Imminent European NPL wave energises regulatory push for transaction platform adoption and digitalisation
Europe’s banks are braced for a new wave of non-performing loan (NPL) portfolios from early next year, aligned to the unwinding of direct government lending to corporates in response to the coronavirus crisis. As government support tapers, loan defaults, corporate insolvencies and bankruptcies are all expected to spiral. The pandemic has hit European economies hard – and unevenly – with much of the fallout still to come.
While EU banks are far better capitalised today than in the wake of the 2008 financial crisis, a severe economic downturn would impact banks’ ability to lend to corporates and households. A deterioration in banks’ loan book asset quality will increase NPL ratios and provisions which will combine to restrict over lending capacity. “In the coming years, the crisis could create a sizeable amount of new NPLs in all our countries,” warned Valdis Dombrovskis, the European Commission’s executive vice president. The European Central Bank has simulated possible outcomes in the scale of a new NPL wave, driven by the pandemic. In its severe scenario, the stock of non-performing loans could soar to €1.4 trillion euros, according to Andrea Enria, Chair of the ECB Supervisory Board, which would exceed the impact of the financial crisis. Thus, improving the secondary NPL market will reduce the capital constraints on banks to support economic recovery throughout the EU and enable more lending.
To tackle the upcoming flows of NPLs and support member states’ recovery, the ECB, together with the EBA and supervisory authorities, is now considering explicit recommendations to NPL stakeholders to adopt European NPL transaction platforms “in certain circumstances”. The central bank says transaction platforms “have the potential to create active, liquid and efficient secondary markets for NPLs in Europe”. NPL transaction platforms would provide an infrastructure upgrade supporting banks’ primary exit strategies: direct sales; securitisation; and through a network of national asset management companies (AMCs). Debitos and DebtX were the only two NPL transaction platforms invited to present their solutions to the European Commission’s roundtable on NPLs, held on the 25 September 2020, to tackle the expected wave of NPLs in the aftermath of the COVID-19 pandemic by further development of secondary markets for distressed assets.
The ECB’s proposals are an acknowledgement that Europe’s secondary NPL market remains relatively modest in liquidity and depth, compared to the US and China. At the same time, bid-ask spreads are often still high, and regulatory impediments hamper NPL securitisations. These proposals also reflect a recognition that previous voluntary measures to improve NPL data quality and transparency – such as through the EBA’s development of data templates – have been ineffective. Many banks considered templates laborious and were not incentivised to use them. Insufficiently aligned incentives have been a primary bottleneck in the development of the NPL secondary market. Thus, more substantial incentives are necessary – supported by explicit recommendations – to accelerate progress. The current global health crisis has sharpened attention and impetus to make progress before the next NPL wave arrives. More recently, the ECB’s European Data Warehouse has made some progress in overcoming bank resistance to data templates by revising (and reducing) their scope to “crucial data fields”. Potentially, future consensus on data templates could be adopted by NPL transaction platforms. Plans are also afoot to establish an “Amazon-style marketplace” which could help to broaden the market to buyers of smaller portfolios, disrupting the dominance of the handful of major NPL investors over the last five years.
NPL transaction platforms provide symmetrical access to reliable, granular, readily available standardised information on asset quality and loan tapes in banks. These benefits will be shared between vendors, buyers, advisers, regulators and supervisory agencies while strengthening protections for underlying borrowers. These include shared and reduced transactional activity costs; a vastly broadened investor base; reduced instances of market failure such as minimising information asymmetries; and increased creditor coordination.
All of which should align incentives between NPL vendors, buyers, regulators and supervisory agencies, advisers and technology service providers. The net effect should lower bid-ask spreads, increase NPL transaction execution speed and activity, and improve NPL market pricing. These benefits should incentivise banks to manage NPL sales through transaction platforms, adopt standardised data templates, thereby enhancing overall NPL data and information disclosure. In turn, these improvements in standardised and comparable data may inspire greater investor confidence in NPL securitisation, and synergies between a network of national AMCs and transaction platforms could emerge. The ECB suggested this interplay would resemble “a hub-and-spoke model, in which a centralised European hub could provide a data warehouse function, bringing together relevant data from across Europe”.