Non-performing loans continue to weigh on the minds of bankers and politicians across the EU. In the decade since the financial crisis, the spectre of bad loans that caused the crisis hasn’t gone away and, in some countries, remains so prevalent that it poses serious risks to the European financial system.
The enormous volume of NPLs still swilling around Europe’s banks offers a significant opportunity for specialist debt investors to pick up portfolios at a serious discount and activity in this area has picked up in recent years. However, investors face a number of potential hazards which have to be navigated successfully, covering the political, the macroeconomic and day-to-day business management.
While almost every country in Europe suffered from growing levels of NPLs in the wake of the collapse of Lehman Brothers and the ensuing financial crisis, some countries were more severely affected than others.
Data from the European Central Bank show Greece and Cyprus are particularly adversely affected by NPLs, with levels far above any other country in Europe. Given the particularly acute economic crises these countries experienced in the wake of the 2008 crash, this is little surprise. However, NPL levels in Greece remain eye-wateringly high and barely reduced between 2016 and 2017.
Beyond that, the NPL burden is largely confined to southern and eastern Europe, with Ireland being an exception. While each of these geographies comes with a potential wealth of opportunities for private funds to acquire NPL portfolios, they also have their own unique challenges.
Ireland is very much an oddity among the countries listed. As a north-western European nation with a well-developed economy and legal system, Ireland has managed a strong recovery out of the financial crisis and its economy today is doing well. In particular, it is seeing rapid growth of its finance sector as it picks up fund domiciles due to an attractive tax regime and also benefits from uncertainty over the UK’s departure from the EU.
Despite this, NPL rates remain high. The Irish government (which also still owns shares in various Irish banks) is keen to act on the issue, but political drama can get in the way. Back in February, PDI reported that Irish MPs were attempting to block the sale of €4 billion of NPLs from state-backed bank Permanent TSB. The MPs argued that selling debt at a discount to funds was unfair and should have been offered to the underlying mortgage holders. They also accused private funds of being “vultures”.
Moving to the east of Europe, there is a group of countries in the top 10 list of outstanding NPLs: Bulgaria, Slovenia, Hungary, Romania and Croatia.
According to AnaCap’s investment director, Rakesh Balasundaram, the central and eastern European market “is behind western Europe in the NPL deleveraging cycle”.
This means that while many banks in other European jurisdictions have already offloaded some of the better assets in their portfolios, CEE banks are still rife with opportunities, but they do differ from those available in the west.
For AnaCap, the main attraction of central and eastern Europe is the size of deals available. While portfolios for sale in other parts of Europe have been quite large, a smaller and more diverse array of portfolios are available in the CEE region.
“Countries like Slovenia fit our sweet spot in terms of size. The smaller portfolios get less interest from the big investors,” Balasundaram says.
More opportunities are expected to arise in the region in the near future. In Slovenia, banks still have a significant problem with their NPLs, according to Balasundaram. Most of the banks are still state-owned but the Slovenian government wants to privatise them in the coming years, which will require turning them into healthy businesses so they can resume their lending activity. Offloading NPLs is a major factor in enabling this. Similar situations exist in Poland, Hungary, Czech Republic, Croatia and Romania.
In the more familiar developed markets of western Europe, there has been a notable north-south divide in how the NPL market has developed. While all countries saw NPLs spike in the wake of the financial crisis, most of north-west Europe has seen an economic recovery and significant reduction in NPLs back to more normal levels.
But countries along the Mediterranean have fared very differently. Even a decade after the financial crisis, unemployment remains high and economic growth has only just begun to recover. Greece, by far the worst affected by NPLs in Europe, has emerged from a multi-year bailout programme and suffered the worst economic contraction in its history. However, it seems as though the region is now starting to recover and banks are using this as an opportunity to clean up their balance sheets.
“We’re at an interesting stage in the NPL market’s development now because there are three or four interesting countries in southern Europe at the same time meaning there is a lot of volume out there,” says Francisco Milone, partner and head of real estate at Värde Partners.
“2017 saw our highest deployment of capital in real estate in 10 years and so far 2018 is going to be a very good year for us in terms of capital deployed.”
Even though there has been growing pressure on banks to offload their NPLs by both regulators and politicians, business concerns are also relevant and this is why southern Europe is only now starting to become a highly active market for NPLs, despite the problem weighing heavily on banks for some years.
“These markets can move slowly. Even when the ECB says a bank has to sell, it doesn’t mean it can be done immediately,” says Milone.
However, while the opportunities are presenting themselves at the same time, each country is quite different in terms of the kind of loans offered and the approach NPL investors need to take towards them.
“In Spain, there’s a lot of competition for NPLs but most of the underlying asset is land. If you end up owning land you need to know what to do with it and have a plan in place to develop that land. We invested in a developer to turn that land into residential developments,” explains Milone.
“The Italian market is very different, portfolios are less homogenous than they are in Spain. Italy can be more complex because you have to get the timing right and not rush into deals. Many investors don’t get the timing right and it can adversely affect your IRR.”
Europe right now seems to offer a veritable banquet of NPL opportunities for all types of investor. However, regional difference in terms of both business considerations when buying portfolios, and the political issues which often ultimately affect when and to whom portfolios are sold, means it’s essential to have good knowledge of the geographies funds are investing in. Having local links to banks and businesses that can help manage down portfolios is essential to getting the right price and being able to turn difficult loans into a profitable business.