Special Report: Tackling Europe’s NPL mountain

Pressure is growing on the continent’s lenders to address the massive volumes of non-performing loans sitting on their balance sheets, writes Lauren Parr.

Regulators are tightening the screws on European banks and those that have been sitting on non-performing loans since the global financial crisis are coming under increasing pressure to clean up their books.

NPL resolution is high on the European Central Bank’s agenda following the latest round of European Banking Authority stress tests last year. “The NPL problem is one of the main reasons behind the low aggregate profitability of European banks,” ECB vice-president Vítor Constâncio said in February.

Last December, the EBA’s 2016 ‘transparency exercise’ on 131 EU banks showed that the NPL ratio had dropped to 5.4 percent from 6.5 percent at the end of 2014. More than a third of EU jurisdictions showed NPL ratios above 10 percent, the report found.

“Europe’s banks are still sitting on €1 trillion of non-performing loans which are clogging up balance sheets,” says Richard Thompson, the partner in charge of PwC’s portfolio advisory group. “Therefore, there is an increased drive across Europe to deal with problems.”

Internally, banks continue to prepare for more stringent accounting rules and higher capital adequacy requirements and they are getting more organised about what they want to sell. Economic improvement in many countries has encouraged lenders to market NPL portfolios.

The real estate loan sales market is shifting from western to southern Europe, as UK and Irish banks and asset management agencies have largely completed the sale of non-core commercial real estate loan books. Residential property loans are the next phase. In Ireland, AIB and Bank of Ireland have large residential holdings, while the state-mandated UK Asset Resolution recently sold a performing buy-to-let residential mortgage portfolio relating to Bradford & Bingley to Blackstone and Prudential for £11.8 billion ($14.8 million; €13.6 million).

In the real estate NPL space, Spain and Italy are expected to be this year’s most active markets. Spain accounts for 45 percent of Europe’s non-core real-estate exposure according to investment banking firm Evercore. Just under half of the country’s non-core exposure constitutes foreclosed real estate-owned (REO) assets and land.

“The Bank of Spain has asked banks to get rid of REOs completely over the next four years, likely to result in an increase in sales,” says Federico Montero, managing director of real estate portfolio solutions at Evercore.

Loan sale volumes in Spain have dropped since 2014’s €16.3 billion high. Last year saw circa €9.3 billion of portfolio disposals, albeit coming from an increasing number of active sellers.

“If Spanish banks want to clean up their balance sheets they need to pick up the pace,” says Montero. He expects further large loan trades by the national asset management agency SAREB, following its sale of the €553 million face-value Project Eloise to Goldman Sachs in December.

Italy was the most active European loan sales market across all asset types during 2016, with ongoing and completed deals totalling €76 billion by year-end, according to Deloitte’s latest Deleveraging Europe report. But this merely scratches the surface of what needs resolving. Gross non-core Italian real estate represents circa €84 billion today, by Evercore’s estimation.

The Italian government has introduced initiatives to help disperse Italy’s NPL backlog, including the Atlante fund which can invest in NPLs; and the GACS scheme which guarantees the senior notes of potential NPL securitisations. Reforms have also been made to the country’s enforcement regime, to make it easier to take control of assets.

As the market evolves, the first purely secured real estate loan portfolios are beginning to surface, including Banco BPM’s Project Rainbow, with a gross book value of €770 million. Without intervention by the government or ECB by way of a formal bad bank, however, the Italian market “has a way to go to become a mature market with bigger volumes”, says Montero.

The Dutch market also offers opportunities, given the level of distress created by a severe decline in capital values post-crisis. Deloitte anticipates disposals by Rabobank and ABN Amro, which has already brought to market a non-performing CRE portfolio this year. The volume of loan deals will inevitably be lower than the record €10.4 billion clocked up in 2016, which was skewed by the €5.2 billion sale of the Propertize portfolio to Lone Star and JPMorgan.

Germany is unlikely to yield much transactional activity beyond HSH Nordbank’s €3.2 billion Project Leo – €2 billion relating to real estate debt. Bank of America Merrill Lynch has agreed to buy €540 million of CRE loans, with further packages of international real estate set to be traded by the middle of 2017.

Despite more than €240 billon of non-core assets in the system, loan sale activity has been relatively low as the country’s positive economic outlook and German banks’ low cost of capital has allowed them to keep hold of assets. Bad banks EAA and FMS Wertmanagement will continue to be a source of deals, albeit at a slow pace due to their long-term wind-down targets. The difficult-to-manoeuvre central and eastern European markets may generate some smaller deals, but the Austrian and Italian banks that expanded heavily are nearing the end of their NPL disposal processes.

Across Europe, Evercore forecasts an up to €10 billion increase in the amount of NPL sales this year, following around €50 billion of sales in 2016. Spain is likely to lead the way.

“In certain countries the most obvious NPL opportunities have passed,” says PwC’s Thompson, “but there’s still a mountain of bad debt out there and it’s gradually unravelling.”

Greece and Portugal on the cusp of NPL sales

For debt investors, Greece has the potential to be an important market. Economic uncertainty, political instability and an inadequate NPL framework have not been conducive to loan sales so far, but Greek banks are sitting on more than €100 billion of NPLs and could start bringing portfolios to market by the end of this year in order to stabilise their balance sheets.

At the end of last year, the Bank of Greece set an ambitious target to reduce banks’ non-performing exposure to circa €67 billion by the end of 2019.

Several third-party servicers have applied for licences to manage banks’ NPLs.

“The idea of servicing is a brand new thing in Greece,” says Christian Thomas, head of deal advisory at KPMG in the country. Investors can now deal with servicers rather than understaffed banks, he adds.

Portugal is also on the cusp of increased activity, with regulatory and political pressure mounting in the context of a 14 percent-plus NPL ratio; at least €40 billion, according to Deloitte. The creation of a bad bank is underway and Portuguese banks are taking over from Spanish banks on the deleveraging front. Investors are hoping they will come forward with larger, secured portfolios at
realistic pricing.

Lone Star recently acquired a 75 percent stake in Novo Banco, the banking unit created from the collapsed Banco Espirito Santo, through a €1 billion capital injection.