At present, European banks have an estimated EUR944 billion of NPLs (non-performing loans) sitting on their balance sheets, with Italy accounting for EUR224.2 billion, and Greece comprising EUR112.3 billion of that sum total.1 By securitising NPLs and selling them onto yield-hungry institutional investors, banks are incrementally removing risk from their balance sheets, allowing them to grow their businesses once again. 

    The NPL disposals have also been driven by regulatory demands from the European Commission (EC) and European Central Bank (ECB). The EC, for example, has warned banks they could face heightened capital requirements if they continue to hold NPLs following proposed revisions to the CRR (Capital Requirements Regulation). The disposal strategy so far is evidently working with European NPL activity proving to be remarkably buoyant.

    ECB data shows the total gross book value of NPL portfolios traded in the Eurozone topped EUR66 billion in Q4 of 2017, while transactional volumes for the whole of 2017 reached EUR157 billion, an increase of 42 per cent from the previous year.2 It added that Italy and Spain dominated these transactional volumes.3 As a consequence of this widespread trading activity, NPLs now make up for 11.1 per cent of all loans in Italy, compared to 16.8 per cent in 2015.4

    Private capital and hedge funds take stock of NPLs

    Alternative asset managers including private equity and hedge funds have emerged as the biggest enthusiasts for European NPLs, seeing these instruments as an excellent opportunity to augment returns and diversify away from traditional revenue streams. Investors believe they will generate strong, double digit IRR (internal rate of return)5  from European NPLs which is leading to firms building up their portfolio exposures. 

    PIMCO, the US bond manager, along with Fortress acquired EUR17.7 billion dry of NPLs from UniCredit as the Italian bank continues to clean up its balance sheet.6 More recently in May 2018, Cerberus Capital Management purchased EUR1.1 billion of NPLs from Allied Irish Bank (AIB).7 As the levels of powder in private equity and private debt continues to grow, more managers will scope out European NPLs as a lucrative source of returns.  

    Many of these NPL sales have been abetted by shrewd government policies, most notably the GACS (Garanzia Cartolarizzazione Sofferenze) scheme in Italy, which is designed to help banks remove NPLs from their balance sheets. The non-mandatory initiative is a bank-by-bank securitisation guarantee scheme,8 which is available to senior tranches of NPLs.  While Italy still has a long way to go with its NPL disposals, GACS will play a positive role in accelerating sales. 

    Pricing NPLs

    Pricing NPL portfolios has been a challenge at a number of European banks, exacerbated by the high bid/ask spreads in the market, something which slowed down sales, at least initially.9 In countries where the economic situation is normalising such as in Spain and Portugal, or where the asset is strong, NPL pricing will naturally be more competitive. However, the sheer volume of NPLs now in circulation is growing and will expand significantly when Italian UTPs (unlikely to pay) come to market. Such NPL oversaturation may result in price declines, according to some experts. 

    Investors will typically price NPLs based on the underlying fundamentals of the market and the nature of the portfolio’s composition, as this will determine the likelihood and timeliness of asset recovery. Asset recovery rates are also dictated by other factors, such as local legislation and historical precedent. Spanish institutions, for example, have been offloading NPLs for several years now as the country was fairly quick to respond to its financial crisis. This has enabled foreign investors to become more comfortable with the country’s asset recovery processes, and the speed at which debt is paid off.10

    While Italy has introduced judicial reforms to accelerate its bankruptcy processes and enforcement proceedings, the country has less of an asset recovery track record for allocators to base their investment decisions on. The country’s asset recovery times – as a result of local regulation – have historically been much slower with repayments usually taking up to seven years to complete, in contrast to the three to four years seen in Spain. Such criteria need to be priced into the value of the asset. 

    Choosing the right servicer

    Appointing a servicer is a critical decision at any NPL investor as it can influence the likelihood of debts being recovered. A growing number of investors are purchasing servicers directly in order to gain better insights and understanding about the nature of their transactions by leveraging providers’ robust data and information sets on debtors, thereby driving efficiencies in the investment process.  

    Below Servicers acquired in Italy in 2017 and 2018 YTD from international investors

    2017 2018
    KKR
    Acquisition of Sistemia

    Kruk
    Acquisition of 51% of Agecredit
    Lindorff
    Acquisition of Gextra, a small ticket player from doBank
    Anacap/Pimco
    Acquisition of majority stake in Phoenix AM
    Bain Capital
    Acquisition of 100% of HARIT, specialized in secured loans
    Arrow Global
    Acquisition of Europa Investimenti and Parr Credit
    Varde
    Acquisition of 33% of Guber
    IBL Banca + Europa Factor
    Joint venture for the creation of the new Servicer Credit Factor
    Davidson Kempner
    Acquisition of 44.9% of Prelios and launch of mandatory tender offer
    Intesa + Intrum
    Joint venture for Intesa Sanpaolo NPL platform
    Cerved + Quaestio
    Acquisition of credit servicing platform (Juliet) from MPS
     
    Cerved
    Acquisition of BP di Bari NPL Platform
     
    Intrum/ Lindoff
    Acquisition of 100% of CAF
     
    Credito Fondario
    Acquisition of Banca Carige servicing platform
     

     

    Here below servicers acquired in Spain by international investors in recent years

    Servicer First Developer Actual Owner
    Aiqon Capital Espana Aiqon Capital Link Financial
    Aktura Banesto Intrum/Lindorff
    Altamira Santander Apollo
    Anida BBVA Cerberus
    Anticipa Caixa Catalunya Blackstone
    Haya RE Bankia Cerberus
    HypoGes Iberia Lehman Brothers former employees KKR
    Servihabitat Caixabank Caixabank

     

    However, there are circumstances when buying a servicer does not make sense or is unviable, which will force managers to use local, independent providers. Ensuring the servicer has widespread experience of the assets in question is absolutely key, and many fund managers will only use providers who they have had long-term commercial relationships with.

    This may not always be possible, particularly in markets where servicers are a relatively new phenomenon, such as Greece. However, some of the nascent servicer entrants in these markets have developed rapidly, investing heavily into their technology and proving themselves to be highly sophisticated and capable.

    Incentivising servicers to perform their role to a high standard can be achieved through customised fees. Managers have said repeatedly they will not pay fixed fees to servicers, preferring a performance related remuneration structure, or even insisting the provider co-invest in the NPL portfolio itself so as to maximise the alignment of interests.11

    Conclusion

    With more international investors entering the European NPL space, it is important that they understand not just how the assets are priced, but work with servicers who can be trusted to perform their role to an excellent standard. HSBC has played a leading role in facilitating NPL disposals across a number of markets including Italy, where it has provided financing, hedging, distribution and arrangement. Recent high-profile examples have included HSBC’s work as co-arranger, hedge provider, and joint lead manager for Monte Dei Paschi Di Siena’s EUR24 billion jumbo disposal of NPLs into the public market in May 2018.12

    1 Bloomberg (February 14, 2018) Five charts that explain how European banks are dealing with their bad loan problem
    2
    Financial Times (May 25, 2018) European non-performing loan sales rise sharply
    3 Financial Times (May 25, 2018) European non-performing loan sales rise sharply
    4 The Economist (May 26, 2018) Bad loans remain a concern in Italy and across southern Europe
    5 Ashurst (December 4, 2017) Greek NPL momentum builds
    6 FN London (July 17, 2017) Pimco and Fortress buy EUR17.7 billion of bad UniCredit loans
    7 Private Debt Investor (May 17, 2018) Cerberus to buy NPL portfolio from AIB
    8 Axa Investment Managers (February 9, 2016) Italian banks: No bad bank, no silver bullet
    9 KPMG (May 2017) Non-performing loans in Europe: What are the solutions?
    10 Debtwire – European NPL investors heading south for summer
    11 Global ABS Conference – panellist remarks
    12 HSBC (internal PDF)

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