 billion of leveraged finance and commercial real estate loans.

Under the plan, the government makes a payment to the participating institution if a trigger event occurs, such as a payment default or a bankruptcy.  Once the “first loss” – an initial amount to be borne by the scheme participant – has been exceeded, further losses will be 90 percent borne by the UK government. For example, in the case of RBS, which has a first loss amount of around 6 percent, the bank could only ever lose 15.4 percent of the principal.

“Where there are syndicates including lenders who have participated in the protection scheme, it could get interesting, as stakeholders around the table may have different agendas,” said Mark Dewar, a London-based senior managing of restructuring advisory firm FTI Consulting. “There could be less incentive for some to get a deal done.”

Mitchell added that borrowers may not even know whether their debt is being held in the scheme. “If the borrower comes to renegotiate with lenders it could then find the process is more difficult and protracted than usual, or that the lender is not interested,” she said.

Furthermore the scheme could cause complexity and delay in refinancing processes, because if any debt is to be rolled over into a new facility, it will need approval from the Treasury, she said. “Delays are bad news when you are a company in trouble,” said Mitchell.