The definition of a non-performing loan (NPL) is a loan on which the borrower is not making interest payments or repaying any principal. At which point the loan is classified as non-performing by the bank, and then becomes ‘bad debt’.
If your next-door-neighbour was unable to make any interest payments on his mortgage, would you lend him money? Would you call his bank and tell them that you will take the mortgage off of the bank’s books and then tell your neighbour he can pay you back at a later date? I thought not. But what if his house was worth £600,000 and his mortgage was only £200,000? Suddenly, becoming his sole creditor doesn’t seem like such a horrible idea. So, is that why so many investors are buying NPLs?
According to analysis from Deloitte, sales of NPLs in Europe are expected to surge by more than 60% this year to over €150bn, an increase of 63% on the total of €93bn for 2014. This is being driven by increased loan sale activity in continental Europe, particularly in Spain, Italy (with a 190% expected increase in loan sale values) and Central and Eastern European countries (where loan sales are expected to quadruple compared to 2014).
Deloitte reports that debt investors have raised around €100bn in the past 18 months targeted for Europe, which with leverage, means they potentially have over €300bn in cash ready to spend.
David Edmonds global head of portfolio lead advisory services at Deloitte, commented: “2014’s figure was already a three-fold increase on 2013’s, and we expect to end this year even higher. Selling these types of assets becomes a good option to improve capital positions, with banks under increased pressure from regulators and shareholders to clean up their balance sheets. We expect to see the market drift away from Britain and build further in Spain, Italy and Central and Eastern European Countries (CEE).
“In the past, these sales have been driven by commercial real estate loans, but now we are seeing more residential mortgages being sold off in improving markets. Distressed debt investors and challenger banks are willing to step up and buy these loans on the basis they will start performing in future as the economy improves.”
Deloitte estimates loan sales to top £35bn (€48bn) in 2015 in the UK, €21bn for Italy, €22bn for Spain, €8bn for Austria and CEE and €29bn for Germany.
Edmonds concluded: “Looking further ahead, we expect sales will only continue to increase with such a significant amount raised by distressed debt and private equity funds looking for a home across Europe.”
While the major growth is occurring on the Continent, the UK is still by far the largest market for NPLs. Considering the collapse of Northern Rock was just eight years ago, the quantities of NPL portfolios being traded has reached remarkable levels, according to James Walton, real estate finance partner at solicitors Rosling King.
Walton said: “Anyone involved in the real estate and real estate finance market is acutely aware that the market is hot, with both the sheer volume of lending and the number of new lenders to the market continuing to increase. However, with all this new origination going on, what is surprising is the sheer quantities of NPL portfolios which continue to change hands.”
According to Walton, the buoyancy of the real estate finance market has been well documented in reports by Savills and De Montfort University. They revealed 46 new providers of commercial real estate loans have entered the market over the past 12 months, bringing the total of new entrants to the market to 150 in the past 3 years.
“One may have thought that those banks holding NPLs would by now have cleaned up their balance sheets. That appears not to be the case”, added Walton.
I ask Walton why he thinks so many investors are buying NPLs at the moment. “PE (private equity) funds, particularly US PE funds, can’t get enough of NPLs because they can make a lot of money from them! They aren’t constrained by some of the political issues that certain high street lenders have. For example, these funds can take enforcement action straightaway to foreclose on a property and sell it, thus realising the value of the asset. Certain high street lenders have issues to think about, like are they harming the business community by taking action to foreclose. With residential properties, they don’t want to be seen to be repossessing people’s houses unnecessarily.”
If the funds are buying NPLs then they must be doing so knowing that there is equity sitting in the units. I ask Walton what the typical LTV is for a NPL. “The LTV of the underlying loan will vary but they will most probably be 70% plus because these are legacy loans which were originated pre-Lehman. The price at which they are being sold at (i.e. the price paid by the purchaser when compared to the outstanding balance of the loan) also varies – the more ‘distressed’ the loan, the bigger the discount and the less the buyer pays.”
Are investors viewing this as a way of buying property at below market value with the returns actually being higher than if they rented the unit themselves? “No. It is true that certain funds and PE houses are looking to buy loans to get their hands on the underlying property asset. However, with most NPL trades, the strategy is to buy as many loans as possible at, say 70p in the pound, and if they can get 80p in the pound back (through a variety of strategies – could be foreclosing and selling the property at auction or on the open market, it could be as simple as going to the borrower and saying they will release their security over the property if the borrower can find 80p in the pound from another source of funding), then they will have made a quick profit.”
