Resolving Non Performing Loans in Europe (...or at least trying to)

Banks and NPL investors beware: summary of key EU level actions with imminent impact on NPL strategies and the secondary distressed debt market

Various authorities with the highest relevance in the European banking sector have been extremely active with respect to the non-performing loans topic, in a crescendo which culminated over the last few months:

1. In September 2016, ECB published its first Stocktake of national supervisory practices and legal frameworks related to NPLs

2. In March 2017, ECB published its "Guidance to banks on non-performing loans".

The guidance deserves (at least) a couple of legal comments:

Non binding...or is it?

• ECB's NPL guidance is supposed to be non-binding in nature. However, this should not mean that it is to be taken lightly, since...
• Banks should explain and substantiate any deviations upon supervisory request, and
• ECB's NPL guidance is taken into consideration in the SSM regular Supervisory Review and Evaluation Process and non-compliance may trigger supervisory measures (so much with the non-binding nature...?)

So, while stated to be non-binding, if not taken into consideration it may trigger supervisory measures. May sound like nice food for thought for lawyers, but before taking this any further into legal interpretation, it seems unlikely that many banks would dare to rely on the guidance's "non-binding nature" give the aforementioned potential consequences. From here may derive, for some, the temptation of a direct strict compliance with the guidance ("better safe than sorry" they say).

On the flip side, an ad literam compliance approach vis a vis the guidance might also not be the best option, since ECB was also clear in stating that the guidance "does not intend to substitute or supersede any applicable regulatory or accounting requirement or guidance from existing EU regulations or directives and their national transpositions or equivalent, or guidelines issued by the EBA". On the same note, ECB goes even further in warning the banks that "where binding laws, accounting rules and national regulations on the same topic exist, banks should comply with those."

All common sense, one could say, then again, not simple regulatory / legal waters for the banks to navigate in this respect (i.e., prior to implementing ECB's guidance, banks may want to first make sure that, by doing so, they would not be in breach of any local or EU laws/directives/regulations).

3. Recently, June 2017, ECB published its second Stocktake of national supervisory practices and legal frameworks related to non-performing loans (NPLs) in the euro area. 

In July, things accelerated decisively:

4. On 5 July 2017, Vítor Constancio, Vice-President of the ECB, stated: We need a coordinated European NPL strategy.

To select only a few of the views expressed in Mr. Constancio's opinion piece:

• The prices that investors are prepared to pay for NPLs are much lower than the prices banks would be prepared to sell them for, and this is caused, inter alia, by structural inefficiencies in debt and collateral enforcement, high uncertainty around recoveries and their timing, and barriers to entry such as licensing requirements.
• In ECB's Vice-President's opinion, "these symptoms of market failure, aggravated by legal constraints, call for a public policy response. European and national authorities should launch a comprehensive strategy that combines a range of suitable tools to deal effectively with Europe’s NPL problems."
• A key aspect of that strategy will be aligning incentives between the parties involved: banks, investors and the authorities.

5. On 10 July 2017, EU Commission launched a public consultation document, on the Development of secondary markets for non-performing loans and distressed assets and protection of secured creditors from borrowers’ default, inviting interested parties to provide feedback by no later than 20 October 2017 

6. On 11 July 2017, EU’s Economic and Financial Affairs Council (EcoFin) published its conclusions on Action plan to tackle non-performing loans in Europe

7. On 11 July 2017, the European Systemic Risk Board (ESRB) has published a report on policy proposals on the same topic. The title of the report says it all in terms of urgency: Resolving Non-Performing Loans in Europe.

ESRB's report starts by acknowledging that...size matters: "The stock of NPLs in the EU banking sectors was around €1.0 trillion at end-2016, which amounted to 5.1% of total loans. The banking systems in ten EU countries have average NPL ratios of over 10% and a large number of banks have even higher ratios."

In terms of solutions envisaged by ESRB's report, all options are explored:

• On-balance sheet solutions (typically internal workout, but also more complex asset protection schemes (APSs) - potentially state backed),
• Potentially partial off-balance sheet true sale/synthetic securitisation, up to creation of asset management companies (AMCs) - again reference is made to potential state support.
• Where market liquidity permits, direct sale to investors is preferred and here it is expected that the supervisors will push for addressing the "market failure" causes as referred to above, aiming to increase the NPL purchases prices. Will surely be interesting to see the market's reaction to the expected correlation between regulation and market prices.

In brief - significant added complexity for the NPL strategies of the banks and for the NPL investors' landscape. But also, potential new opportunities for those well prepared, at both ends. To be continued...

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Useful info below:

Deleveraging Europe, H1 2017

CEE Benchmark Study on Non-performing Bank Loans, 2017

Deloitte Legal CE Guide to transfer of NPLs