In the last 5 years, the NPE market was gradually heading towards a medium-term steady state. Deleverage activities 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 (€135bn in 2019 vs €341bn in 2015) and, at the same time, they have set up their NPL platform and organizational controls that will allow to manage non-performing loans more quickly and efficiently and thus to 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.
Today, still in the aftermath of the healthcare emergency, we have some (few) certainties.
Paradoxically, the first certainty is a degree of…uncertainty. Despite several economic forecasts which have been released by public institutions or private research centers (one of the latest of which, by the European Commission, points at a 9,5% decrease in GDP in 2020) the situation is still largely unpredictable both for its complexity and incomparability with previous economic downturns and for the unpredictable evolution of the health emergency.
The second certainty is that 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, in 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 revenue and worsening of 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. Market consensus is that NPE new inflows will be in a range between 60 and 100 billion in the next 18 months with a direct impact on current UTP and NPL stock.
Also because, and this is the third certainty, 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 likeliness to pay of their clients, and with objective or subjective indicators of financial difficulties emerging, many exposures will need to be reclassified. The clear 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.
All in all, these few certainties bring with them some clear market consequences.
Unlikely to Pay (€61bn as of 2019) 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.
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.
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. Innovative structures such as restructuring funds will emerge, given the expected increase in the market space.
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.
All in all we believe that the financial services sector has now proven to be more resilient and Ready to Face the Crisis.
Pier Paolo Masenza
Financial Services Leader, PwC Italy
Tel: +39 06 570252472
Partner, PwC Italy
Tel: +39 02 66720351