Non Performing Loans (NPL‘s) –

how to handle and optimize

Ralf Zeitlberger

Head of Group Corporate Workout

Erste Group Bank AG

11 September 2015 1

Agenda

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1. • NPL portfolios across Europe

2. • Outcome and treatment in the AQR test of ECB

3. • Relevance for banks‘ equity and P&L account

4. • Possible solution strategies: restructure, liquidate, sale

5. • Sale of NPL‘s

6. • NPL‘s of corporates, real estate and retail

7. • Most successful recoveries for corporate loans

1. NPL portfolios across Europe

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Country Total NPL‘s as % of

total banking assets

Austria 3,5%

Netherlands 3,1%

Sweden 1,2%

Ireland 20,7%

Romania 13,9%

Portugal 11,9%

Spain 8,5%

Croatia 16,7%

Hungary 15,6%

Czech Rep. 5,6%

Source: IMF, Financial Soundness Indicators, NPL Balances as

of Dec. 2014

• € 1,2 trillion of NPL‘s across Europe (= 3% of total banking assets)

• Current indicators for total Europe as of Dec. 2014

1. NPL portfolios across Europe – CEE

• 9 countries in CEE accounted for € 58bn NPL‘s in 2013:

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CEE country Total NPL‘s (as %

of total banking

assets)

% Corp. % Retail

Poland 16,5bn (8,5%) 11,5% 7,1%

Romania 10,7bn (21,9%) 29,1% 13,7%

Hungary 6,4bn (18,4%) 17,9% 18,8%

Croatia 5,9bn (15,6%) 28,1% 11,1%

Bulgaria 4,9bn (14,5%) 19,3% 13,3%

Czech Rep. 4,7bn (5,9%) 7,1% 5,0%

Serbia 3,5bn (21,4%) 27,3% 11,2%

Slovenia 3,4bn (13,8%) 20,4% 5,3%

Slovakia 2,0bn (5,8%) 8,1% 4,2%

Source: Houlihan Lokey

1. NPL portfolios across Europe – trend

• Upward trend of NPL‘s started with the outbreak of the economic crisis in 2008

• NPL‘s reflecting macro-environment (unemployment rates, low GDP growth, …)

• Increased GDP growth in CEE region:

• The northeastern European countries (e.g. Latvia, Poland, Estonia) are driving the CEE growth

• Croatia and Serbia as the only CEE countries with negative GDP growth until 2014

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Development of NPL as % of total bank loans Source: World Bank

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

2. Outcome and treatment in the AQR test of

ECB (2014)

• AQR („Asset Quality Review“) = Assessment of data quality, asset valuations, classifications

of NPE (non-performing exposures), collateral valuation and provision

• Risk-based portfolio selection, covering at least 50 % of RWA

• Exercise included the calculation of AQR-adjusted CET1 („Common Equity Tier 1“) results

were compared with the Capital target of 8 % CET1

• Assessment of provisioning levels based on „Going or gone concern?“

• Going concern cash-flow analysis

• Gone concern collateral analysis

• Various NPE definitions across participating banks AQR imposed a standard definition acc.

to final draft of forbearance and NPE standards by EBA

NPE stocks of in-scope institutions were increased by total € 136bn to € 879bn

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Source: ECB

2. Outcome and treatment in the AQR test of

ECB • Total adjustment in participating banks asset carrying values as a result of AQR was € 47,5bn:

Credit file review € 16,4bn adjustments

• Exposures reclassified from performing to non-performing € 6,6bn

• Increase of provisioning of existing NPE‘s € 8,1bn

Projection of findings (findings of the sample were extrapolated) € 10,3bn adjustments

Collectively assessed provisions (review of provisioning models) € 16,2bn adjustments

Review of fair values € 4,6bn adjustments

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Source: ECB

3. Relevance for banks equity and P&L account

• NPL‘s are part of the banks balance sheet

• NPL coverage = the extent to which NPL‘s are covered by Loan Loss Provisions (LLP‘s)

• LLP‘s are needed to cover expected losses effect of Loan Loss Provisions on banks

financials – increase of LLP‘s as an expense in the banks P&L

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If a bank tries to reduce NPL‘s without having them sufficiently covered with

LLP‘s, the losses need to be directly covered by equity (= expensive).

• Additionally to the min. requirements, several additional

capital buffers are being introduced such as a "capital

conservation buffer“, a "discretionary counter-cyclical buffer“

and capital buffers for systemic risks.

Systemically important institutions that are considered

as “risky” will be required to build up additional capital

buffers for these risks.

3. Relevance for banks equity and P&L account

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Basel III / capital requirements:

• Acc. to Basel III the min. Tier 1 capital amounts to 6 %, thereof 4.5 % of CET1 + 1.5 % of

additional Tier 1.

3. Relevance for banks equity and P&L account

• The Capital Requirements Directive (2013/36/EU) (CRD IV) and the Capital Requirements

Regulation (575/2013) (CRR) together implement the Basel III international agreement on bank

capital requirements into EU law.

• Three approaches for the risk weighting:

• Standardized Approach

• Internal Ratings Based (IRB) Approach

• Advanced IRB Approach

• The CRR regulates among others:

• The amount of the required capital according to defined and

weighted risks by the supervisory authorities

• The disclosure requirements

• The consideration of collateral

• The liquidity requirements

• The calculation of the leverage ratio

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3. Relevance for banks equity and P&L account

• Risk weighting of defaulted exposures acc. to Standardized Approach (CRR Art. 127):

• 150 %, if loan loss provisions are less than 20 % of the value of the uncollateralized part of the risk position

• 100 %, if loan loss provisions are more or equal to 20 % of the value of the uncollateralized part of the risk

position

• Risk weighting of defaulted exposures acc. to IRB Approach (CRR Art. 153, 154, 158, 159):

Two different approaches:

• IRBF (“Foundation IRB approach” – in many banks used for Corporate exposures):

No risk weight is assigned to defaulted exposures in IRBF

Expected Loss (EL) is calculated based on estimates of Probability of Default (PD) and Loss Given Default

(LGD) EL = PD x LGD

EL excess / shortfall is calculated (difference of risk provisions and EL):

EL excess = provisions > EL this EL excess is counted for in the Tier 2 capital (CRR Art. 62)

EL shortfall = provisions < EL this EL shortfall is deducted directly from the Tier 1 capital (CRR

Art. 36)

• IRB (“Advanced IRB approach” – often relevant for Retail exposures): risk weighting might be relevant; risk

weighting calculated as LGD (Loss Given Default) – ELBE (Expected Loss Best Estimate)

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The need for capital backing is dependent on the level of provisioning.

4. Possible solution strategies:

restructure, liquidate, sale

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“Restructuring / Going Concern” “Exit / Gone

Concern”

Restructuring of debt:

• Moratorium, grace period

• ST to LT debt

• Restructuring interest rate

• Prolongation of repayment period

Usually higher recoveries

Cooperation of client is necessary

• Sale of exposure to an

investor, usually at a

discount

Liquidation / sale of assets:

• Insolvency proceedings

• Legal enforcement

proceedings

• Out-of-court sale of assets

5. Sale of NPL‘s

1. Internal: actively reducing NPL‘s through special units within the bank

2. External: Sale of single loans or portfolios of NPL‘s

3 different options of portfolio sales:

Sale of receivables via an asset deal

• Transfer of collateral together with the receivable

• Involvement of borrower needed

Sale of shares

• No notification to borrower required

• No transferability issues, but not every seller has such a structure available

Hybrid structure

• Asset transfer to a SPV („Bad Bank“) NPL‘s not in banks balance sheet anymore

• Sale of shares to investor

• Bank provides financing and / or equity

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5. Recent NPL portfolio sales

• In Europe, NPL portfolio sales have been most significant in the UK, Ireland, Spain, Portugal and

Germany over the last years.

• As competition for distressed assets intensifies in the more established European NPL markets,

investors are seeking for opportunities in other countries, such as Italy f.ex. (NPL transactions

2013/2014):

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Source: Deloitte

5. Recent NPL portfolio sales – examples from

CEE

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Date Country Seller Buyer Portfolio type Size (EURm)

Dec. 2014 Romania BCR Deutsche Bank Corporate and

CRE

400

Nov. 2014 Croatia, Serbia,

Montenegro, Slovenia

Hypo Alpe Adria B2 Holding Mortgage,

consumer

169

Aug. 2014 Romania MKB APS Corporate 85

July 2014 Romania BCR DB, APS SME 227

July 2014

Romania

Volksbank

Romania

DB, Anacap,

HIG, APS

Mortgage 495

July 2014 Slovenia Undisclosed DDM Group Consumer

Sept. 2014 Romania ÖVAG Banca

Transilvania

Mixed 2.000

• Some progress with regard to NPL portfolio sales can already be noticed in the CEE region

• Romania has been in focus of many investors in CEE.

Source: Houlihan Lokey, Deloitte, KPMG

5. Sale of single non-performing loans

• Only for large international clients there is a secondary market for the banks loans

towards the client (e.g. Scholz AG, Alpine Bau, Takko,…) .

• Secondary market prices are regularly quoted via brokers (e.g. large investment

banks).

• Sale either through brokers or directly to investors such as hedge funds, private

equity funds, financial institutions…

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6. NPL‘s of corporates, real estate and retail

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Real estate

• Asset is in the main focus

• Asset Takeover solutions possible: • when client is not

cooperative

• to increase the value of the asset (through investing or good management)

• Problematic market for non-income producing assets (landplots)

Retail

• Standard processes for Early and Late Collection (reminder mechanism)

• Portfolio sales quite common after acceleration of the loans: • Mortgage loans

• Consumer loans & credit cards (unsecured)

Corporate

• Restructuring preferred, if possible: • Cooperative client

• Sound business model

• Favorable market conditions

• Alignment with other stakeholders

• …

• Not always possible…

7. Most successful recoveries for corporate

loans

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Statistical data proves higher recoveries under the

restructuring scenario

Recovery

Liquidation (est.)

Recovery

Sale (est.)

Recovery

Restructuring

Food distribution and

convenience retailer ~ 10 – 25 % ~ 20 – 30% 100% + Interest

Shoe retailer ~ 0 – 20% ~ 50 % 100% + Interest

Agro-industrial

conglomerate ~ 10 – 20% ~ 75% 100% + Interest

7. Most successful recoveries for corporate

loans

Successful case – Food distribution and convenience retailer in CEE

• Total indebtedness of € 1,1bn (leverage ~11,7x in 2012)

• High short-term debt significant liquidity shortfall due to

repayment of CP‘s, overdue supplier payables…

• Operating difficulties (poor cost efficiency, underperforming

non-core investments)

Restructuring solved among 55 banks and several lessors within the period of 18 months

Debt reduction of € 200mn (downpayment)

New shareholder with huge synergy effects

Long-term stabilized financing structure

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NO HAIRCUT and full release

on loan loss provisions

Thank you for your attention!

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