Will COVID-19 trigger a rapid wave of non-performing loan (NPL) transactions?

The economic downturn caused by coronavirus (COVID-19) will inevitably lead to an increase in non-performing loans (NPL) in the European banking system. The question is how long this will take to translate into a similar increase in NPL transactions?

In the aftermath of the global financial crisis (GFC), reported NPLs across Europe peaked at around €1.2 trillion in 2013. However, NPL transaction volumes, as measured by PwC, didn’t peak until three years later.

The lag between increasing NPL volumes and transaction volumes was down to a number of key factors, the most important being that European banks were not accustomed to selling large chunks of their NPL portfolios. Whilst most banks were used to selling fully charged off consumer debt or similar, it took time for them to assess their overall balance sheet position and get their minds around large scale disposals. Additionally, it took time for the development of independent servicing, and key elements of this developed through the carve out of servicing operations from the banks.

It is also worth noting that the transaction peak might have come earlier if the market had developed quicker in Italy, where transaction sales lagged behind other parts of Europe like Spain, Ireland and the UK.

Increase in bad debt levels

It seems likely that bad debt levels will increase to the levels seen after the GFC. Based on our review of additional provisioning disclosed by a sample of the largest European banks in their Q2 earning results, we can see that banks’ cost of risk has increased significantly. Our review covered a sample of 22 of the largest banks and showed that total provisions for the first half of 2020 exceeded EUR 40bn. This represents an almost 7% increase in the European stock of NPLs. Interestingly, there has not been a material change in provisioning during Q3. We expect it will take another 2 – 3 quarters before the position becomes clearer.

When will increasing bad debt levels feed through into NPL transactions?

Banks are now used to selling NPLs, there is clear buy-side demand with significant funds available and we have well-developed servicing infrastructures. However, unprecedented European government support schemes will delay, and hopefully reduce, bad debt levels and it will take time for banks to assess their overall balance sheet strategy. The emphasis right now is on developing their own workout functions and supporting their customers with appropriate forbearance options where required.

European NPL transaction volumes will increase in 2021 and beyond, but we will not see a tidal wave in the short term. Consistent with the financial crisis, volumes will build up over a number of years and it will be a few years before we reach a peak. Similar to post the GFC, banks will once again be prompted to reassess their priorities so we are likely to see a continued wave of balance sheet restructuring.

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Source: https://pwc.blogs.com/deals/2020/11/will-covid-19-trigger-a-rapid-wave-of-non-performing-loan-npl-transactions.html