When the global financial crisis reached Central and Eastern Europe (CEE), in the fall of 2008, the era of easy, foreign-financed credit came to an abrupt end and export markets collapsed. The region’s economy was plunged into a deep recession. Problems with the quality of banks’ assets emerged soon thereafter and non-performing loans (NPLs) rose sharply. Additionally, the high level of local debt denominated (predominantly) in Swiss francs made local borrowers extremely vulnerable and led to them sub-performing. The first wave of NPL resolutions was borne within the Vienna Initiative 1, which aimed to keep western European banks committed to the CEE market.
NPL resolution since then has evolved substantially and the strategies that are available for banks range from internal work-outs to direct sales. The structure of the transactions will depend on various factors, such as the transferability of the portfolio, the legal and regulatory frameworks (including those applicable to servicing capabilities and the enforcement of debt), the nature of the asset, financing the acquisition and the security of the exposure. The disposal of a portfolio of secured loans is preferably structured as an asset sale because, depending on the law governing the loans and/or collateral, the security interest could be transferred together with the loan. Unsecured exposures might be transferred by way of a share sale, when the entire entity holding the relevant portfolios is sold. We have seen recent examples of investors purchasing an entire bank (e.g., in Serbia) in order to overcome licensing and servicing impediments.
A purchaser’s licensing requirements have proved to be a barrier to entry into certain markets (e.g., Hungary). Innovative structures recently used ‘EU-passported’ fronting banks to purchase the NPL portfolios and in turn the investors acquired synthetic exposures to the portfolio by way of sub-participations or risk participations. Where servicing of NPL portfolios is a licensed activity (e.g., in Greece), investors are setting up their local servicing companies prior to entering the market. Alternatively, purchasing of a servicing platform together with the NPL portfolio could optimise recovery or overcome licensing obstacles.
The securitisation of loan portfolios has proved a success in the Polish market. Under the Polish legal regime, the portfolios are acquired by special securitisation funds and, financing such acquisition, the funds issue hybrid instruments called investment certificates. A nuance to this structure exists when investors acquire shares to access the economic interest of the fund.
Governments and regulators have also realised that comprehensive strategies are needed to address the NPL problem. The national schemes of asset management companies (AMCs) have been adapted to deal with bad assets in, for example, Slovenia (DUTB) and Hungary (MARK). History has proven that AMCs can swiftly clean up NPLs from banks’ balance sheets and resolve them over a longer period of time. AMCs, however, must be supported by debt enforcement frameworks in order to achieve better recoveries than the originating banks. The promotion of the early restructuring of viable companies and the easy liquidation of collateral and non-viable companies was the aim of the new pre-bankruptcy legislation in Croatia. Serbia, on the other hand, has changed its enforcement procedure as part of the Vienna Initiative 2, to reduce time and improve efficiencies.
In its most recent NPL resolution guidance, the European Central Bank (ECB) outlines measures, processes and best practices which banks should incorporate when tackling NPLs. The ECB expects banks to fully adhere to the guidance in line with the severity and scale of NPLs in their portfolios. The ECB does not stipulate quantitative targets to reduce NPLs; instead, it asks banks to devise a strategy that could include a range of policy options such as NPL work-outs, servicing, and portfolio sales.
Lastly, the advantages of the establishment of an AMC at European level were highlighted in the guidance as it would facilitate raising private funding in the market and offer a quick clean-up of banks’ balance sheets. The evolution of CEE NPL resolution is continuing…