One of the long-term impacts of the global financial crisis was a sharp uptick in non-performing loans as lax underwriting standards prior to the crisis and the global recession that followed created a perfect storm where over-levered borrowers were unable to repay their debts, writes John Bakie.
While this was bad for banks, which were forced to clean up their balance sheets by regulators and sell off their large NPL books, it provided huge opportunities for private markets investors specialised in buying NPLs.
Now many are looking at whether the coronavirus crisis could create a similar opportunity for investors to acquire discounted loan books.
Initial research suggests that the crisis will see banks’ NPL books growing once again, after more than a decade of working to reduce their exposure. Germany’s Federal Association of Loan Purchase and Servicing expects NPLs in the country to surge from €33 billion at the end of 2019 up to around €100 billion this year.
Real estate investor CR Investment Management believes this will be a particular issue in the real estate sector, which is not expected to be a major beneficiary of government support packages, which have so far been primarily aimed at SMEs.
CR’s managing director, Torsten Hollstein, explains: “Even at this time, the market is already showing signs of distress. Over the next two or three months, we will see a sharp increase in the number of NPLs. This development is not likely to ease up before the end of the year.”
The firm said it is already receiving requests to take on workout mandates for real estate financing arrangements.
Support is limited
While the German government has announced generous guarantees, Hollstein stresses that support is likely to be limited and will not cover real estate loans, meaning the sector won’t see relief any time soon.
However, increases in NPLs are likely to be highly geographically varied depending on both the severity of coronavirus outbreaks and the way governments respond.
Charles Rusbasan, chief executive of specialist NPL investor Balbec Capital, which buys debt linked to consumer insolvency, says: “Our servicers are receiving initial inquiries for forbearance on our mortgage book, however, a lot of those borrowers are continuing their payments; there has actually been very little deterioration in cashflow to date.”
However, even within the US this can vary, with more acute problems in New York, which has seen the most coronavirus cases and deaths in North America.
“In Europe, the opportunity set is very regional with Italy, Greece and Cyprus quite badly hit, while other countries are within the range of normal variance.”
In Europe especially, NPL disposals by banks have been largely driven by regulation intended to improve bank capitalisation. However, regulators are already taking a proactive approach to ensure banks are able to deal with the current crisis. The European Central Bank has issued guidance for banks saying it will take a flexible approach regarding classification of obligators as unlikely to pay. It will also extend preferential treatment to publicly guaranteed loans made as part of governments’ responses to the coronavirus crisis.
Banks will also benefit from more relaxed supervision in order to help support them during the crisis. The ECB statement says: “The ECB is… very much aware of the need to support banks at this difficult juncture, when they face not only economic distress but also an impairment of their ordinary working modalities. This means that the supervisory burden on their operations should be alleviated to the maximum extent possible.”
This includes postponing remedial action deadlines by six months and allowing banks with stable recovery plans to submit only core elements of their recovery plans for 2020, with a focus on covid-19 stress. Banks will also be permitted to address only key deficiencies in their 2019 plans.
These measure could, in the short-term, result in banks being under less pressure to sell on NPL books to non-bank investors, though it is expected that they will still need to reduce their overall NPL exposure in the medium to long term, meaning investors are likely to see a steady supply of NPLs coming onto the market over the next few years.
NPL investors themselves are likely to face challenges of their own in acquiring new investments due to the virus, according to one NPL investor.
“Investors are going to face logistical hurdles too as there will be difficulty flying people in for meetings due to travel restrictions. We expect this will be more of an issue in Europe than in the US,” he says.