Collateralised NPL: These trends are shaping the market in 2018.

Will 2018 be the year in which non-performing loans finally become recognised as a legitimate investment opportunity? The EU Commission, the ECB and the EBA are employing a number of measures to make NPL trading more structured, more accessible, and thus more attractive.

Around 2007, when the term ‘toxic loans’ began to surface in the media, it sent shivers down the spines of many financial services professionals. The ‘banker’ brand was significantly damaged in the minds of the public, who felt that they were paying for the mistakes of the industry. In 2010, even the Oxford English Dictionary began to give examples of financial instruments under the entry for ‘toxic’.

Fast forward ten years and the headlines, if not the sentiments, have died down somewhat. So much so, that few people know that investing in non-performing-loans (NPLs) has since become an everyday occurrence: the global market has been there for decades but the desire of the regulators to de-risk bank balance sheets has caused a resurgence. A study by Deloitte found that close to EUR 130 billion of NPL packages were expected to be sold EU-wide last year – around one-third more than in 2014. The total gross volume of non-performing bank loans in the European Union (EU) stood at about EUR 1.3 trillion at the end of March 2017, of which EUR 921 billion were on Eurozone bank balance sheets, amounting to around 5% of its entire credit volume.


A Win-Win-Situation for everyone in the NPL market?

Despite the significant upturn in the economy since the Great Financial Crisis, the ratio of potential credit defaults is not falling as fast as the EU Commission would like. In July 2017, the EU council charged the Commission and a number of other bodies with the production of an action plan to deal with the issue, and ensure greater financial stability across the EU. These included the European Banking Authority (EBA), the European Central Bank (ECB) and European Securities and Markets Authority (ESMA), as well as the European Systemic Risk Board (ESRB). Part of this plan would involve simplifying the process by which banks can transfer NPLs to non-banks, encouraging secondary markets in NPLs, and possibly establishing an NPL transaction platform.

The latter would use standardised templates and processes, all of which would encourage public perception of NPLs as a legitimate investment option. This would also enable banks to de-risk, restructure their portfolios and redeploy NPL resources to their core activities. Most importantly, it would free up capital to perform those functions, which banks do best, such as funding economic growth. Finally, it would also allow the regulators to keep a watchful eye on the market and how business is conducted.

A win-win situation for everyone then. And just the beginning, according to the EU council, which is planning further measures for 2018. For NPL experts such as the EOS Group, this is going to be an exciting year, particularly as increased regulation will make it more attractive to invest in this asset class.

Increased structure and standardisation in the NPL market, perhaps helped by the launch of national asset management companies (AMCs), will encourage confidence in these markets and attract higher-quality investors. The portion of the NPL market which is collateralised by, for example, real estate, planes, ships, securities etc., is already an increasingly attractive option, according to consultants in this field, such as Deloitte.

The ECB, in its attempts to encourage banks to divest their balance sheets of NPLs, suggests winding up or writing down these debt receivables. This proposal is unpopular with the banks, as it would leave them with little or nothing, whereas selling on non-performing assets provides at least some hope of a return. For example, KBC Bank of Belgium sold 40 % of its debt receivables during its restructuring, enabling it to repay the government support it had received five years ahead of schedule. The NPL portfolios were acquired by EOS Aremas, an experienced player in the Belgian financial services sector.

This effective role model for investing in NPLs could be usefully repeated in Italy and the Balkan states, where the recent collapse of the property market may significantly increase the number of large, collateralised NPL portfolios on offer. Banks in the region are under pressure from the regulators to de-risk and thereby improve their credit ratings.

Investing in NPL is no easy business.

While there will a lot of opportunities, asset managers need to keep on thing in mind: An investment in NPL portfolios is not for the faint-hearted or inexperienced. The management of collateralised and mixed portfolios is a complicated business and receivables management companies face many challenges. The thorny issue of data is one, which can be partially addressed through the NPL platform mooted by the EU. Banking secrecy laws and the GDPR (General data protection regulation) may make it difficult for asset management companies to obtain all of the information that they need. Then there is the additional challenge of collateral valuation, which must be monitored continually. The EBA has recognised these as key issues, which might hinder the further development of the industry and emphasises the importance and integrity of the underlying data systems.

The EOS Group has developed a considerable depth of expertise; especially in the area of loans collateralised by real estate. By employing case managers, legal counsel and outside specialists, EOS has become a leading player in this sector. But for EOS, along with professionality must come heart: “The way we treat our customers is very important for us”, says Veerle Timmermanns, KBC’s Director of Commercial Credit. “Anyone who works with us must treat them with respect and empathy, as we do ourselves.” The reputational risk for the bank in divesting these loans is huge and not to be underestimated. In the eyes of the world, its responsibility does not stop when the portfolio is acquired by another organisation. The public and the press will give no quarter if they feel that banks are allowing their former clients to be badly or unfairly treated. Hence, the successful divestment to EOS Aremas, an organisation which shares similar values to those of KBC.