UK: Game Of Loans August 2017

Last Updated: 25 August 2017
Article by Nigel Shilton, Charlie Vincent and Michael Griffith

Most Read Contributor in UK, August 2017

A brief introduction to the loan portfolio market today

The international loan portfolio market has seen significant growth and continued innovation in recent years, as lenders bundle up and offload risk from their balance sheets. Large scale portfolio transactions are often key to stabilising the positions of 'problem' lenders; as we write, details are emerging on recently rescued Spanish lender Banco Popular's €30bn non-performing loan portfolio.

Over the last three years, nearly a third of loan portfolios by volume have involved those specifically backed by commercial or residential real estate assets. For the vendors, the certainty of a lump capital sum can trump potentially less secure future cash flows, even where the magnitude of future cash flows has the potential to exceed the "cash-in-hand" sum. Add in the much enhanced regulatory and capital adequacy requirements, for commercial real estate lending in particular, and the arguments for trading out of a legacy loan book often become compelling.

In a simple world, two components are key to understanding the dynamics of an otherwise complex loan portfolio transaction: a) the quality of the future cash flows to be received from borrower repayments; and b) the quality of the assets to which the loans are secured. The latter is of particular importance where non-performing real estate lending is involved, with buyers often actively intent on taking direct control, where possible, of the underlying assets.

When multiple loans are bundled together, it is common for the value of the portfolio to differ to the sum of its parts. In the years immediately following the financial crisis, discounts to the value of future cash flows or assets were commonplace, due to a perceived high risk of borrower default and uncertainty regarding underlying asset values. Countering this, the ability to acquire a large portfolio of loans in a single transaction is an attractive proposition as the repeat transaction costs associated with multiple fragmented transactions can be avoided.

Market dynamics in Europe and beyond

Deloitte publishes "Deleveraging Europe", an overview of the European loan portfolio market, twice a year (search Deleveraging Europe for further information). This publication outlines expectations on how loan sale transactions may evolve over the coming year and provides viewpoints from market players.

A total of €42 billion of loan portfolio deals were completed in Europe during the first half of 2017, compared to €45 billion during the same period in 2016, with a further €87 billion of deals ongoing.

The UK has traditionally been a significant market for loan sales and was the only market in Europe which saw more activity in the first half of 2017 compared to 2016, albeit the €20.2 billion of transactions in H1 were mainly accounted for by a single residential mortgage portfolio sale from the on-going wind-down of UKAR.

The UK market has begun to recover from the pause induced by the Brexit vote in mid-2016; already this year we have seen UKAR's €19 billion sale of the Bradford & Bingley building society mortgage portfolio to Blackstone and Prudential Capital. In addition, Cerberus sold a €735 million portfolio of residential mortgages to the UK Challenger bank, Metrobank. Future mortgage portfolios are likely to come to market over the next 12 months.

So, why has there been a relative slow-down in transactions? One element that has tempered the pace of deals in 2017 has been the heavy regulatory load on potential NPL sellers, who have traditionally driven the loan portfolio markets. This includes new guidelines on NPL recognition and disposal strategy, the forthcoming adoption of a new accounting standard (IFRS 9) and the European Banking Authority's 2017 Transparency Exercise. 

In the Irish market, sales have been a modest c.€1 billion in 2017 to date. But the beginning of re-privatisation of Allied Irish Banks (AIB), one of the pillar banks nationalised at the height of the financial crisis, is likely to create new deal flow. The float of AIB could trigger substantial sales of residential and corporate loans portfolios (AIB holds €16 billion in non-performing loans). Ongoing sales from Danske Bank and NAMA could see the market hit c.€10 billion for 2017.

And what for the future? Deloitte predicts that Italy will be the busiest market in Europe in 2017 for the second year running as the legacy of non-performing loans in its banking system is tackled. New European markets that have not seen much activity in the recent past are anticipated to emerge, especially Portugal and Greece, where momentum for significant deleveraging is building.

In Italy, the volume of completed transactions fell in the first half of 2017. However, the second half of 2017 is set to correct that; with €9.3 billion of deals completed and over €44 billion of deals ongoing, Italy is set to be the most active market for distressed debt in Europe. The bailout of troubled bank Monte Paschi di Siena (MPS) and the insolvency of Banco Popolare di Vicenza and Veneto Banca will help deal flow.

Investors have been waiting a long time for the Greek NPL market to take off; there are now signs this is happening. Greek banks have already disposed of most of their non-Greek assets in Central and Eastern Europe and portfolio sales in Greece are beginning. Reforms that make it easier to obtain NPL management licences and reduce the personal liability of banking executives over NPL disposals, are improving the market environment and incentivising portfolio sales. The four "pillar" banks which are also the largest banks by NPL holdings – Pireaus Bank, Alpha Bank, National Bank of Greece and Eurobank have started preparing data for loan portfolio disposals and the first portfolio from Eurobank is in the market.

Looking ahead

We started this piece by asking ourselves if "trading loan portfolios multiplies the chances of trouble, akin to a multi-£bn game of 'pass the parcel"? Provided appropriate due diligence is completed on both the buy and sell sides of the transaction, risks will be identified, understood and quantified. As such, we believe loan portfolio sales will continue to have an important role to play in balancing risk and exposure throughout the financial system.

The European Banking Authority estimated in its last Eurozone transparency exercise that just over €1 trillion of NPLs remain on banks' books in the Eurozone; we estimate that when non-eurozone and non-core assets are included in total there is around €2 trillion in European loans that could come to the market. This is despite the many years of deleveraging we have seen to date. There will be busy years ahead. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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