NPL/NPE prevention strategy
How to prevent, not how to dispose
In 2017, in Central and Eastern Europe recorded after 2016, an intense activity of trading of the portfolios of non-performing loans (NPLs). The most active markets in the region, which have recorded the highest volume of portfolios sold in the last few years, have been Romania, Hungary, Croatia and Slovenia. Although the corporate portfolios of non-performing loans will remain the most traded, some investors have already expressed interest in the residential mortgage loans.
Over the course of the past weeks, the ECB, EBA and European Commission have published a number of documents relating to their work on NPL. The publications follow the European Council’s July 2017 Action Plan on the reduction of non-performing loans in Europe, which seeks both to reduce stocks of NPLs and prevent their future emergence.
Data cited by the Commission show that NPLs in the EU have fallen to their lowest level since Q4 2014. Nevertheless, the total volume of NPLs remains well above pre-crisis levels (€910 billion), and there are uneven ratios across the EU – ranging from 0.7% to 46.7%. For these reasons and because of slow progress made in some countries in remedying legacy problems, policymakers continue to have significant concerns.
The proposed initiatives can be grouped around the themes in the Council’s Action Plan:
- Reducing stocks of NPLs: changes to facilitate out of court collateral enforcement foster the development of secondary markets for NPLs and establish national Asset Management Companies.
- Preventing their future emergence: new Pillar 1 and Pillar 2 capital requirements, and guidance on forbearance measures and governance.
The initiatives have been well signalled in advance and will not in themselves come as a surprise to banks. Publication of the documents though is an important milestone after a period of debate, and banks will need to start engaging more closely. The initiatives from the Commission and EBA are relevant for all banks in the EU; those from the ECB will only apply to significant banks in the Banking Union. Subject to that scope, all banks will need at a minimum to consider changes to reporting and capital requirements. Advice provided by the EBA on the introduction of a prudential backstop and also published in the past week, estimates that most banks will be able to easily cover the capital impact with retained earnings.
Key details of the publications can be found below.
European Commission Proposal
On 14th March, the European Commission published a proposed package of measures to reduce NPLs. Key components include:
- A Regulation amending the existing Capital Requirement Regulation (CRR) for banks;
- A Directive on credit servicers, credit purchasers and the recovery of collateral,
- The Directive would further foster the development of secondary markets for NPLs by removing barriers to credit servicing and to the transfer of bank loans to third parties across the EU through the development of an EU passport.
- A non-binding blueprint for how national Asset Management Companies (AMCs).
EBA Consultation on Guidelines on the management of non-performing exposures (NPEs) and forborne exposures (FBEs)
On 8th March, the EBA published a Consultation on Guidelines on the management of NPEs and FBEs, outlining the key elements of an NPE strategy and providing guidance on forbearance measures. The consultation closes on 8 June 2018. Key points include:
- Credit institutions with a NPL ratio of 5% or more should establish a NPE strategy to target a time-bound reduction of NPEs.
- An outline of the governance and operations of a NPE workout framework.
- Forbearance measures should aim to return the exposure to sustainable repayment, and credit institutions should monitor both the efficiency and effectiveness of forbearance measures.
- Guidance on the governance of the NPE impairment measurement and write-offs.
ECB Addendum to its Guidance to banks on non-performing loans
On 15th March, the ECB published its final Addendum to its Guidance to banks on non-performing loans, setting out its supervisory expectations for levels of prudential provisioning for NPLs. The Addendum has been controversial with some groups, but ultimately has been introduced. It introduces a Pillar 2 backstop for newly non-performing loans. Key points include:
- Newly non-performing loans, which are fully unsecured, should be fully covered after 2 years, while NPLs, which are fully secured, should be fully covered after 7 years.
- The addendum will act as a basis for supervisory dialogue, and the ECB will discuss divergence from its prudential provisioning expectations on a case-by-case basis.
- The addendum will apply to loans classified as non-performing from 1 April 2018, and the result of the dialogue the ECB will hold with banks will be incorporated into the 2021 SREP process.
- All above are seen as a supervisory measure to apply pressure to the sector to adopt the guidelines and integrate such in the entire lending process.
Deloitte can help you:
- Assess the entire lending process to establish potential gaps that contribute the generation of NPLs.
- Evaluate the forbearance/restructuring methodologies to establish effectiveness on the long term health of the loan
- Stress your workout strategy and operations to determine which areas could potentially contribute to more efficient troubled loan resolution
- Establish Early Warning Indicator technology framework to avoid forbearance and NPL creating using models already developed for IFRS9
- Develop your NPE strategy document for the regulator