When the economic sub-group of Europe’s Council of Ministers meet in Malta on Friday, they will consider a few ways to start resolving Europe’s non-performing loans problem, including the suggestion, from Andrea Enria of the European Banking Authority, for a pan-European “asset management company” to buy bad loans from banks and sell them off. Ministers will consider this proposal (hated by the Germans) as well as national bad banks or asset management companies, and any other structural impediments to selling down NPLs
It’s a topic that needs tackling — PwC estimates the European banking sector has €1.3tr in ‘non-core assets’ and €781bn in NPLs — but most of the solutions on the table are too little, too late, and concentrate on the wrong parts of the problem.
First up is the idea that NPLs are a “European” problem. Europe might have partially unified banking supervision, but the size of the problem differs so drastically between countries it can’t really be considered continent-wide.
The EBA’s study last year shows four basic groups — suffering Greece and Cyprus, with 47% and 49% NPL ratios, other peripheral countries (Italy, Portugal and Ireland) in the mid-teens, challenged CEE countries (Bulgaria, Slovenia, Romania, Hungary) around the same levels, and single digits everywhere else.
Italy has the largest stock of NPLs by absolute size, and seems the scariest for many investors — it has plenty of weak banks, a heavily indebted sovereign, low growth and is far too large to be rescued.
But this has been a topic of hand-wringing in the market for months, if not years. For most of last year, Monte dei Paschi lurched from crisis to crisis, falling into the arms of the state just before Christmas. Each new setback meant a wave of headlines — and every credit analyst in London learned the differences between sofferenze (the suffering, or insolvent) and incagli (substandard).
Lots of banks took serious action to tackle the problem, though they’ve yet to make much of a dent in selling or fully provisioning Italy’s NPL stack. But UniCredit raised €13bn of capital earlier this year — and spent the lot on NPL writedowns. Smaller firms started to trade portfolios in private, into the eager and waiting arms of private equity firms, who had raised buckets of cash for the 'European deleveraging trade' as early as 2012. Some banks approached the government about its GACS (garanzia cartolarizzazione sofferenze) scheme for wrapping securitizations; others have simply smartened up their data collection before selling assets.
By the time any European solution comes to pass, though, progress ought to have accelerated. European policymaking isn’t noted for its speed and decisiveness, especially on contentious risk-sharing arrangements that pit austere northerners against profligate southerners. Banks that are waiting on a sale to a “European asset management company” will be waiting for years.
Fortunately, time is now on the side of the banks. Economic growth and credit growth are seeping out across Europe, improving the prospects of small and medium enterprises, boosting business confidence and returning some troubled assets to respectable condition. Steeper yield curves are helping bank profitability, giving them cashflows and capital to cushion losses that do get realised.
Meanwhile, for assets that can’t be salvaged on balance sheet, leverage conditions for private equity firms are improving, increasing the prices they can pay for troubled assets.
But none of this was true five years ago, or even earlier. Policymakers in 2011 and 2012 were focused on the “bank-sovereign doom loop” and ways to break the destructive cycle. But had they started work on actively cleaning up bank balance sheets, that would now be paying growth dividends (and the peripheral banks might be paying actual dividends).
Action need not even have been through aggressive, TARP-style forced purchases and recaps — the state’s cost of capital and time horizons mean it can outbid the private equity firms for beaten up assets in a free and fair auction. Countries that did structure coordinated bad asset relief programmes, such as Spain’s SAREB or Ireland’s NAMA, have found themselves market darlings in 2017, with higher growth to carry them ahead of countries such as Italy, which did nothing.
Of course, some action at a European level now is better than none at all. If ministers start out discussing a European asset management company, they might end up on some of the nuts-and-bolts tweaks that would make a real difference — standardisation and transparency on NPL definitions and data, better conditions in the courts, clearer conditions for capitalising arrears, government-sponsored forbearance or own-to-rent schemes.
But at this point, it’s surely better for banks to hang onto their NPLS than to plan a sale to a putatative state-sponsored purchaser. Contemplation and collection of NPLs ought to improve origination standards in future, and working on the data and management of bad loans strengthens a bank’s business overall. Customers, too, may find their treatment more congenial in the hands of their local bank than one of the US private equity houses.
European banks should be pushed hard into recognition, provision, proper servicing and transparency around NPLs, but the mirage of a state-sponsored asset management company won’t help.