“Relationship banking” is defined by Investopedia as banks “cross-selling financial products and services to strengthen their relationships with customers and increase customer loyalty”.
What it means in practice is that many banks are happy making unprofitable, or barely profitable, loans since what counts is the opportunity to sell other things to the borrower once they have signed on the dotted line. Loans are often referred to these days as loss leaders.
The relationship aspect is significant since it helps to explain why Europe’s non-performing loan mountain is not being chiselled away more quickly.
On the face of it, there is a huge opportunity. According to European Central Bank estimates, the value of NPLs held in ECB-supervised banks at the end of September 2016 was €921 billion.
Investors hope that a combination of factors such as Brexit, uncertainties around the new US administration, elections in key European countries and low oil prices might collectively unsettle the banks and act as a trigger for more distressed deals.
According to PDI data, closed-ended distressed debt fundraising reached a peak of $9.6 billion in 2012 before falling away markedly in the years that followed – last year, the total was just $2.5 billion.
However, almost $7 billion of capital for Europe is currently being targeted, including a $3.5 billion-target Apollo fund. This increased interest is not surprising in light of a recent Debtwire/Orrick/Greenhill survey that found that 73 percent of distressed debt investors believed European restructurings will hit their peak this year.
Others are far more cautious, pointing to low default rates and low interest rates as reasons why only a modest number of deals have been triggered so far. With their relationships to think of, banks are reluctant to transfer their exposures to others at the big discounts buyers might be hoping for.
When it comes to performing loans, there are also reasons to sell, since doing so allows the recycling of capital tied up in low-return activities. This has led to an opportunity for ‘risk-sharing’ deals where investors take the first-loss risk of a loan portfolio while leaving the senior tranche on the banks’ balance sheets. This preserves the relationship aspect, since the assets remain with the bank and the borrowers are not notified.
In this case, the constraint on deal activity is not a lack of willingness from the banks to do them, it’s a lack of willing buyers. Only a handful of fund managers (including Chorus Capital, who we interview in our April issue) and institutional investors target the space due to the level of expertise needed and the danger that, without that expertise, you can easily be outsmarted by the sellers.
For different reasons, therefore, the handbrake may remain applied to Europe’s NPL and performing loan sales for the foreseeable future – or at least until the region’s economies take a more dramatic turn for the worse.