ECB On Non-Performing Loans: Time To Act Is Now

At a recent NPL industry event, a banker credited with completing some of the largest European NPL sales observed: “The Irish and UK banks were distressed sellers. Now their banks are on the path to recovery. The Italian banks refused to be distressed sellers. Now they are mostly distressed banks.”

The ECB’s guidance published on March 15, 2018 is likely to increase the pressure on European banks to follow the approach Irish and UK institutions took to clean up their NPLs, executing bulk or smaller note sales..

The Irish/UK Experience

The successful resolution of NPLs in Ireland and the UK shows what is possible when governments and banks are proactive in moving dead weight off their balance sheets.

When Irish and UK NPL sales were being conducted by NAMA and UKAR, there was much consternation that these dispositions were nothing more than fire sales and that governments had left money on the table.

As it turned out, this approach proved to be very effective.

The assets were put into funds that scaled up their recovery operations faster than any bank or government agency could. The funds had greater flexibility to negotiate with the borrowers and committed additional capital to projects where they saw opportunity.

Today, these NPLs have largely been resolved. The partially completed development projects that dotted Dublin are now completed or under construction. Private equity firms are moving on from Ireland to other markets for the next opportunity. Though some still argue that assets were sold too cheaply, no one believes that the recovery would have happened as quickly if these NPLs were still held by the government or banks.

As important, the banks that were weighed down with NPLs are becoming competitive institutions again. Their workout departments are slowly winding down and management is again focused on growth and productive lending.

The ECB Agenda

The ECB has indicated it wants banks to show progress on multiple fronts.

First, the ECB has made it clear that hiring more staff for workout departments is no longer considered an acceptable response to managing NPLs. Second, the ECB wants to see evidence that loans are being properly valued and that the level of NPLs is being steadily reduced. Third, ECB regulators want to see more competitive bidding for NPLs that are being sold.

With regard to this third point, the ECB is increasingly frustrated with the oligopolistic nature of the European buy-side. It wants greater competition and is encouraging banks to facilitate more frequent, smaller sales.

Smaller Sales Work

For banks with a large inventory of NPLs, smaller sales will provide two critical benefits. They provide evidence to the ECB that the institution is progressing. The market pricing data from these transactions is also useful in determining future sales for the entire NPL market.

Executing smaller transactions has proven effective for banks across Europe.

Smaller transactions have frequently resulted in higher loan sale proceeds than larger bulk transactions. The competitive bidding leads to elevated prices and to more transparency for all parties. Given the ECB’s focus, it’s likely that 2018 will see a growing number of smaller transactions. The ultimate goal is a robust and dynamic European NPL market, similar to that in the US.

In the meantime, the go-to strategy for European NPLs will continue to be the larger bulk sale. Disposing of large amounts of NPLs in a single transaction is a favored approach at the board level of many institutions because it visibly moves the needle. In 2018, we are likely to see more of these larger transactions, which some believe could total €100 billion. For banks with access to adequate capital or those that have adequate reserves, bulk sales will be a key part of the disposition strategy for 2018 and 2019.

Whether the sales are large or small, moving beyond the currently unacceptable level of NPLs is very important. As the ECB noted in its recent guidance: “High levels of NPLs affect banks’ capital and funding, reduce their profitability, divert resources that could be put to more effective use, and inhibit the supply of credit to households and companies. Addressing NPLs is therefore important for both bank viability and macroeconomic performance.”

Europe, and the entire global economy, would be well served to follow the ECB’s wisdom.

Gifford West is Managing Director, International Operations & Business Development of DebtX, one of the largest loan sale advisors in the U.S. and Europe.