Business & finance

Non-performing loans: Getting to grips with bad debts

Levels of non-performing loans (NPLs) are still high in some parts of Europe, placing pressure on banks’ balance sheets. However, investor appetite is growing for non-performing assets.

In the decade since the start of the financial crisis, the European banking sector has worked hard to come back from the brink. Banks have deleveraged and increased their capital ratios, and following the establishment of the European Banking Authority, they are contending with tighter regulations.

However, non-performing loans (NPLs) are still a serious issue across the eurozone, placing pressure on banks and draining their profitability. NPLs are normally defined as loans that are more than 90 days overdue, or those that are unlikely to be repaid in full.

According to the European Central Bank, Europe’s NPL ratio stood at 4.81% in Q1 2018 (looking exclusively at ‘significant institutions’ in the euro area). Another key statistic comes from the European Banking Authority’s (EBA) Risk Dashboard, which bases its data on a sample of large banks. As of the end of 2017, it calculated the EU’s NPL market as €813bn, or 4% of the total loans market.

From one perspective, these figures are heartening. The equivalent ratio was 6.5% at the end of 2014, and 8% at the peak of the crisis, meaning levels of problem loans have fallen significantly. However, the EU has some way to go before it can compare with the US and Japan, where the ratios are close to 1%. It is also far removed from its own pre-crisis levels of 2%.

“The EU’s NPL market is a key concern for policy makers, central bankers and financial institutions,” Thanos Papasavvas, founder and CIO of ABP Invest, tells EMEA Finance. “Furthermore, the significant divergence between member states’ NPL ratios highlights regional issues and potential systemic concerns.”

Indeed, a more granular look at the data reveals wild inconsistencies across the continent. According to the EBA Risk Dashboard, many countries have good NPL ratios – as of March 2018, Finland’s stood at 1.5% and Luxembourg’s at 0.7%. Other strong performers include the UK, Germany and Sweden. The overall average, however, is skewed by certain outliers.

“Amongst the peripheral eurozone countries which were hit hardest by the crisis, Italy, France, Spain and Greece have the largest NPL exposures totalling €530bn, representing two thirds of the total,” says Papasavvas. “With size of NPLs being one of the two key metrics, the second is the ratio of NPLs to overall loans. On this second metric Greece and Cyprus stand out at 45% and 39% respectively followed by Portugal at 15% and Italy at 11%.”

He adds that the high concentration of NPLs in this part of the world is a byproduct of the Eurozone crisis, which hit Europe straight after the financial crisis.

“For example, between 2008 and 2016 Greece lost 26% of her GDP with unemployment rising from 8% to 28%,” he says. “This significantly impacted loan repayments and created a non-performing loan problem which still hangs over the Greek economy and its nascent recovery.”

Of course, it is largely up to the banks themselves to tackle this problem, along with the relevant national authorities. However, the European Commission is also working to address the issue, recognising the risks posed by NPLs to the broader financial system.

In July 2017, the Commission agreed on an ‘Action Plan to Tackle Non-Performing Loans in Europe’. This was followed by a package of specific measures in March 2018. Among other suggestions, the proposals include an amended capital requirement regulation, which would ensure that banks set aside funds to cover the risks of future NPLs.

Another proposal is for a directive on credit servicers, credit purchasers and the recovery of collateral. This would encourage the development of a secondary market for NPLs.

“NPLs may be a threat but they also provide an opportunity of creating a new and viable secondary market, attracting new investors in search of yield and favourable valuations,” explains Papasavvas. “The more liquid the NPL market becomes, the more it entices new potential investors as well as offloading debt from banks’ balance sheets allowing them to utilise their capital more productively.”

Already, NPLs are seen as an attractive investment opportunity in certain parts of the EU. In Italy, for example, NPL sales more than doubled from €30bn in 2016 to €64bn in 2017. This increase was largely due to a few mega deals – notably the €17.7bn disposed by Unicredit, and the €16.8bn disposed by Banca Popolare di Vicenza and Veneto Banca, both in mid 2017.

The first of these, dubbed Project Fino, related to three NPL portfolios, which were sold to Fortress and Pimco through a securitisation. In the second instance, the ailing banks were bailed out by Intesa Sanpaolo.

So far this year, we have seen two more jumbo transactions: a €10.8bn sale from Intesa Sanpaolo to Intrum, and €24.1bn from Banca MPS to Quaestio Capital. Banca MPS, which emerged as Europe’s weakest bank in stress tests, is now 68% owned by the Italian treasury after a government-backed rescue. Quaestio manages Italy’s banking industry rescue fund, Atlante.

“Whether Italy manages to reach this year’s target of €70bn is uncertain given the changing political climate, but what plays in banks’ favour is the processes and relationships, knowhow and products which have already been well established over the last few years and will likely maintain some of the momentum,” says Papasavvas.

This process has been helped along by various government initiatives. For instance, Italian policymakers have approved a scheme called GACS, a bank-by-bank securisation guarantee scheme available to senior tranches of NPLs. And the European bank bail-in regime has forced banks to take losses on NPLs before they can access state funds to avoid bankruptcy.

The last couple of years have also seen impressive NPL sales from Spanish lenders. According to the KPMG Loan Transaction Tracker, Spanish banks disposed of €66.7bn of NPLs in 2017, with the largest transaction being Santander’s €30bn sale to Blackstone. By the end of 2017, Santander and BBVA (Spain’s two largest banks) had NPL ratios of less than 5%, dipping below the European Central Bank’s threshold for a ‘high NPL bank’.

BBVA, which will soon finish the sale of its €13bn real estate exposure to Cerberus, is expected to double its profitability on completion of the deal.

“This transaction is extremely important, because it significantly reduces our exposure to a non core business, and it allows us to strengthen our transformation process,” said BBVA CEO Carlos Torres Vila on a release.

Another country with a high NPL ratio is Ireland (it stood at 11.4% as of late 2017). Having reached a degree of maturity, this market is seeing a fall in NPL deal volumes, but there have been several notable transactions in recent months. In May 2018, Cerberus Capital Management acquired €1.1bn of NPLs from Allied Irish Bank.

“This is another important step in our non performing exposure (NPE) deleveraging strategy and we remain on track to reach normalised NPE levels by end 2019,” the bank said on a release.

Perhaps the biggest NPL story this year, however, is happening in Greece. Given the uncertainty surrounding ‘Grexit’ between 2014 and 2015, the country has only recently begun to offload its NPL stock, bringing a wealth of new opportunities for foreign investors.

“It has only been over the past year that the Greek NPL market has shown some signs of a turnaround. As of the end-March 2018, the stock of NPEs decreased to €92.4 billion or 48.5% of total exposures,” says Papasavvas.

He adds that all four systemic banks (Attica Bank, Alpha Bank, Piraeus Bank and the National Bank of Greece) have now packaged and sold NPLs of varying sizes and types. They have built experience in the process and picked up momentum.

For instance, Piraeus Bank’s Amoeba project, in May 2018, involved the first sale of NPEs secured with real estate assets. In the European Stability Mechanism’s (ESM) fourth and final review, which gave Greece a clean bill of health, this project was cited as having “marked an important next step in the creation of a dynamic NPL market in Greece”.

“Furthermore, amendments to the regulatory and legal framework such as out-of-court workouts, the household insolvency law, the e-auction framework and protection from criminal liabilities of officials or staff involved in the context of NPL sales and restructurings have all helped address the impediments surrounding NPLs,” says Papasavvas.

Greece now aims to reach a 35.2% NPL ratio by 2019. This figure is still high, but it’s a big step down from the peak. Reducing the ratio to a more typical level, in line with the rest of Europe, is likely to prove a more abiding challenge.

“We will be continuing the discussion on Greece and the broader NPL market at the forthcoming MR&H event in Athens 17-19 October,” says Papasavvas. “With Greece experiencing a fifth consecutive record year of tourism and having exited the bailout programme, interest is high amongst potential investors and sovereign wealth funds alike.”

Regarding the European situation more generally, there are plenty of opportunities on store for investors, particularly in less mature markets where NPL stock remains high. Although NPLs are still posing problems for banks, initiatives at both a European and national level are beginning to pay off.

“Europe has made good progress since the depths of the crisis, halving the NPL ratio on average. However, the more pertinent issue of dispersion amongst the continent remains high,” says Papasavvas. “Regulatory and accounting amendments alongside supportive macroprudential measures should see the NPL ratio coming down further. However, this will take time with a few countries continuing to be outliers for the foreseeable future.”

This article appears in the October-November 2018 edition of EMEA Finance

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