Long live the European distressed debt market. The European NPLs market

By Javier Martín Banderas

 

A recently published report from Bruguel “Risk reduction through Europe’s distressed debt market”, quantify the size of the European NPLs (€870bn) and non-core assets (€1,1tn) stocks held by EU banks, highlighting the importance of addressing the situation for the banking industry recovery and so, Europe’s economic growth.

However, the till now slow resolution process followed by the banks and the expected further supply of NPLs as a results of: (i) the new ECB Guidance to banks on NPLs -published on March 2017-, (ii) the IFRS 9 accounting rule -effective from January 2018-, and (iii) the stress tests the EBA will run in 2018; imply a future strong activity in the European distressed debt market.

Notwithstanding the above, the development of an enhanced European distressed debt market it is something that will be underpinned by the implementation of several actions allowing a deeper and liquid market, mainly increasing transparency through the divesting process and reducing transaction costs. Successfully solving those market flaws would allow the reduction of the entry barriers widening the investor base and so gaining a more competitive environment.

A non-conventional approach

Many of the key points highlighted in Bruegel´s report, coincide with those exposed previously by Davide Serra -from Algebris Investment– along his presentation at the Second ESRB annual conference on September 2017. At the same time he showed, from a different point of view, which should be the best way to manage this type of problematic assets.

It’s worth seeing his speech, starting at 38´40´´, where he underlines several important issues:

  • (i) Banks usually do not allocate its best people to deal with their most worrisome problem: NPLs.
  • (ii) Disbelieve the role of AMCs.
  • (iii) The need of a ready-to-act investment/servicing industry.
  • (iv) Corporate loans: Set up policies that allow an early debt-for-equity swap.
  • (v) To reduce the observed bid-ask valuations gaps, you need to accelerate the whole process: “It´s all about speed”.
  • (vi) There is no “silver bullet” solution: forget the likes of a “tech platform” to sell the assets, everyone is different and there is no way to standardize them.

A country level view

While the 80% of the NPLs stock -2015 to 2017- have been located in only four countries: UK, Italy, Spain and Ireland; things are prone to change as a result of:

  • (i) Ireland: in October 2017, NAMA paid off the final tranche of the €30,2bn debt guaranteed by the Irish government reaching that point three years early than the set up target.
  • (ii) Spain: the steep pace at which banks are divesting NPLs and REOs, especially in the 4Q17 when the deal flow volume rocketed up “…considering Spain is going through one last splash of NPL portfolio sales”.

The following chart from Deloitte reflect NPLs deal flow across Europe, showing an increased activity in Italy and Spain:

Anyway, the NPL and coverage ratios along Europe countries shown an heterogenic landscape that, in the meantime, could lead to the arise of NPLs levels not previously thought in others countries. Sort of can be deducted from the PwC´s chart that follows:

Pivoting to Italy

The size of the NPE has been growing from 2008 until it reached its peak of almost €350bn in 2015 and a NPL ratio of 16%-18%.

This chart from PwC´s “The Italian NPL market” show how much remain to be done in this market.

As a result, along 2017 the interest of the NPLs’ international investors drove to a flush of deals either regarding NPLs portfolios as servicers companies.

From Capital Structure “NPL 2017 Review and Outlook”:

“Other notable transactions included KKR‘s purchase of Rome-based special servicer Sistema, Varde Partners purchase of 33% of the equity of Guber, Bain Capital‘s acquisition of HARIT and David Kempner‘s acquisition of 44.9% of Prelios. In a move that bucked the M&A trend, however, Lone Star Funds sold its Italian NPL servicing business, CAF, along with a portfolio of NPLs to Lindorff-Intrum in December”.

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