Banks turn to investors as means to improve restructuring of NPLs

Banks across Europe are aiming to reduce their exposure to non-performing loans, as new regulations and accounting requirements come into force. To do so, investment funds are being increasingly targetted by in-house teams from banks, such funds are seen as better equipped to deal with the transformation processes across various areas.

The financial crisis of 2008 created a massive increase in non-performing loans (NPLs) across Europe. The resulting recession, created a host of negative outcomes for millennials entering the job market to economic output more widely, particularly across the West. In a variety of countries, the scars of the crisis remain – as financial services institutions, particularly in Greece, Italy and Portugal, continue to have relatively large numbers of non-performing loans (NPLs) on their balance sheets.

Many of those loans are now being sold, removing them from the balance sheets of banks, as part of the wider clean-up of the sector following the crisis, with European NPL market projected to hit a record €128 billion in deals this year.

In a new report from Oliver Wyman, titled 'The Dawn of a New Era in Corporate Restructuring', the consulting firm explores changes to the regulatory market that have spurred financial services institutions to sell NPLs to investment funds.

The study notes that non-performing loans have largely remained concentrated in Southern countries, with Greece predictably noted as holding the highest level of NPLs at 46.9% of gross loans, followed by Portugal and Italy, at 19.7% and 16.4% respectively. The beleaguered economies have faced stringent repayment conditions from the EU for a number of years, even including technocrats being installed to override the democratic will of those nations with regards to the debt. Meanwhile, Western European countries have relatively low-levels of NPLs still on their books. In total, around €1 trillion in NPLs remain across Europe.

New regulations, including the Single Supervisory Mechanism, Basel IV and accounting standard IFRS 9, mean that banks are facing increased pressure to move the loans off their balance sheets. In preparation, institutions are professionalising the movement of NPLs off their books, including the use of ‘in-house’ teams to identify possible strong bets for sale to corporate or investors.

In terms of how banks will change the way that they treat NPLs, portfolio transparency comes in number-one spot in both high- and low-NPL countries, at 77% and 84% respectively, reflecting the effect of Single Supervisory Mechanism. The sale of NPLs to investors is noted as increasingly important, at 74% of low-NPL and 69% of high-NPL countries. In addition, focus will be placed on in-house expertise 69% vs. 50% and outsourcing to service providers – although largely in high-NPL countries.

The major driving forces behind the sale of corporate NPLs are headed by risk exposure reduction, rated by banking leaders as a priority, levelled at 4.1 out of five. The focus of in-house resources on the most relevant corporate NPLs takes the second spot in terms of relevance, particularly in high-NPL countries. Dropping the NPLs to avoid lengthy and difficult restructuring processes follows, with restructuring providers also seen as more able to support transformations compared to the banks themselves.

The move by banks to extricate themselves from their NPLs where possible, in many instances using in-house teams to bundle and market NPLs, has resulted in the broadening of interest in NPLs from investment funds, both specialists and private equity firms.

Banks and Funds

When asked whether there is an interest in acquiring NPLs, 60% of investors in distressed debt/equity noted interest and 36% of approached private equity firms. Private equity firms did note considerable selective interest in NPLs, at 37% of those surveyed.
The organisations take relatively similar approaches to NPL strategy, with 43% investors in distressed debt/equity focusing on taking control via debt-equity swaps, while 60% of private equality firms approach the situation in this way. Actively driving turnaround as a lender comes in at 40% for investors in distressed debt/equity and 30% for private equity firms.

One reason to turn to investment funds to restructure corporate NPLs, is their inherent strength in the activity relative to banks. To better map the areas of disadvantage, the consultancy firm ranked 13 different criteria, as well as the advantage to banks (5) or to funds (1).
Banks win out in terms of their local presence, as well as the networks in which they operate, while garnering considerable credibility and trust with shareholders and management. In addition, they have stamina, experience and knowledge about the market environment.

Funds meanwhile considered better equipped for the transformation of debts. They are perceived as more able to leverage their expertise to quickly execute turnaround plans, and can act without reputational constraints. They contribute additional equity and also have lower level of regulatory scrutiny meaning they have less trouble converting loans into equity. As a result, the trend for banks divesting of NPLs to investment funds remains likely to continue and even increase, as the institutions of Europe continue to hasten their recovery from the financial crisis of a decade ago.