Blockchain’s latest financial use case: Securitizing 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 just really like traditional banks with a strong core deposit base, with stable earnings, with stable asset quality,” said Palsson. “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 subordinated debt of 300 community banks. 

“We’ve been underwriting 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 adequacy, assets, management capability, earnings, liquidity and sensitivity. Angel Oak’s proprietary ratings model uses 15 years of history and 1 million different data variables, Palsson said, to determine the probability of default. 

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

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

It’s the latest example of how banks and Wall Street firms occasionally try out new use cases for distributed-ledger technology. 

“There was a period of time when a lot of banks and other big companies woke up to the opportunity of blockchain technology: the shared databases, the reduced cost and complexity,” said Alex Tapscott, managing director of the digital asset group at Ninepoint Partners and author of several books on blockchain technology. “But they looked 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 couldn’t grow. Some never made it past the trial stage. (Permissioned means means only authorized parties can use it.) 

The development of protocol layers like 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 large enterprises are going to realize, if they haven’t already, that all of the innovation in this area 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 for the next year or so and then well into the future.”

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

The securitization of bank debt normally requires a lot of gathering of documents, sending them to different parties, tracking the files in a spreadsheet and sharing the notes with a broker-dealer, which then disseminates them to all the different stakeholders involved, according to Joe Vellanikaran, founder and CEO of 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 deal underwriters to share data and documents with prospective investors while also maintaining privacy and permissioning, Vellanikaran said. 

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

“Right now there are people who have to aggregate the payment information and then update the file, update the latest loan tape,” 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.” Brightvine’s platform integrates with loan-servicing data so that users stay up to date on the latest payment information, he said. 

The banks whose debt is being bought through this technology don’t have a 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 reaching out to us to learn more about the portal,” Vellanikaran said. “Even in this initial securitization with Angel Oak, the banks that were 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 says that at some point, the securitized bank debt itself may be tokenized and traded on Brightvine’s platform. But for now, Palsson is content to have a central document and data repository. Even persuading investors to use blockchain-related technology this much was a challenge, he says.

“As we talked to the investors, it was clear that let’s do baby steps and let people get comfortable with this,” Palsson said. “Just the word blockchain is kind of hard to swallow. People got a little bit hesitant, and they said wait a minute, it is 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’ll help you. It’s the ease of access and efficiency and the amount of information that I have access to in one place is very helpful.”