Following the 2008 global financial crisis, the formation of a secondary market for European non-performing loan (NPL) deals provided a crucial channel for banks to clear out their loan books. To manage an anticipated increase in NPL volumes post-pandemic, regulators in the European Union (EU) have pursued similar initiatives during the past couple of years to further energize the secondary NPL market. These efforts have yet to bear fruit.
The EU’s NPL Directive was implemented at the end of 2021, and the EU member states had until December 2023 to incorporate its guidance in national legislation. The Directive introduced various reporting and NPL servicer requirements aimed at making the EU NPL markets more liquid by removing impediments to and providing safeguards for the transfer of NPLs by banks to credit purchasers and to safeguard borrowers’ rights.
Regulators hoped that by standardizing reporting and harmonizing NPL servicer regulation, the Directive would make the NPL market more transparent and competitive. The intention was to make it easier for banks to dispose of their NPL portfolios and reduce the risk of future NPL accumulation.
Economic realities bite
The NPL Directive holds NPL servicers to solid minimum standards and increases transparency in the market. This standardization and regulation are a positive development for the NPL space and has been well received by established market players in the financial industry, as well as the introduction of passporting rights, which allow NPL servicers authorized in one member state to operate across all EU countries. However, the challenging macroeconomic environment has inhibited efforts to boost secondary NPL deals.
The risk assessments published by the European Banking Authority in November 2024 show that EU bank NPL stocks reached €373 billion in June—a 3.4% increase year-on-year. But the market is only a fraction of the size it was in 2016 when NPL stocks hit a high-water mark of more than €1 trillion. Moreover, NPL outflows have been flat year-on-year, with only €103 billion recorded in H1 2024, against inflows of more than €113 billion.
This reflects the ongoing normalization and, to a certain extent, the professionalization of the NPL industry. Even with the year-on-year inflow of new NPLs, there are no signs of a new “avalanche”—bank regulation, management, proactiveness and capital are in a much stronger position today than in the aftermath of the post global financial crisis. This has resulted in limited transaction flow and, combined with elevated interest rates, has created challenges for traditional buyers of NPL portfolios. Buyers predicated their NPL business models on high deal volumes, winning associated servicer contracts, and the ability to raise cheap financing on capital markets to fund portfolio purchases.
With these commercial levers coming under strain, key buyers of bank NPL portfolios have been unable to offer prices that would make NPL disposals worthwhile for banks. This removes capacity and competition from the market. Thus, as banks now enter NPL trades for better capitalization, they would rather hold underperforming loan books than sell at too-steep a discount.
The harmonization and disclosure requirements of the NPL Directive have simply been insufficient to counterbalance the commercial headwinds blowing through the market.
Indeed, in some ways, the Directive’s additional disclosure and reporting requirements have added complexity and increased compliance costs. They have made it more difficult to operate as a NPL servicer and, to a lesser degree, as a buyer.
Eventually, investors, who enter the NPL market at a benign point in the economic cycle, may emerge and value the transparency and disclosure requirements that the Directive mandates. But in the current market, the Directive’s provisions are unlikely to change the perspective of experienced NPL players.
NPL buyers become NPL sellers
In some cases, market pressures have become so severe that the traditional buyers of NPL portfolios are now forced to sell them.
Lower deal volumes and elevated interest rates have hindered recoveries and weakened return expectations for NPL portfolios. In response, the market has adopted a more sophisticated and specialized approach to portfolio curation. NPL investors are conducting thorough reviews of their portfolios, focusing on the assets where they have the most expertise, and selling off loans outside those parameters in the secondary market.
To date, these deals have been relatively small and low-profile as compared to the banks’ bigger NPL disposals. For example, a NPL vendor is more likely to find a specialist buyer for a specific loan exposure than sell a larger, mixed bundle of loans in a big transaction.
The NPL market is maturing and becoming more professionalized. Nevertheless, there is still a clear need for professional servicing players and capital. Many of the well-known NPL servicers are changing their operating models by no longer deploying their balance sheets for new NPL investments and focusing on consolidation opportunities in the servicing sector, reflecting the increasingly strategic importance of scale in the industry. In turn, NPL investors with capital are exploring selective strategic capital partnerships with NPL servicers to reduce fees and boost net returns.
Backstop boost
While the NPL Directive has not enhanced the liquidity of the NPL secondary market as the regulators may have hoped, there is another piece of regulation that continues to keep NPL deal volume ticking over, irrespective of the ups and downs in the credit cycle. Passed in 2019, the EU's Backstop Regulation, amending the EU’s Capital Requirements Regulation and requiring banks to back NPLs with core equity, has consistently driven banks to offload their NPL exposures.
The Backstop Regulation requires banks to book minimum levels of provisions for NPLs based on a uniform “provisioning calendar,” a backstop for insufficient NPL coverage, and to apply a deduction to their capital to the extent their provisions fall short. The calendar determines the required level of coverage at different points in time, starting from the date in which the loan becomes non-performing. As the likelihood of repayment decreases over time, the required coverage gradually increases until it reaches 100%. While the banks must fully cover unsecured loans within three years, secured loans must be fully covered within seven to nine years. The Backstop Regulation, therefore, incentivizes banks to sell NPL portfolios to remove them from their balance sheets.
Although the NPL Directive has not yet spurred Europe’s NPL secondary market, the Backstop Regulation continues to drive deal flow by incentivizing disposals. As the regulatory landscape continues to evolve, the NPL secondary market is poised for maturation.