The important role of transaction platforms in shrouded NPL markets
Regulators are currently increasing the pressure on banks to reduce their NPL stock, which is considered one of the biggest challenges for the banking industry in Europe. In this context, loan transactions are a common recovery tool in workout management. The need of a fully functioning secondary market for NPL portfolios is therefore essential. Yet, current market processes are often time consuming and imply high transaction costs for buyers and sellers involved. Therefore, transaction platforms can play an important role to connect market participants as well as to increase efficiency and reduce costs in NPL deals.
It can safely be expected that latest regulation will force banks to reduce their NPL volumes. Yet, the secondary market for NPLs in its current form does not offer the necessary environment for efficient & lean deal processes. Digitalization – as in many other areas of modern banking – can yet again offer the necessary solutions.
Snapshot of recently issued regulation
In their effort to tackle the issue of sizeable and only sluggishly decreasing NPL volumes among many European banks, EU supervisory bodies have issued a series of guidance papers that give addressees a glimpse of what the direction will be with regard to an overall reduction of NPL volumes.
Recently the need for timely provisioning has been further stressed and more precisely specified by ECB in the Addendum to the ECB Guidance to banks on nonperforming loans: Prudential provisioning backstop for non-performing exposures which became effective January 1 2018. With the Addendum, ECB emphasizes that a build-up of low provisioned NPLs will no longer be feasible for banks by increasing the implied costs of holding NPLs on the balance sheet. More specifically all significant institutions are required to provide full coverage for their exposures newly classified as NPLs after two years for unsecured loans and seven years for the secured portion of their loans, respectively.
A quantitative estimate of the impact of the new regulation on banks is shown in EBA’s report on statutory prudential backstops. The analysis results as a worst-case scenario in a decrease in an average bank’s CET1 ratio of 205 bps. This however, will unlikely turn out to be the true impact of the new regulation as banks are incentivised to reduce their (low provisioned) NPL stock.
Impediments for a liquid secondary market in NPLs
In order for banks to resolve their NPLs, sale transactions are getting an increasingly attractive option. A current NPL volume of ca. EUR 1,300bn within the EU reflects the vast supply calling for a liquid secondary market to transact with investors on an ongoing basis. However, even though NPL sale transactions have been prominent in some countries within the last years (e.g. Croatia, Slovenia, Romania), the market exhibits considerable inefficiencies.
Burdens hindering an efficient secondary market for NPLs are mainly transaction costs as well as information asymmetry. A typical sale process for an NPL portfolio is structured as a bidding process with several investors, accruing significant due diligence costs. The available data quality is heavily dependent on the sellers’ capabilities and willingness to offer transparent data. Due to the information advantage of the seller and often insufficient data for a proper valuation, investors are buying only with significant discount, increasing the bid-ask spread towards the seller.
In some segments, the current market structure for NPL sales, also contributes to the wide divergence of bid and ask prices between banks and investors. Due to high entry barriers in terms of scale, infrastructure and required expertise, competition on the buy-side is limited to a few reputable bidders in many transactions. Thus, by making use of their bargaining power, investors can push prices down further, making it unprofitable for banks to sell.
Overcoming market inefficiencies through transaction platforms
To resolve existing market impediments, an intermediary in the form of a web-based transaction platform can be an effective tool. This market place can bundle market supply and demand through screening and standardizing portfolio data with the help of sophisticated data analytics tools. This in turn bears the potential to reduce information asymmetry and to open up the market for a wider reach of investors reducing the bid-ask spread.
Recently issued data templates by EBA can also be seen as a signal from regulators aiming for standardization and transparency in that market segment. Other benefits of a fully-fledged transaction platform for both buyers and sellers include:
Benefits for buyers:
- Constant deals monitor of market supply and investment opportunities
- Lowered due diligence costs
- Transparent and uniform vendor data
- Outsourcing of services (e.g. portfolio analysis, portfolio valuation etc.)
- Shortened deal duration
- Optimization of post-acquisition assets takeover
Benefits for sellers:
- Wider investor reach
- Directly observable market interest
- Disposal opportunities also for granular portfolios and single assets
- Minimized disturbance to daily business
- Structured transaction process
- Shortened deal duration
- Closing risk minimization
The increasing pressure coming from regulators, who penalize banks for their large NPL stock, makes loan transactions to a nowadays common recovery tool in workout management. The need of a fully functioning secondary market is therefore essential.
Transaction platforms can help to connect sellers and buyers easier than ever, and are able to offer additional services to increase efficiency in a transaction process. In the light of current market developments, this might just be another step ahead towards digitalization in banking.
 Fell, John et al.: Financial Stability Review November 2017 – Special features, 2017. p.130.
For more information please contact:
Consultant, PwC Austria, FS Deals
Senior Consultant, PwC Austria, FS Deals