November 2018

It’s been a long and winding road for non-performing loans on European bank balance sheets. flow investigates how the last few years have presented some opportunities in the market across Italy and Greece

Southern Europe is a hotbed for non-performing loan (NPL) activity as embattled financial institutions gradually wind down their risky assets, which have successively ballooned in the years following the financial crisis. Market regulators including the European Central Bank (ECB) and European Commission (EC) have been leading the charge in pushing local banks to remove NPLs from their balance sheets.

The size of NPLs sitting on European bank balance sheets currently stands at €721 billion (as of April 2018), although this number is a notable improvement from one year ago when that figure was estimated to be at €759 billion 1.  Despite the size of these intimidating on-balance sheet exposures, Deutsche Bank believes there are a number of opportunities (and challenges) in the NPL market across Italy and Greece.

Italy: In recovery mode

Italian banks are struggling under the weight of bad loans, with outstanding NPLs estimated to be in the region of anywhere between €1.85 billion 2  to €2 billion 3,   a harsh after-effect of a triple dip recession. While NPLs comprise a lower proportion (11.8%) 4 of all loans held by Italian banks relative to other European economies, the sheer size of the local NPL market in itself poses a systemic risk for the entire Eurozone.

However, NPL disposals have been steadily increasing, with €36 billion offloaded from bank balance sheets in 2016, compared to €17.3 billion in 2015 5.  A driving factor behind this activity has been the actions of the Italian government, who in 2016 introduced the GACs scheme, an initiative designed to incentivise domestic banks to sell their NPLs into securitisation vehicles (SPVs) by providing a state guarantee on senior debt tranches.

As a consequence, J.P. Morgan expects GACs will help Italian banks sell €30 billion to €40 billion in NPLs 6 .   Institutional investors including private equity, hedge funds and distressed debt managers, increasingly view NPLs as a useful performance generator, through its 15% IRR, a return stream that is hard to match elsewhere given the volatile equity market conditions and low interest rates.

In January 2018, Monte dei Paschi di Siena sold 95% of a tranche of €25 billion in NPLs to Quaestio, a Milan-based fund manager 7.   Monte dei Pasci di Siena also completed a securiitsation for sale of a €24.1 billion bad loan portfolio in May 2018 8,   while it has been reported more recently the bank is in informal discussions with investors about selling €2.9 billion of senior notes packaged in that same securitisation 9

While positive reforms have been made to Italy’s notoriously byzantine insolvency laws and slow bankruptcy processes in what should expedite asset recovery times 10,   there are concerns about how the Unlikely to Pay (UTP) loan portfolios will be managed, a segment of the market estimated to be in the region of €94 billion 11.   A number of banks are still assessing how best to wind down their UTPs and instigate disposals 12,   leading to calls in some quarters for the government to incorporate UTPs into the GACs scheme 13.

Greece: A long way to go still

Despite the recent economic recovery in Greece, the country’s finances remain in a perilous condition, a legacy resulting from a highly protracted and devastating recession superseded by a tough post-crisis restructuring. NPL coverage ratios in Greece peaked in 2016, when they stood at 50.5% or €106.9 billion 14.  This ratio has since fallen to 46%, but it remains among the highest inside the EU, said a report by Ernst & Young (EY) 15

However, the size of the Greek NPL market relative to that of Italy’s is much smaller so the broader systemic risk is far lower. As with Italy, Greece is making incremental progress on scaling down its bad loans. The country is forecast to reduce non-performing exposures (NPE) across its banks by €15 billion in 2018, and €16.6 billion in 2019 16.  

Investor interest in Greek NPLs is fairly strong in comparison to other similar markets. A survey by law firm Ashurst said 84% of respondents acknowledged they would build up their exposures in Greece over the next 12 months, whereas 53% said the same for Italy, and 26% for Spain 17.   The proof is in the pudding, with a number of NPL transactions taking place in Greece over the preceding year.

The most recent high-profile disposal saw Piraeus Bank sell €1.45 billion of secured, non-performing business loans to Bain Capital Credit, a transaction which helped the financial institution reduce its NPE ratio by 100bps.  In March 2018, Alpha Bank offloaded €3.7 billion of unsecured retail NPLs to B2Holding Group, while in October 2017, it was announced that Eurobank would sell €1.5 billion of non-performing unsecured consumer loans to Intrum in Sweden for around three percent of the loans’ face value.  

Reforms in Greece to its insolvency and restructuring regime have helped galvanise international investors. Historically, the Greek legal process underpinning asset recovery and insolvencies was slow when benchmarked against other markets. The average Greek recovery, for example, typically yields 33.6 cents on the dollar, and takes three to five years to complete versus the 64.6 cents on the dollar and 1.8 years in Italy.   By streamlining these processes, Greece will be able to attract more investors into its NPL market confident they will have a better chance of recovering assets.

The steps ahead

The sheer volume of NPLs available in Greece and Italy is seen by many distressed investors as being an excellent commercial opportunity, while regulatory bodies across the Eurozone view the disposals as being an effective mechanism by which to remove bad loans from bank balance sheets. However, NPLs are not risk-free assets and remain vulnerable to political and economic shocks, which investors need to be cognisant of.

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  1 Reuters (April 30, 2018) Euro zone banks continue to work off bad debt: ECB
2 The Economist (May 26, 2018) Bad loans remain a concern in Italy and across southern Europe
3 Bloomberg (February 14, 2018) Five charts that explain how European banks are dealing with their bad loan problem
4 European Parliament (March 15, 2017) Non Performing Loans in the Banking Union
5 Deloitte – Uncovering opportunities in 2017: Deleveraging Europe 2016-2017
6 Reuters (December 5, 2017) Italy’s bad loan scheme poised to deliver after long gestation
7 Financial Times (January 10, 2018) Monte Paschi rises 5% after bad loans sale
8 Reuters (May 10, 2018) Monte dei Pasci completes securitisation for $28.7 billion bad loan sale
9 Bloomberg (May 16, 2018) Paschi sounds out investors for senior bad loan notes
10 White and Case (October 5, 2017) NPLs in Southern Europe
11 PwC (June 2018) The Italian NPL market
12 PwC (June 2018) The Italian NPL market
13 Debtwire (May 1, 2018) Analysis: Italian NPL  market on track for record GACs and M&A volume
14 Ernst & Young (February 2018) Opportunity out of adversity: Investing in the Greek non-performing loan market
15 Ernst & Young (February 2018) Opportunity out of adversity: Investing in the Greek non-performing loan market
16 Ernst & Young (February 2018) Opportunity out of adversity: Investing in the Greek non-performing loan market
17 Ashurst (December 4, 2017) Greek NPL momentum builds

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