The outstanding amount of non-performing loans (NPLs) held by EU banks is estimated to be just over €1 trillion, or approximately $1.2 trillion.

These NPLs, which are loans in default for at least 90 days, are emerging as a key issue for European banks. With banking authorities pushing for disposal of NPLs, many EU banks are now looking to reduce their exposure while investors, including U.S. hedge funds (which are not subject to U.S. or EU prudential regulations), are eyeing opportunities for European NPL investments.

Non-performing Loans-Opportunity in Distress Infographic

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Regulatory Pressure on NPLs Disposal

Three considerations should boost NPLs sales by EU banks in the near future:

  • European banking authorities are increasing their pressure on EU banks to reduce their exposure to NPLs. After an EBA study on 160 European banks completed in July 2016, the ECB published its final guidance to banks of NPLs on March 20, 2017. This guidance mandates banks with high NPL exposure to establish realistic, time-bound NPL recognition and disposal strategies. Indeed, NPL exposure contributes to banks’ profitability decline by requiring additional provisioning and capital constraints and affects their ability to finance the European economic growth.
  • The new International Financial Reporting Standard (IFRS) 9, applicable as of Jan. 1, 2018, will oblige EU banks to significantly increase their depreciation of NPLs by valuing them on the basis of the expected losses, and no longer on the basis of the likelihood of a severe credit event as was the case so far. Moreover, the ECB will reportedly soon request EU banks to fully (i.e., 100%) depreciate loans newly qualified as NPLs, while NPLs are only subject to an average depreciation of 46.9% as of today on their balance sheets. Finally, the European Commission has recently announced it is working on an initiative designed to reduce current NPL levels and to prevent their future increase.
  • Some U.S. hedge funds set up in 2013 will have the next year to draw down commitments from their investors, which, if not used, will be canceled.

The European NPL Market

At mid-2017, €42 billion of distressed portfolio trades have been completed in Europe and €87 billion are ongoing. UniCredit finalized a €17.7-billion Italian NPLs deal with Pimco and Fortress in July 2017, and similar large-scale deals by other banks are currently being negotiated. Hedge funds and investment banks have emerged as a key source of demand for EU NPLs.

Investors sometimes resort to securitization (mainly in the form of RMBSs) to finance their portfolio acquisition and enhance their returns, as Loan Star and Oaktree did with recently acquired Irish portfolios. The Financial Stability Review published by the ECB in May 2017 includes proposals to support NPL securitization. However, an exclusion of self-certified mortgage loans from portfolios eligible for securitization, which was recently included in the new EU draft STS securitization regulation, might harm the ability of investors to securitize NPLs after Jan. 1, 2019.

The Untapped French NPLs Market

The French market is characterized by a high stock of NPLs amounting to €147 billion, the second-highest absolute amount in the Eurozone behind the Italian market. BNP Paribas (€42 billion), Crédit Agricole (€30 billion), BPCE (€26 billion) and Société Générale (€25 billion) are the largest NPLs holders, while Crédit Foncier de France is reported to become a seller.

The French market is still relatively untapped. With an NPL ratio of 3.9% (the average ratio for the EU is 5.6% and exceeds 10% in some member states), the regulatory pressure for NPL disposal is indeed relatively low and banks have for now favored internal work-out solutions. However, as high-NPL banks are reaching the limits of their internal work-outs capacity, the situation is changing rapidly. The French NPL market is now expecting strong growth over the coming years, and Deloitte predicts that NPL sales in France will double by 2020 to reach at least €10 billion.

While the French market had only been addressed by a few players until now (including Cerberus with the support of its special servicer MCS), specialist NPL investors have started to put resources into the French market over the past few months, and foreign buyers, especially U.S. investors, have been more and more involved in NPL transactions since 2015.

Moreover, while sales had so far been almost exclusively focused on corporate and leasing loans, a €40-million consumer portfolio sale occurred during the first quarter of 2017, and two large mortgage NPLs sales are ongoing.

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