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A new credit cycle ushers in fresh class of European NPLs

Just when it looked as though the European NPL tide was at last beginning to fall, 14 years on from the start of the great financial crisis, a new surge of NPLs is on the horizon. It’s time to launch the securitization lifeboats. Tom Brown reports.

As a wave of non-performing loans (NPLs) looks set to hit a European economy already struggling with sharply higher government debt, coronavirus moratoriums and declining revenues, national and private banks are searching for solutions. 

Courts have shut in NPL-heavy jurisdictions like Italy and Greece, complicating the resolution of defaulted loans. Meanwhile, most European governments have also placed moratoriums on foreclosures, preventing NPL portfolio holders from enforcing on the properties.

In the UK and Italy, both governments are exploring the possibility of extending mortgage moratoriums and foreclosure moratoriums for up to a year, hampering NPL consolidation.

In Spain, investors were surprised when a Catalonia law resulted in mortgage owners having to grant tenants many more years of debt consolidation before enforcing on the property.

With the Brexit transition period  set to end on December 31 this year, the Bank of England has floated a memo supportive of the idea of creating a UK intermediary bank, similar to a bad bank in design, but devised to shift loans granted payment moratoriums by selling them back into the market with a government wrapper.

“You might find a new class of NPL — Covid-19 NPLs — which are caused solely because of the impact of the measures implemented to tackle Covid-19, rather than poor underwriting criteria, valuation and over-leverage,” says Mandeep Lotay, a partner at Freshfields Bruckhaus Deringer in London.

In Italy, NPL securitizations are set to decrease by up to 70% this year, according to Scope Ratings, with little activity expected across the rest of Europe in the wake of coronavirus lockdowns. After the slowdown, banks will look to securitize the next generation of defaulted loans in 2021.

In Italy, securitization has proven itself to be a useful tool in removing NPLs from bank balance sheets via the NPL Securitization Guarantee, or Garanzia Cartolarizzazione Sofferenze (GACS) programme.

The Italian government guarantee scheme is set to expire in 2021, but new defaults brought about by the pandemic are projected to propel Italy’s NPL levels to one of the highest in Europe. 

“It’s too early to predict whether they will be extended, though I do think you have to go with the view that they need to be extended and even broadened, to stimulate the market, given the predicted quantum of new Covid-19 NPLs,” says Lotay. “For jurisdictions like Greece and Italy, NPLs could reach GFC levels. I would expect the impact on Ireland and the UK to be less severe.”

However, compared with the last crisis, a larger proportion of credit risk will be covered by sovereigns that stepped in to guarantee corporate financings. These defaulted loans are more likely to be held by the central bank rather than on private bank balance sheets, muzzling securitization volumes.

Market commentators expect the European Central Bank to relax annual non-performing exposure reduction targets to allow banks to consolidate the spike following coronavirus lockdown measures.

Herculean efforts

In Greece, all four of the country’s leading banks are set to use the newly-implemented Hercules Asset Protection Scheme (HAPS), an NPL securitization programme established in late 2019.

Alpha Bank intends to frontload the sale of its NPL exposures with a €12bn securitization from Project Galaxy, while Eurobank plans Project Cairo, a securitization of €7.5bn secured and unsecured loans. Eurobank will be the first to use the HAPS scheme if achieved.

National Bank of Greece is planning a €6bn mortgage-dominated NPL securitization under the programme, whereas Piraeus has also announced plans to use HAPS to securitize €7bn of residential and commercial NPLs.

This is unlikely to be enough to stem the rising tide of NPLs set to hit the country in the wake of the pandemic, however. The Greek government has been preparing plans for a national-level bad bank, to be considered by European authorities.

Market commentators say plans for a Greek bad bank will likely run into opposition from the European Commission, which is also combating plans for the establishment of a Europe-wide ‘bad bank’, which would pool bad debt between member states.

Greek officials are supportive of debt pooling, but recognise the resistance from other member states. Something needs to be done though — Greek banks have the highest level of defaulted loans on their balance sheets, comprising 35% of total loan books in the country. 

However, it will be hard to gauge just how badly banks have been hit in terms of NPLs as the EU and the UK governments have decided to postpone stress testing this year, obscuring what opportunities lie ahead for NPL investors.

Greece and Italy are set to be hit hardest during the recovery period, with Cyprus, and Spain close behind. The UK and Ireland will escape the worst of the coming NPL wave, but even with the setting up of bad banks and liquidity platforms, the continent will once again begin the hard labour of cleaning up bank balance sheets.