There is opportunity still in the NPL market

European regulators deserve credit for pressuring banks to deal with toxic loans, but the weight of capital chasing distressed property debt is also driving activity.

Non-core loans remain a huge problem for the European banking system. As much as €1 trillion of non-performing debt is still clogging up balance sheets, the European Banking Commission says, while investment banking firm Evercore’s most recent estimate puts property-related distressed loans and lender-owned assets at more than €500 billion.

For as long as banks hold toxic debt on their balance sheets, capital costs will hold them back and their ability to allocate capital elsewhere will be severely hampered. The legacy of last cycle’s lending continues to haunt many of Europe’s financial institutions.

Progress made last year should be welcomed. After a comparative lull in 2016, banks and asset management agencies offloaded more than €100 billion of real estate debt in 2017 and there is a healthy pipeline, with almost €35 billion of live sales, calculates Evercore.

Credit is due to the European banking authorities, which have steadily turned up the heat on those sitting on NPLs. Regulatory and supervisory pressure has helped break the deadlock in Europe’s most debt-stricken banking system – Greece – while markets including Cyprus have shown signs of finally dealing with the legacy of the last cycle.

The European Commission’s latest progress report on its NPL action plan, published in March, includes positive measures which, if sufficiently acted upon, would further boost activity. Proposals include reforms to national restructuring, insolvency and debt frameworks as well as the development of a regulated secondary market for NPLs.

It has taken time to get to this point and the effectiveness of political pressure is far from fully tested, but the current climate dictates it is no longer enough for financial institutions to put off dealing with the consequences of pre-crisis lending.

As well as regulatory pressure, the volume of capital aimed towards Europe’s distressed debt is also playing an important role. CBRE estimates around €76.5 billion of dry powder is available to invest in European loan sales, mainly from US private equity. Macro-economic improvements across the eurozone have increased investor demand for real estate across Continental European markets and for those seeking opportunistic returns, non-core loan sales present a logical route into markets.

The increased sophistication of Europe’s NPL market is also boosting activity. The emergence of NPL securitisation, driven to a large degree by the Italian state’s guarantee of notes in such issuances, has the potential to open the market to new investors. Similarly, investment in loan servicing platforms across Southern Europe has provided private equity investors with the ability to handle large quantities of distressed debt.

The challenge ahead is for NPL buyers to get to grips with what sellers have to offer. Although some expect a final wave of Irish sales this year, activity is shifting into territories such as Italy and Greece, which remain unfamiliar to many buyers – however, they can no longer count on being able to acquire NPLs in well-trodden locations.

A lot of investors are scratching their heads, pondering how to find value and scale in the distressed debt market. While last year presented a handful of mega-deals in jurisdictions including Spain, investors will increasingly need to explore new territories and be prepared to deal with loans attached to a variety of asset types, including land.

Across a series of upcoming features, Real Estate Capital will examine Europe’s non-core real estate loan sales space, including the emergence of Greece, Spain’s recent boom and the rise of NPL securitisation. The non-core loans market will generate business for loan portfolio buyers in the coming years, but they will need to work harder for their returns.

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