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European non-performing loan trends in a post-COVID-19 world

Foreword

While the overall European non-performing loan (NPL) market has been in decline since its peak in 2018, the ongoing impact of COVID-19 may soon change things.

It has been a tough year for European business and consumers, as waves of COVID-19 lockdown restrictions took their toll. Entire sectors were effectively shut down, with many surviving on government support and employee furlough programmes, as well as tapping liquidity markets and taking advantage of any debt relief measures on offer.

Travel restrictions and economic uncertainty also impacted the NPL market. Though activity shut down in the second quarter of 2020, the final quarter saw a partial recovery, with deals worth €28.6 billion signed in Q4 2020 alone. However, price gaps continued to impact some deals. The first month of 2021 saw deals close that were worth €3.3 billion, as some deals paused due to lockdown conditions managed to compete. Looking to the rest of 2021, Greek NPL deals are keeping the NPL pipeline filled.

The impact of COVID-19 on loan quality has yet to be felt. Many companies have managed to avoid slipping into insolvency thus far, whether through government stimulus measures or agreements with lenders, but once those measures wind down and lenders reassess the creditworthiness of their borrowers, that is likely to change. Provisioning levels at top European banks in the UK, Spain, France, Italy and DACH reflect this reality, almost doubling year-on-year from 2019 to 2020, according to Debtwire.

Governments across Europe recognise the challenge they are facing. A spike in NPLs among lenders could spell trouble for those same lenders, prompting the EU to consider regulatory options that will help smooth the process. Standardised templates, securitisation and boosting secondary NPL trading are all on the cards, as regulatory bodies and lenders take a proactive stance to prepare for a potentially rocky road ahead. Taking these steps also opens the door to more buyers entering the market—including some that were once active but may have stepped aside as things cooled, including PE firms, banks and other debt servicers. It may also encourage partnerships to invest in NPL portfolios, which may also drive the speed of portfolio disposals in the coming year.

New market opportunities in sight?

At a regional level, Italy and Greece remain NPL hotspots, as the securitisation of NPL portfolios coupled with state-backed guarantee schemes continue to help reduce NPL stocks among banks. But other markets are now showing signs of activity, and investors are watching very closely.

In Spain, moratoria on mortgage and non-mortgage debts are set to expire, prompting many Spanish banks to prepare for an uptick in NPL stocks—the four top banks in the country put aside provisions of €22 billion in 2020, up from €15 billion in 2019.

Many expected UK banks to move quickly in the event of an expected rise in NPLs, given the high economic fallout of multiple lockdowns. Top UK bank provisions rocketed by 3.1x year-on-year, to €21.2 billion, as banks braced for loan losses.

Ireland, France, Portugal and even typically cautious Germany (where SME loans are expected to be the largest source of NPL stock rise) are all on the radar for investors. But the degree of rise in problem loans still has a large degree of variability, with the speed of economic recovery and the end of huge levels of government support still unclear.

COVID-19 and the state of the European NPL market

Early in 2020, as the pandemic took hold, the European NPL market went into lockdown along with the rest of the economy—but as the market opened up in the second half of the year, NPL sellers jumped back in, setting the stage for a busier 2021.

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Key figures: At a glance

NPL and non-core loan deal activity for 2020 fell by more than a third year-on-year while provisioning among top banks in the UK, Spain, France, Italy and DACH have almost doubled during the same period, setting the stage for what is expected to be a very busy 2021.

 

Regional spotlight: NPLs in France, Germany, Spain, UK & Ireland

Opportunities for NPL investors are presenting themselves in European jurisdictions outside of the largest markets: Italy and Greece. Here is an assessment of markets where new opportunities for NPL deal flow are emerging.

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Conclusion

Where will the European NPL market go from here? A lot depends on vaccine rollouts and the end of debt relief measures. For many, that will be their first chance to assess the damage and plan ahead.

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Regional spotlight: NPLs in France, Germany, Spain, UK & Ireland

Opportunities for NPL investors are presenting themselves in European jurisdictions outside of the largest markets: Italy and Greece. Here is an assessment of markets where new opportunities for NPL deal flow are emerging.

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Drilling down into the data reveals substantial NPL activity just under the surface waiting to break across Europe

Europe's two largest non-performing loan (NPL) markets—Italy and Greece—accounted for the majority of European NPL deal activity in 2020 and absorbed most investor attention. Government-supported NPL securitisations and high levels of legacy NPL stocks will see these countries continue to take the spotlight when it comes to NPL deal flow.

At the same time, other European countries are showing signs of activity that point to more dealmaking in the months ahead. Provisioning levels at major banks in France increased in 2020, as did those in Germany, Austria and Switzerland (DACH) as well as Spain.

In the UK and Ireland, meanwhile, several larger deals that were put on hold due to COVID-19 are now set to go ahead, while the UK's largest banks are reporting an increase in loans at risk, suggesting an active 2021 for NPLs.

Elsewhere, there are signs of potential activity in the months to come. For example, bank loans worth approximately €23.2 billion in total are currently subject to COVID-19-inspired moratoria in Spain, Portugal and Greece. These could turn into NPLs in the months ahead. The issue is particularly serious for Portugal, which could see its NPL level increase by more than 50 per cent after the programme expires in September 2021.

Drilling down into the data reveals substantial NPL activity just under the surface waiting to break across Europe—and buyers and sellers alike will not hesitate to take advantage of the opportunity.

 

FRANCE: On the rise

France is positioned for a busier year of NPL activity in 2021. The country's banks have been slower to deal with NPL exposures than their counterparts in Italy and Greece, given that the NPL ratio of the system has remained low. As a consequence, by the end of the year, France was holding the highest volume of NPL assets in Europe. France's four main banks—BNP Paribas, Société Générale, Groupe BPCE and Crédit Agricole—saw their NPL holdings increase from €83.8 billion in 2019 to €85.1 billion in 2020.

French banks also provisioned €14.6 billion that year to cover anticipated distressed loans emerging from the disruption caused by COVID-19—more than double the €6.4 billion set aside in 2019.

France's banks will be under pressure to offload these loans as pandemic volatility subsides, and some lenders have already moved to reduce their NPL exposure.

In August 2020, for example, Société Générale sold its €550 million Project Gaya—a primarily secured SME loan portfolio—to CarVal and iQera, a debt purchaser and servicer owned by BC Partners. This was the largest French NPL portfolio deal since 2015.

NPL sales momentum is expected to carry through 2021 with Société Générale bringing forward Project Orsay, a €200 million secured NPL portfolio deal, at the end of 2020.


 

GERMANY: Cautious but well prepared

The German NPL market has not been as active as other jurisdictions, having already made sales earlier in the NPL cycle. The market will remain of interest as German banks continue to pay close attention to capital adequacy requirements, controlling leverage and analysing the impact of COVID-19 on the performance of existing loan portfolios.

Provisions at DACH banks— although much lower than levels in the UK, France, Spain and Italy— almost tripled year-on-year in 2020, to €4 billion. German SME loans are expected to be the largest source of NPL stock rises in Germany, accounting for almost two-thirds of increases in NPL ratios, according to publicly released analysis from PwC. On a sector basis, retail credit is expected to be the largest contributor of new NPLs in Germany, accounting for approximately 30 per cent of the NPL ratio rise.

Although provisions are rising, NPL transaction volume in Germany was limited to a handful of deals in 2020. Cerberus sold a portfolio of shipping loans with a gross book value (GBV) of €250 million to LCM Partners, which also acquired a pool of unsecured loans from Hamburg Commercial Bank with GBV of €360 million. Hamburg Commercial Bank, meanwhile, offloaded a €700 million wind farm loan portfolio to Unicredit. It has been reported that a number of affected

German banks have become more vigilant when reviewing their workout options, including disposals and/or structures to take ownership of the underlying collateral, thereby avoiding market losses and allowing them to wait for recovery.

Some German banks are also considering risk transfer transactions for still-performing loan portfolio assets that are at risk of NPE status, in order to avoid negative accounting consequences. It generally remains to be seen whether higher levels of provisioning actually leads to real NPL activity in Germany, where lenders have historically sought to manage troubled credits internally.

€22 billion
Total provisions put aside by Santander, BBVA, Sabadell and Caixabank in Spain in 2020

 

SPAIN: Expectations rise

NPL deal activity fell to a five-year low in Spain in 2020 as NPL transactions were put on hold due to tight COVID-19 restrictions. Banco Santander's Project Prometeo, a €2.1 billion NPL sale that was on track to go to M&G, was one example of a large NPL transaction that stalled following the pandemic. Pricing gaps also added to deal delays.

The tally for closed NPL deals in Spain reached €6.8 billion in 2020, less than half the €16.1 billion recorded in 2019 and 88 per cent down from the €54.9 billion in transactions posted in 2017 when the market was at its peak.

Falling NPL volumes in the country's four largest banks—down from €65.5 billion at the end of 2019 to €62.9 billion in 2020—also meant there was slightly less urgency to offload NPL portfolios.

Spanish banks are, however, preparing for NPL stocks to start climbing once again, as moratoria on mortgage and non-mortgage debts expire. These limited the deterioration of credit quality through the pandemic and, without them acting as a buffer, many of these loans may fall into distress.

Between them, Santander, BBVA, Sabadell and Caixabank put aside provisions of €22 billion in 2020 to cover potential losses, up almost 50 per cent on the €14.7 billion set aside in 2019.

NPL deal activity in the country showed initial signs of recovery in the second half of the year, as COVID-19 restrictions eased and markets reopened. This rebound saw eight deals close in the second half of 2020 worth €4.4 billion, including Project Saona, a €1.6 billion unsecured mortgage portfolio sold by Sareb (Spain's state-backed "bad bank") to distressed investor Procobro.



 

UK & IRELAND: Credit risk on the rise

COVID-19 saw NPL deals in both the UK and Ireland put on hold through 2020. The UK only saw €3.6 billion in sales, less than a third of 2019 figures and the lowest level of transaction volumes since 2015, according to Debtwire. There was only one sale closed in Ireland in 2020, worth €1.4 billion—down from €9 billion in 2019 and €14.4 billion in 2018.

NPL activity in both jurisdictions, however, is expected to revive as the volume of NPLs on bank books starts to increase in the aftermath of the pandemic. NPL volumes in four of the UK's top banks reached €42.8 billion by the end of 2020, up from €39.4 billion the year before.

The UK market started to pick up at the end of 2020, with the largest deal of the year, Metro Bank's sale of a residential mortgage portfolio for €3.3 billion to NatWest, crossing the line in December.

Metro Bank, which is changing tack after acquiring peer-to-peer lending platform RateSetter, was also involved in the sale of the latter's £167 million property development portfolio to Shawbrook Bank. Natwest, meanwhile, hired advisers early in 2021 to run the sale of a £550 million distressed commercial property loan portfolio.

A 10 per cent increase in impaired loans across the UK's largest banks and a doubling of loans with significantly increased credit risk could also see NPL deal volumes increase.

Loan loss provisions at Ireland's pillar banks, meanwhile, also increased through the pandemic. DBRS Morningstar figures show that Irish banks increased their loan loss provisions more than tenfold in 2020, rising to €2.74 billion from €241 million in 2019.

In addition to a rise in anticipated deal flow from increasing NPL exposures, deals halted through lockdowns could also come back to market. Allied Irish Bank's mortgage NPL portfolio deal, meanwhile, was relaunched and sold to Apollo.


 

 

This publication is provided for your convenience and does not constitute legal advice. This publication is protected by copyright.
© 2021 White & Case LLP

 

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