Buyers of European non-performing loan portfolios face a major challenge if they are to turn a profit, with covid-19 throwing workout plans into disarray.
US private equity investors have made discounted purchases of real estate NPLs from banks in countries such as Spain, Italy and Greece. Investment banking advisory firm Evercore says sales with a face value of €177 billion were completed in Europe in 2018 and 2019.
Buyers have bid aggressively, backed by loan-on-loan finance. However, they now face weaker property market conditions and delays to workout timeframes as they attempt to reach payoff agreements with borrowers or take ownership of underlying real estate.
“Many who acquired NPL portfolios in the last couple of years will be under pressure,” said Jacob Lyons, co-founder of principal investor and capital markets advisory firm Rivercrown, which itself invests in NPLs. “They may now face radically different outcomes to what was underwritten in their business plans. It will be increasingly difficult to achieve anything other than consensual resolutions to distressed scenarios as the balance of power has shifted towards borrowers.”
Alok Gahrotra, partner in Deloitte’s portfolio lead advisory services team, said large volumes have been raised for NPL strategies with return targets in the high single and low double digits. During the pandemic he has seen a 15-25 percent shift in pricing in bids for portfolios. Market watchers expect a wave of secondary portfolio sales this year, as NPL owners recalculate their exit plans and aim to sell off portions of their books wholesale.
“Investors’ business plans could be delayed by 12-18 months in Spain, Italy and Greece, so they may want to start looking at selling the tails of their portfolios now,” said Federico Montero, managing director in Evercore’s real estate division. “For many, an exit this year is not possible, so towards the end of this year and start of next year they will do many secondary trades. These investors have IRR thresholds, dependent on two factors: time and a multiple. If they fail to meet either, they could be in a difficult situation.”
According to Lyons, whereas buyers would historically focus on the first 50 percent of a portfolio, while leaving the remainder to a local servicer to work out over time, the pandemic has made recovering the “last dollar” from the tail critical.
“The base case is now often simply the recovery of principal – with initial IRR targets now just pipe dreams,” he says. “Some investors who aggressively sold down significant volumes of their portfolio over the past couple of years are undertaking ‘clean-up trades’. They have already recovered their principal, often met their IRR targets, and are now looking to exit ahead of new fundraising, the imminent end of a fund’s life or simply a desire to focus elsewhere.”
NPL sales by European banks have slowed. Evercore reported €18.1 billion in H1, 34 percent down from H1 2019.
“It is very difficult to price anything,” said Montero, “or for buyers to forecast the time it will take to acquire underlying assets, so underwriting is tough.”
The pandemic has led to a loss of momentum in the Greek NPL market, where €7 billion closed in H1. Alpha Bank is aiming to sell its €10.6 billion Galaxy portfolio, through a securitisation, in what could prove a key deal for Greece’s loan sales market. Across Europe, Evercore is tracking €18.6 billion of live transactions, though it is uncertain they will all be concluded.
“If a deal were in its early phase when covid-19 began, banks generally put those on hold,” said Gahrotra. “There is no reason to accept significant discounts. Regulators have been understanding, and stress tests and NPL reduction targets have been put back. We are recalibrating to a new reality, and sellers need to adjust their price expectations. The hope is, by Q4, bid/ask spreads will not be more than 10-20 percent versus pre-covid levels.”
He added that loan-on-loan finance will be harder for NPL buyers to source: “Spreads are expected to have widened a couple of hundred basis points, with loan-to-price ratios also having come in.”
The economic stress will result in new NPLs on banks’ books, though payment holidays and government stimuli may delay the impact. Gahrotra does not expect banks to aggressively sell new NPLs: “Covid-19-related NPLs are 12-18 months away from being packaged. In places like the UK and France, banks are well capitalised, but an increase in NPL ratios will drag on profits, so they may accelerate sales of remaining legacy assets.”
However, in places like Greece, where banks’ NPL ratios remain high due to unaddressed 2007-08 defaults, lenders will seek to sell more legacy loans to better manage the burden of new NPLs. “Now is not the time to recognise loans as NPLs,” saaid Montero. “But that will change next year when banks find out which companies are through the crisis and which are zombies.”