Navigating the NPL Maze: A Year in the Credit Secondary Market
The Financial Landscape in 2024 by Jürgen Sonder and Ludwig J. Weber *
Expansion of Secondary Market for Delinquent Loans Boosts Financial System Stability
Michael Theurer, German Federal Bank board member, spoke truth earlier this month. The economy, buffeted by geopolitical turmoil, is in dire straits. A solid financial system is crucial to weather this storm. But let's not forget the real economy—it's the lynchpin for steering through crises, especially in tumultuous times.
With corporate insolvencies resurging to pre-COVID levels, it's clear our economy is on shaky ground, and the anticipated rise in the coming year echoes the tense reality. Resilience, therefore, is the mantra for our financial system. But what's the key to maintaining that resilience? A close look at corporate insolvencies, non-performing loans (NPLs), and commercial real estate is where we should start.
The Eyes on Commercial Real Estate
The latest edition of the NPL Barometer by the Federal Association of Credit Acquisition and Servicing (BKS) and the Frankfurt School of Finance & Management has shed some light on the matter. The upward trend in NPLs across all asset classes, notably in consumer loans, small and medium-sized enterprises, and commercial real estate, has caught the attention of the Federal Bank and the banks themselves.
Prevention is better than Cure
Each year, German banks face NPLs amounting to over 40 billion euros across industries. In the face of this imminent credit risk threat, prevention is the way forward. Enter the professional secondary market for NPLs, a powerful tool that can help the financial sector stay afloat during a potential self-reinforcing downward spiral.
A Year of the Credit Secondary Market Act
The Credit Secondary Market Act (KrZwMG), enacted in 2023, is a major step towards building a unified legal framework for the secondary market across Europe. It came into effect on December 30, 2023. The KrZwMG lays down new obligations for credit institutions, buyers of NPLs, credit service providers, and their supervision by BaFin.
The role of Credit Service Providers
Under the KrZwMG, credit service providers need BaFin approval for secondary market activities. Approved providers can operate across Europe. The BKS members, accounting for the largest portion of the German secondary market for NPLs (in terms of transaction volume), have already met all requirements by summer 2024.
Through the sale of NPL claims, the secondary market offers banks, savings banks, and state banks relief, improving risk structures, ensuring liquidity, and paving the way for future lending. For investors, NPL portfolios are attractive, offering the chance to convert discounted non-performing claims into a risk-adjusted return. The opportunity to invest in the debtor company, via a debt-equity swap or insolvency plan, further sweetens the pot. The success factor in NPL transactions lies in the recovery prospects of the respective portfolios. A thorough due diligence review is vital for assessing yield potential and determining the price for NPL portfolios, enabling the claims themselves and the financial and legal opportunities and risks associated with them to be evaluated. Expertise in navigating crises plays a significant role here.
Balancing Risk and Restructuring
This expertise is crucial for banks assessing default risk, particularly in corporate and real estate financing, where high amounts are typically involved. When a borrower teeters on the brink of insolvency, the question becomes: Can we support the company's restructuring? Both the risk and the restructuring approach must be carefully considered.
Restructuring, in a sense, is no different from handling NPLs: experts join hands, and success is seldom far away. This synergy has played a pivotal role in gradually reducing NPL balances for European and German credit institutions over the past few years, contributing significantly to financial market stability, especially during the exceptionally high-interest-rate phase post-pandemic.
Jürgen Sonder is the President of the Federal Association of Credit Purchase and Servicing, Chairman of the Senior Advisory Board of the Intrum Group in Germany, and a member of the advisory board of the Frankfurt Institute for Risk Management and Regulation. Dr. Ludwig J. Weber is an expert in corporate financing and restructuring at the law firm Schultze & Braun. He advises financiers and investors on the evaluation of credit portfolios and NPL transactions.
The Larger Picture:
The Credit Secondary Market Act (Kreditwesengesetz zur Umsetzung der Richtlinie 2019/2162 über die Einführung von Vorschriften für die Verbriefung von Forderungen - KrZwMG) in Germany is part of broader efforts to implement EU directives related to credit servicing and secondary markets. As of my last update in 2023, this act focuses on strengthening regulations around NPLs, credit servicing, and securitization, which has significant implications for banks, credit service providers, and the overall secondary market.
Key Highlights:
1. Enhanced Regulatory Framework
- Compliance Requirements: Banks and credit service providers must adhere to stricter regulations regarding the servicing of loans, including NPLs, enhancing consumer protection and oversight.
- Securitization Rules: The act may affect securitization by aligning German regulations with EU standards, improving transparency and oversight.
2. Impact on Banks
- Risk Management: Banks may benefit from more efficient management of NPLs through structured approaches to sale and securitization. However, increased regulations could boost operational costs.
- Compliance and Risk: Stricter regulations could reduce the allure of purchasing certain NPL portfolios due to more stringent servicing standards, potentially impacting the secondary market's liquidity.
3. Credit Service Providers
- Licensing Requirements: The act may lead to a more streamlined and regulated credit servicing industry, focusing on compliance, consumer protection, and clear communication with borrowers.
- Increased Transparency: Greater emphasis on transparency could improve consumer trust but increase operational complexity for credit service providers.
4. Secondary Market for NPLs
- Market Dynamics: The act could affect the dynamics of the NPL market by making it more transparent and regulated. This may attract investors interested in structured products with clear oversight, but could also diminish the appeal for those seeking less regulated environments.
- Investor Confidence: Potential investors may find a sense of security in purchasing NPLs due to the enhanced regulatory framework, potentially helping stabilize and grow the secondary market.
Future Developments:
- Evolving EU Directives: The act is part of a broader EU effort to standardize financial markets. Future updates to EU directives could further influence Germany's regulatory landscape for NPLs and credit servicing.
- Regulatory Adjustments: As the market responds to these changes, regulatory bodies may adjust details of the act to better align with market realities while maintaining consumer protection and stability.
- Given the ongoing geopolitical turmoil and the rising corporate insolvencies, maintaining resilience in the financial system is crucial.
- To do this, we must focus on preventing the accumulation of non-performing loans (NPLs), especially in corporate insolvencies, small and medium-sized enterprises, and commercial real estate.
- The Credit Secondary Market Act (KrZwMG), implemented in 2023, has laid down new obligations for credit institutions, buyers of NPLs, credit service providers, and their supervision by BaFin, aiming to build a unified legal framework for the secondary market across Europe.
- For investors, portfolios of NPLs offer an attractive investment opportunity, providing the chance to convert discounted non-performing claims into a risk-adjusted return, or investing in the debtor company via a debt-equity swap or insolvency plan.
