In the last 5 years, the NPE market has gradually headed towards a medium-term steady state. Deleverage activities have reduced sharply bad loans and, as a result, market participants were starting to focus on Unlikely to Pay (UtP) and on how to manage the tail of the huge non-performing stock cumulated during the past decade.
Italian banks, in response to market and regulatory pressure, have halved the total stock of NPL (€ 130bn in H1-2020 vs € 341bn in 2015) and, at the same time, they have set up NPL platforms and organizational controls that will allow to manage non-performing loans more quickly and efficiently and thus face the incoming economic crisis in a more resilient way.
The COVID-19 crisis, needless to say, has surprised everybody, reshuffling the cards and bringing back to the table all participants that are now trying to understand how the market will evolve in the next few months and years.
Despite several economic forecasts, released by public institutions or private research centres (one of the latest, by the European Commission, points at a 9.9% and a 7.4% decrease in GDP in 2020 respectively for Italy and EU) the situation is still largely unpredictable both due to its complexity and incomparability with previous economic downturns. Looking at the near future it is assumed that the virus control measures will remain in force, however their stringency will gradually ease in 2021 thanks to the arrival of a vaccine.
The economic downturn will lead to an increase in NPL in the short to medium term. When, how much and how will this increase materialize? Probably not in the next few months, during which the shield of payment holidays and public support through the release of state guarantees will largely “freeze” the portfolios, delaying and possibly reducing the flows to NPE. Nevertheless, moratoria will end, and the combined effect of the decrease in revenues and a worsening financial position of many companies will lead to a severe scrutiny of the capability to pay creditors which will turn into an unavoidable reclassification to default of a significant number of counterparties. It is still very difficult to make reliable forecasts, but market consensus is that NPE new inflows will be in a range between € 60 and 100 bn in the next 24 months. This value will be mitigated by banks’ workout, UtPs backed to bonis and by legislative measures. Given this, the net new inflows are assumed in the range € 50 - 70bn.
Furthermore, notwithstanding a general relief of supervisory and regulatory pressures on banks in this “emergency” situation, the focus on a rigorous valuation of the credit quality of banking portfolios will be high and increasing in the next few months. Banks will be forced to assess the ability to pay of their clients, and with objective or subjective indicators of financial difficulties emerging, many exposures will need to be reclassified. The confirmation of this expectation can be found in the increasing provisions that some large banking groups have already posted in their balance sheets to account for future losses.
Unlikely to Pay (€ 59bn in H1-2020) will probably be the most relevant and complex asset class that will need to be addressed. Banks will have to come up with some reliable drivers in order to identify those clients to support and those which will not be able to be restored. Banks and servicers, because the number, granularity and sectorial composition of UtP will probably be different than in the past, will need to deploy new servicing capabilities and strategies. Investors, with an appetite for new finance which will be increasing, will be able to find potential new opportunities when economic recovery will show up. Many private equity funds specialised in UtP portfolios and restructuring/turnaround move in this direction, with the aim to help industrially solid companies which are now in a situation of financial distress.
The debt purchaser and debt servicing market will also be affected, turning the industry from a focus on the stock, which considering the primary and secondary market will amount to about € 350bn by the year end, to a new focus on how to manage the upcoming flows. Luckily, one of the legacies of the last crisis is the presence, now, of a sustainable NPL industry that will be able, more rapidly and effectively than in the past, to manage increasing volumes, supporting the economy and, when possible, helping to bring back to viability some of the companies that will experience financial difficulties. In the period 2021-2022 we expect a € 30 – 40bn of transactions per year, and this trend is expected to continue in 2023. For these reasons, we do not expect a peak of NPL stock like in 2015 but an amount in line with the one registered at H1-2020 because financial services sector is now more resilient.
The crisis will have other clear market implications. On the price of collaterals, with Real Estate prices potentially decreasing, at least for a temporary period, and with geographical and sectorial evolutions which will have to be carefully assessed by investors. On NPLs recoveries, which have slowed down due to the stop of Courts activities in these months, and that will lead to a review of the underline business plans of the serviced portfolios.
Finally, the “NPE issue” will be deeply influenced by the effectiveness of public support and economic recovery schemes, by the timing and intensity of the removal of the current regulatory relief measures and by the implementation of “systemic” solutions. Such solutions could be especially important for the UtP positions where a mobilization of the main economic stakeholder could be a game changer for the Italian economy. The solution must be rapid, at market conditions and need to leverage on local economies and stakeholder.
Pier Paolo Masenza
Financial Services Leader, PwC Italy
Tel: +39 06 570252472
Partner, PwC Italy
Tel: +39 02 66720351