Banks urged to deal with bad loans as investor appetite and regulatory implementation create a perfect storm for opportunities

As optimism levels in the banking sector in Europe are at the highest in recent years, banks are being urged to address non-performing loans. A combination of banks having implemented a raft of financial regulation and appetite from funds to buy up portfolios has created an environment in which banks should be able to take strong steps forward to deal with non-performing loans.

Research from global law firm Linklaters, published today, shows that European banks overall have cut their non-performing loans by more than 280 billion euros since the end of 2014 whilst according to figures from the European Central Bank (ECB), the NPL ratio fell to 4.6% at the end of the second quarter of 2017, down by roughly 1 percentage point year-on-year.

The research also shows that Distressed debt/special situations private equity funds with a focus on Europe have an estimated US$37.6bn of dry powder with a focus on Europe so the investor appetite is there.

Edward Chan, Banking partner at Linklaters, says: “After almost ten years of tightening regulation, Europe’s banking sector is in better shapes but there is still more work to be done. It’s encouraging that European banks’ asset quality continued to improve last year but the level of non-performing loans held by banks is still an issue with nearly €900bn of bad loans still on balance sheets.”

Despite the downward trend, when compared to other parts of the world, the total volume of NPLs across the EU remains high. The analysis shows that:

  • The NPL ratio (non-performing loans as a percentage of total loans) of European banks has also continued to decrease in 2017. However, one third of countries still have NPL ratios above 10%. 
  • Significant loan portfolio disposals have already taken place in the UK, Ireland and Netherlands while Spain, Italy and France still have some way to go. In Portugal, Greece and Cyprus there is still a requirement to address banks’ high levels of non-performing loans.
  • Italian, Spanish and French banks hold the highest levels of non-performing loans while Greece, Cyprus and Portugal have the poorest asset quality.

The figures show that Italian banks hold the highest levels of NPLs in Europe and as of H1 2017, accounted for nearly a quarter of the Eurozone total. The latest data from the Bank of Italy shows NPLs fell 5.5% in November to €173bn compared with the preceding month, down 6.4% compared with the same month last year.

Dario Longo, Capital Markets partner at Linklaters, says: “In the last few years Italian banks have taken steps to address their NPL burden and 2017 saw a record amount of disposals. We’ve seen that recent legal reforms and increased efficiency around processes have improved the deal making environment and increased investor confidence.”  

In March 2018, the European Commission published a package of new legislative measures aimed to reduce the level of existing NPLs and prevent their build-up in the future.

The proposals would mean that banks have to set aside capital to cover loans that turn bad in the future, encourage the development of a secondary market where banks can sell their NPLs, facilitate out of court recovery of loans secured by collateral and provide a blueprint on setting up asset management companies to take on bad loans.

Chan says: “The big issues affecting the banking sector following the financial crisis have mostly been dealt with – the wave of regulation has now moved into implementation phases. So we have an environment now where it seems like a perfect time to address some of the historic issues. We have already seen progress with dealing with NPLs but we’re approaching a phase where that activity could really ramp up over the course of the year.”

Percentage

Year

European Union