NPL Iberia 2020
Notes on the Spanish NPL market
Prepared by Allen & Overy
Key takeaways: A summary of discussions during the Spanish session at the IBERIA 2020 conference, by Allen & Overy
“Over the course of the next few years, the NPL market in Spain will undoubtfully be shaken-up and become tremendously exciting.”
Ishtar Sancho, Counsel, Allen & Overy
The NPL Market in 2020

In Q1 and Q2 of 2020 the NPL market was frozen due to the COVID pandemic. Market players had to adapt quickly to the new environment but were slowed-down in their response times by the high level of uncertainty and the subsequent fear of making strategic errors. The end of the year has shown that the market is picking up and we are seeing the completion of sales of portfolios put out to market at the beginning of the year.

The Effects of COVID-19

Although it is difficult to predict, COVID and new accounting recognition rules for banks will create new NPL inflows, although it may take 1 or 2 rounds of refinancing/restructuring until current loans qualify as non-performing.

By the end of 2021 and 2022-2024 a new mass of NPLs will affect the market.

Asset classes will be affected, and it is expected that the order of timing will be; first consumer (unsecured) loans defaulting, secondly SMEs (although the roll-over of ICO financing will smooth default rates in the second half of 2021) and finally, individual residential mortgage loans.

New originators, by sector and industry – we are seeing the consolidation in the market of not only Bank NPLs, but also consumer finance, autofinance, fintech and amongst others, telcos.

The expected increase in SME NPLs will require a new risk assessment exercise, as the new positions may provide investors a higher return in restructuring situations rather than pure liquidation of the collateral. This will require a change; of mind-set, business models, the role of advisors and investor appetite.

The Typology of investors

The SME class assets expected to arise as a consequence of COVID will introduce a new volatility and risk pattern analysis to be considered by investors. The purchase prices and underwriting stage risk premiums will attract more specialised funds with a more private-equity approach, and a return between 15-20%.

An important effect concerns how the portfolios will be designed by the sellers and their advisors, either by creating isolated portfolios of assets or by mixing different asset classes and buckets to diversify.

The investors will also be conditioned by new markets and opportunities arising in countries such as Germany and France.  Investors may seek to invest in such new markets to both diversify their positions and to avoid regulatory and judicial issues and uncertainties of the Spanish market.

Drivers that will speed up or slow down the market
  • Default rates are expected to rise
  • The change in IFRS 9 accounting rules and new definition of default affecting perimeter of assets classified as default is going to be larger and the expected loss on a loan is higher with an impact in solvency rate, with direct impact on bank originators.
  • Mortgage moratoria ended in October. This will result in more defaults in the next 6 months.
  • The need of Banks to clean up former portfolios.
  • ICO loans and their extension to the end of June 2021 and grace period of 2 years.
  • ERTEs for individuals, expected to end January 2021 but may be extended to May.
  • How the regulator will behave, and the support of the political measures to support the situation.
Pricing and valuation methodology

The judicial and regulatory risks which are directly impacting the market, reducing cashflow recovery which is reducing final profitability, and the regulatory uncertainty are also delaying expected collections and affecting the model.

Statistical and qualitative approach to define pricing correctly: new requirements, as the advisors and servicers will need to update daily the data and collectability analysis to reduce gap of uncertainty, with daily benchmark information and data.

Prices have not been affected immensely and the market has stabilised, but prices may be affected in the coming months, although additional factors will clearly affect the final prices. The gap between price expectations will increase in coming months.

Strategies Banks will adopt in their approach to NPL deals

After efforts to clean balance sheets from prior COVID NPLs. Spanish banks come to this crisis more prepared (but less than other EU financial institutions), but also the industry has enlarged. The stock of NPLs is much higher than in the previous crisis.

Going forward, banks will try to outsource operations to servicers to restructure or recover defaulted positions, which may be a first attempt to recover retail solutions. After that…. Who knows?

Key quotes from the session
“By the end of 2021, and between 2022-2024 a new mass of NPLs will affect the market.”
“The wish list: a change of mind set, business models, role of advisors and investor appetite.”
“Going forward, as a first try banks will try to outsource operations to servicers to restructure or recover defaulted positions, which may be a first try to recover retail solutions.”

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