Blockchain’s latest financial use case: Securitization of bank debt

Johannes Palsson, managing director and senior portfolio manager at Angel Oak Capital Advisors in Atlanta, likes to invest in boring banks.

“There are some unique banks out there, but we only like traditional banks with a strong core deposit base, with stable earnings, with stable asset quality,” Palsson said. “The banking space is better capitalized than ever and has better liquidity than ever, is better regulated than ever, is better managed than ever. So we like the space.”

Palsson helps institutional players invest in the responsible debt of 300 community banks.

“We’ve guaranteed these banks for a very long time,” he said. He analyzes the banks with his own version of the rating system used by regulators called CAMELS, which stands for the rating factors capital coverage, assets, manageability, earnings, liquidity and sensitivity. Angel Oak’s proprietary rating model uses 15 years of history and 1 million different data variables, Palsson said, to determine the likelihood of default.

Recently, Angel Oak began using distributed ledger technology in connection with the securitization and sale of the banks’ subordinated debt. According to Angel Oak and technology partner Brightvine, this is the first time blockchain technology has been used to execute bank debt transactions. For Palsson, the technology has been most valuable so far in providing one place to find all relevant documents and data.

“Where the advantage is, and where the difference is, is a centralized location of all information,” Palsson said. “Here we have a place where we basically put everything and different constituencies have access to different documents.” Notes, appraisal reports and contracts are stored in the ledger, which was developed and managed by Brightvine.

It’s the latest example of how banks and Wall Street firms are occasionally trying out new uses for distributed ledger technology.

“It was a period when many banks and other large companies woke up to the possibility of blockchain technology: the shared databases, the reduced costs and complexity,” said Alex Tapscott, managing director of the digital assets group at Ninepoint Partners and author of several books on blockchain technology. “But they were looking at a lot of public blockchains like Ethereum that weren’t ready for prime time.”

Some early attempts to use private, permissioned blockchains failed, he said, because they were closed projects that could not grow. Some never got past the trial stage. (Permission means that only authorized parties can use it.)

The development of protocol layers such as Quorum, the increased viability of tokenized assets, and the ability to buy and sell on distributed ledgers using stablecoins have all made the technology more practical for businesses.

“The big banks and other big enterprises are going to realize, if they haven’t already, that all the innovation in this space is happening on platforms like Ethereum and Solana, and it’s not happening on closed-loop systems that they’ve developed themselves,” Tapscott said. “Enterprise adoption of public blockchains is going to be a very big trend in the next year or so and then well into the future.”

Brightvine’s version of blockchain technology is based on the Ethereum blockchain and uses the Quorum protocol layer originally developed at JPMorgan Chase and now managed by Consensys. Brightvine also uses Hyperledger Besu, Java-based software that implements the Enterprise Ethereum Alliance specification to create the permissioned blockchain.

Bank debt securitization normally involves a lot of gathering documents, sending them to various parties, tracking the files in a spreadsheet and sharing the notes with a broker-dealer, who then distributes them to all the various stakeholders involved, according to Joe Vellanikaran, founder and CEO in Brightvine.

“It’s a very manual, email-driven, phone-driven process,” he said.

Many of the workflow tools in Brightvine’s blockchain-based portal make it easier for underwriters to share data and documents with potential investors while maintaining privacy and permissions, Vellanikaran said.

Having bank debt on a blockchain means investors are continuously updated on payment information, Vellanikaran said.

“Right now there are people who have to gather the payment information and then update the file, update the latest loan loss,” he said. “And there’s a lot of individual work that goes into even just seeing what the most up-to-date view of a loan portfolio is.” Brightvine’s platform integrates with loan servicing data so users stay up-to-date on the latest payment information, he said.

The banks whose debt is bought through this technology have no say in the process, any more than mortgage borrowers have a say in how their loans are sold to investors. Nevertheless, some banks have supported the project.

“Banks have been proactively contacting us to learn more about the portal,” Vellanikaran said. “Even in this initial securitization with Angel Oak, the banks involved in the transaction were happy to talk to us and learn more about it and then actually invite the investors to the portal.”

At Angel Oak, Palsson believes that at some point the securitized bank debt itself could be tokenized and traded on Brightvine’s platform. But for now, Palsson is content with having a central document and data warehouse. Even persuading investors to use blockchain-related technology so much was a challenge, admits Palsson.

“When we talked to the investors, it was clear that let’s take small steps and let people get comfortable with this,” Palsson said. “Just the word blockchain is a little hard to swallow. People were a little hesitant, and they said wait a minute, that’s a lot. We said, yes, it’s a blockchain, but here’s what it is, and here’s what it means, and here’s how it will help you. It’s the ease of access and efficiency, and the amount of information I have access to in one place is really helpful.”