As momentum builds in Europe’s non-performing loans market, investors are looking at opportunities in emerging markets, writes Jouke Boomsma, co-head of NPLs at Mount Street.
With non-performing loan resolution high on the European Central Bank’s priority list and the IFRS 9 accounting standard for impairment requirements coming into force in 2018, we expect to see European banks bringing more non-core assets to the market in the next 24 months.
While there are still opportunities in the more mature markets such as the UK, Ireland and, in particular, the Netherlands, jurisdictions in south and south east Europe are increasingly interesting, although they are not without their challenges. Here we provide our view on some of the most interesting European markets.
The NPL ratio for financial institutions in the Netherlands has moved to below 3 percent. The NPL portfolios we see coming to the market are more granular in nature, which tends to attract buyers which already have a local platform.
We expect secondary loan sales to increase as the work-out of loan books acquired between two and five years ago come to a critical point where investors need to decide whether to sell now – potentially the safer option – or continue to work them out to the end. A greater number of financings for discounted pay-offs, provided by specialist lenders, are likely as borrowers need to refinance. Banks are still cherry-picking and it remains difficult to refinance high-leverage loans. As such, we are seeing specialist lenders enter this market to provide debt with higher margins for a period of around two years. This gives the borrower time to stabilise the assets and attract cheaper finance from banks.
Despite sizeable transaction volumes in 2016, driven largely by Propertize’s sale of the €5.2 billion Project Swan portfolio to Lone Star and JP Morgan, the activity from the three largest banks – ING, ABN Amro and Rabobank – has been relatively modest. Rabobank is reorganising its FGH subsidiary and still has multiple billions of NPLs on its books, so there could be a big loan sale or platform trade on the horizon.
The Portuguese financial system has somewhere between €30 billion and €40 billion of NPLs to deal with, which reflects an average NPL ratio of more than 15 percent. This is unsustainable and we expect loan sale activity to increase significantly.
While investors remain comfortable with the legal environment governing asset transferability and the recovery process in Portugal, the key issues in this market remain seller commitment and price expectation. Nevertheless, regulatory and political pressure are likely to generate a high level of loan sale activity. Whether through independent transactions or a systemic solution, activity in Portugal will depend on the outcome of government negotiations with the private financial sector on creating a ‘bad bank’ for the Portuguese NPLs.
Initial market signs are positive. Sizeable Spanish banks, active in Portugal, started their deleveraging process more than four years ago, and have now largely sold off their positions. This helped to push the total of completed and ongoing trades in Portugal to around €3.3 billion in 2016. It is hoped that banks will now come forward with larger, secured packages but so far pricing has proved unrealistic.
Italian NPL stock is estimated at €360 billion of which around 50 percent is secured by real estate. There is significant granularity and a high quantum of corporate loans, mainly to Italian SMEs. In 2016, NPL transaction volumes were around €20 billion and this is expected to more than double in 2017.
So far, most transactions have been unsecured. For secured trades, the bid-ask spread continues to be an issue, as investor risk premiums incorporate a perception of long enforcement times and poor data. For real estate-secured NPLs, prices can range from 10 percent to 40 percent.
To encourage bank deleveraging and reduce the bid-ask spread, the government has implemented insolvency and enforcement reforms to accelerate debt recovery and create a more creditor-friendly framework. It has introduced beneficial tax rules for bad loan provisions, offered state guarantees (GACS) for senior tranches of NPL securitisations and created two ‘Atlante’ funds, mandated to recapitalise banks and acquire junior tranches of NPL securitisations.
GACS in particular are expected to reduce bid-ask spreads and increase liquidity. In October 2016, Banca Popolare di Bari successfully securitised €480 million of retail and corporate NPLs. Its success seems to have set a precedent, with Banca Carige, Monte dei Paschi di Siena and UniCredit likely to follow suit. The Italian Constitutional Referendum in December 2016 and the subsequent resignation of prime minister Matteo Renzi served to delay the implementation of a number of the aforementioned reforms. However, the situation has stabilised quickly and these reforms, coupled with GACS, are expected to facilitate the forecasted uplift in NPL transactions during 2017.
It has been well documented that the four systemically important banks in Greece are under pressure from the ECB to significantly reduce their non-performing loan exposure by the end of 2019.
In spite of this increasing pressure and recent changes in legislation intended to address the NPL issue, transactions have been limited. However, we believe that the banks will start to move from planning to execution in 2017. The opportunities for an independent servicer, particularly one with a track record resolving commercial real estate and hospitality debt, are significant as local restructuring and work-out expertise remains in short supply.
There are challenges for companies which wish to enter the Greek market. The revised enforcement and NPL framework, implemented in early 2016 to allow the transfer and sale of loans to servicers or specialist asset management companies, has so far resulted in only two licences being granted from a list of more than a dozen applicants. It has been argued that this is mainly a result of the application process, which is complex, but also because the Bank of Greece has limited resources to process all the applications.
Reformation of the application process has been rumoured, and this would certainly be welcomed by the banks and prospective servicers, however the Bank of Greece will want to ensure that licences are only granted to applicants with appropriate strategic and operational capabilities. A high proportion of the loans in Greece are syndicated which makes decision-making on the smaller exposures particularly challenging. The banks are looking for ways to address this issue and the solution will almost certainly require a third party servicer.
Cyprus is a relatively untapped market which comes with its own challenges. Secondary assets tend to be harder for the banks to deal with and capital values remain subdued. There is also a significant amount of land away from the coastal regions that is difficult to value accurately. There is a concern that, when the banks start to sell assets from their balance sheets, this will drive capital values in secondary locations down even further.
However, the economy in Cyprus continues to show signs of improvement due in part to its robust tourism industry. Total NPLs fell by 11 percent in 2016 to just under €25 billion although the country still has the highest NPL ratio in Europe at greater than 47 percent. Government incentives such as capital gains tax exemptions and a reduction of transfer fees accounted for a significant part of this reduction as the banks moved to take assets onto their balance sheets via debt-to-asset swaps. The larger institutions have set up internal divisions to manage and ultimately liquidate these assets. Furthermore, overseas demand for prime residential assets remains strong which is largely due to the controversial naturalisation scheme whereby international investors can gain citizenship if they purchase real estate in Cyprus, although it is unclear how long this scheme will last.