Are non-peforming loans (NPLs) an investor’s dream come true? Or do they represent immeasurable risks? Either way, a fresh batch of such opportunities is the subject of reform in Brussels. Here, legislation to liberalise secondary markets in the NPLs cast off by Europe’s banking sector is under consideration.

The Directive on Credit Servicers, Credit Purchasers and the Recovery of Collateral (COM (2018) 135), was proposed by the Commission in March. It has moved to discussion in the European Parliament and with member states. Also involved are amendments to Regulation (EU) No 575/2013 which covers non-performing “exposures”.  

As for timing, the Commission hopes for a swift agreement before the European Parliament’s elections in May 2019. But as one commentator says, “it all depends on Italy”.

Officially, NPLs on the balance sheets of banks are loans where the borrower is unable to make the scheduled payments to cover interest or capital reimbursements, when the payments are more than 90 days overdue. 

The new rules will be part of the risk-reduction measures, an element in the EU’s Banking Union programme. The plan, says the Commission, is to combat existing “high fees [which] credit servicing firms charge to purchasers… and low prices banks can realise if they sell NPLs to non-bank investors”.

The overall political background, as stated by the EU’s Single Supervisory Mechanism (SSM), is that NPLs “weigh on banks’ balance sheets… and divert resources from more proactive use”. The danger is a potential threat to bank stability in euro-zone countries. The SSM is a body that grants the European Central Bank (ECB) the supervisory role to monitor the financial stability of banks. The ECB initiates much of the NPL reduction, and recently held an online seminar to discuss NPL challenges. 

Happily, as another EU institution, the Single Resolution Board (SRB) states, NPL ratios have been falling in nearly all member states. Overall, the NPL ratio in the EU has declined to 4.6% as of the second quarter of 2017, down by a third since the end of 2014. 

But, says the SRB, which ensures “the orderly resolution of failing banks”, several member states still have high NPL ratios: Bulgaria, Ireland, Greece, Croatia, Italy, Cyprus, Hungary, Portugal, Slovenia, as at June 2017. 

Willem Pieter De Groen, of the Centre for European Policy Studies think tank (CEPS), says more than 15% of the loans are, or have been, non-performing.  

According to a bank insider, removal of impediments against NPL assets being sold on the secondary market will provide many interesting opportunities for investors. For instance, some so-called NPLs may already be properly covered by collateral. In those cases, a bank might well prefer to hold on to the asset. 

Presumably sensitive to such undue pressure to sell, the ECB states that it is “not pressing banks to sell NPL…. [the bank] has not expressed a preference for certain NPL reduction tools over others”. 

In any case, the Commission, in describing its proposal, writes that its aim is to overcome existing barriers faced by credit servicers to expand cross-border. It is seeking to scale up their activities on trading in secondary markets of assets following bank divestment of NPLs. 


Frankfurt: The ECB has held talks on the challenges of non-performing loans

It explains that the need is because only some member states regulate the activity. And, those that do, it continues, “define very differently the activities covered. This in practice poses a barrier to the development of expansion strategies through secondary establishment or cross-border provision of services in the internal market”.

Furthermore, the Commission continues, a considerable number of member states require authorisations for some of the activities that these credit servicers engage in. They impose different requirements and do not provide for possibilities of cross-border scaling up. 

Finally, large differences in regulatory standards across the EU results in market fragmentation. This “restricts the free flow of capital and services within the EU, leads to insufficient competition and slows down the development of a functioning secondary market for bank credits”.

Preceding this picture, in March 2017, the ECB published its final guidance to banks to clarify “supervisory expectations regarding identification, management, measurement and write-offs of NPLs”. The ECB’s stated aim was to strengthen banks’ balance sheets.

Complicating matters are non-perfoming exposures (NPEs), which are more generic. Here, a bank may miss being repaid not only on loans, but also on other assets, such as a defaulted security. The ECB also notes that the new rules will not apply to NPEs originated before 14 March 2018.

Europe’s wholesale financial markets appear to be supportive in principle. Nonetheless, the Association for Financial Markets in Europe (AFME) goes on to set out a number of warnings and suggestions for changes. 

For instance, AFME associate director Julio Suarez says the association’s members are concerned about the Commission’s approach to “minimum provisioning”, which means the extra capital that banks have to set aside as cover for NPLs.  Suarez strongly urges the EU institutions “to collaborate more in standard setting to avoid multiple non-aligned and duplicative requirements”. 

Unsurprisingly, considering the number of EU institutions involved, Constance Usherwood, Prudential director at AFME, complains that the ECB, the European Banking Authority and the Commission all have parallel initiatives with the same intention. Yet, she says, they “are not aligned with each other”.

The European Banking Federation divides NPLs into three groups. Some €329bn-worth are described by the federation as “non-problematic” or elsewhere as “a normal part of banking”. Another group, described as “covered, by provisions or collaterals”, totals €237bn. At the bottom end is €266bn, of which €150bn-200bn is described as “posing a real problem in Europe”. European banks have about €43trn in assets.