3. Introduction 4
Foreword 6
The economic and political situation and a perspective
on the financial environment
• The economic and political situation in the Eurozone 9
• Heavy turbulence in the banking sector 12
• Basel III — reshaping the future landscape 19
Loan portfolio trading
• Recent market developments 25
• Future market trends 27
Country sections
• Germany 28
• United Kingdom 38
• Ireland 46
• Spain 52
• Italy 58
• Turkey 64
• Greece 72
• Portugal 80
• Poland 86
• Russia 92
• Ukraine 98
• Kazakhstan 104
Services 110
Contacts 112
4. Introduction
4 Ernst & Young European Non-Performing Loan Report 2011
5. Nora von Obstfelder, Thomas Griess, Ana-Cristina Grohnert, Daniel Mair
Restructuring follows strategy
The global financial crisis has exposed the weaknesses of the banking industry around the
world and banks need to redefine their strategies to meet the challenges ahead. This
has widened the pool of non-core loan portfolios and banks need to do more than sell their
non-performing loans (NPL) to achieve their desired balance sheet structure.
Ernst & Young’s Strategic Portfolio Solutions team has been around in the “good old NPL
years” before the financial crisis, being directly involved in a large number of loan portfolio
transactions, and has been busy advising financial institutions and investors on their
respective activities during the last few years.
We believe that the coming years will offer historic opportunities and rewards for both
financial institutions executing their post-financial crisis strategy as well as investors in non-
core and non-performing assets.
Ernst & Young European Non-Performing Loan Report 2011 5
6. Foreword
6 Ernst & Young European Non-Performing Loan Report 2011
7. Much has happened since the publication of our European Non-Performing Loan Report 2008.
Back in April 2008, the global credit crisis had already started with the bailout of Bear Stearns
and was just picking up some speed, whereas significant events such as the demise of Lehman
Brothers, the sale of Merrill Lynch to Bank of America, the conservatorship of Fannie Mae and
Freddie Mac and the bail-out of AIG were just around the corner, but seemed unthinkable.
Ireland, Portugal and Spain were considered the growth engines of the Eurozone. Iceland and
Greece were financing their national debt at similar interest rate levels to Germany or the UK.
Sovereign risk was a political, not a financial term.
In the Eurozone and the UK, we saw the failure or nationalization of large financial institutions,
the creation of “bad banks” and the arrival of multi-trillion euro stabilization schemes for the
financial sector in countries throughout Europe.
Three years later, it appeared that the financial sector in Europe had stabilized and started to
heal. High leverage and debt had moved from the private sector to the public sector. As most
of the dust in the financial sector appeared to have settled, we decided to take a fresh look
at the situation and the potential future development of the loan market in Europe.
At the time of publishing this report, European Union leaders are scrambling together with
national governments to put in place a sustainable financial stabilization scheme for the
Eurozone countries. Unsustainable levels of sovereign debt have already resulted in bailouts
being agreed for Greece, Ireland and Portugal, and European institutions are collaborating to
prevent the resulting contagion severely impacting Spain and Italy.
Compared to our 2008 report, we have broadened our perspective and our 2011 report
covers non-performing, sub-performing and performing (non-core) loan markets. Whereas
activity in the European NPL markets has been very subdued since our last report, as the market
participants, especially sellers, have been focusing on managing their portfolios during the most
challenging financial crisis since the Great Depression, we believe that the coming years will see
a much higher level of activity, as transactions are a major step in deleveraging and repairing
the financial system.
We completed our report in mid September and therefore have not covered the most recent
developments after that date such as the fears of another freeze of the interbank lending
market, the rating downgrade of several European banks and the recent nationalization of Dexia.
The potential impact of such developments on the non-core and non-performing loan markets
in the short or longer term remain to be seen.
Ernst & Young European Non-Performing Loan Report 2011 7
8. The economic and
political situation
and a perspective
on the financial
environment
9. The economic and political situation
in the Eurozone
Economic overview Bond yields
The global economy was hit hard by the financial crisis and the
recovery remains unbalanced with advanced economies growing 20% ▬ Greece
at only 2.5%, while emerging economies grow at a much higher 18% ▬ Italy
6%.1 In the emerging economies, the crisis typically left no lasting 16% ▬ Ireland
wounds. Their fiscal and financial positions were generally stronger 14%
▬ Portugal
and hence, the negative impact of the crisis was less intense. 12%
▬ Spain
High underlying growth has strengthened domestic demand and 10%
8%
compensated a shortfall in exports. Better growth prospects and
6%
interest rate levels above that of advanced economies have turned
4%
capital outflows into capital inflows. Meanwhile, in a number of 2%
advanced economies the recovery shows signs of weakening. 0%
Mar 08 Sep 08 Mar 09 Sep 09 Mar 10 Sep 10 Mar 11 Sep 11
In Europe, there is a growing divergence in economic
performance between the north and south. While economic Figure 1 | Source: Oxford Economics; Haver Analytics
growth remains more reasonably robust in the northern part
of the Eurozone — with the exception of Ireland — the south is Peripherals debt
suffering from pre-crisis excesses and crisis wounds: increasing
Gross government debt in % of GDP
borrowing costs, falling house prices, a crash in the construction 180 ▬ Greece Projections
industry and high unemployment rates led to a steep increase 160 ▬ Ireland
of NPLs on banks’ balance sheets, resulting in a deterioration 140 ▬ Portugal
of capital ratios and liquidity positions. 120
100
European governments placed a protective umbrella over their 80
banks, expecting that, with the return of economic growth, bank 60
profits would increase and balance sheets would improve to 40
solve the problem. However, the post-crisis economic recovery is 20
weaker than governments had hoped and, worse still, recovery 0
is weakest where the debts are highest. The sovereign debt 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
markets of the “PIGS” countries (Portugal, Ireland, Greece,
Spain) are under strong tensions, indicated by a surge in Figure 2 | Source: Oxford Economics; IMF; Irish Dept. of Finance
government bond yields. A bank solvency problem thus turned
into a sovereign solvency problem. Peripherals interest burden
Debt interest in % of government revenues
In 2010, the European Financial Stability Facility (EFSF) was 30%
created to provide liquidity to countries that struggle to refinance ■ Greece
at the capital markets. But its remit remains restricted, particularly 25% ■ Ireland
on the purchase of government bonds. A number of proposals ■ Portugal
20%
on economic governance have been made, which go in the right
direction but fall short of a significant move toward fiscal transfers. 15%
This underlines the fact that, as yet, there is no all-encompassing
crisis resolution path. Individual member countries remain keen to 10%
limit their own financial exposure, but the multitude of solutions
5%
14.0%
16.1%
15.6%
16.1%
18.0%
19.6%
19.8%
25.1%
22.0%
25.5%
21.9%
25.1%
they offer do not constitute a coherent approach that could explain
7.6%
8.2%
8.6%
8.6%
8.5%
8.4%
how and when debt sustainability is likely to be achieved in the 0%
Eurozone’s peripheral countries. 2010 2011 2012 2013 2014 2015
1
World Economic Outlook, IMF, April 2011. Figure 3 | Source: Oxford Economics; IMF; Irish Dept. of Finance
Ernst & Young European Non-Performing Loan Report 2011 9
10. The economic and political situation and a perspective
on the financial environment
Economic outlook Forecast of the Eurozone economy
The opinion on the Eurozone’s immediate economic outlook is (Annual percentage changes unless specified)
sharply divided. Earlier this year, confidence indicators painted
2010 2011 2012 2013 2014 2015
an almost euphoric picture, with the Ifo Business Climate Index
GDP 1.7 1.6 1.1 1.9 2.0 2.0
in Germany reaching an all-time high in February this year. In the
wake of sovereign debt crisis and softening economic indicators • Private consumption 0.8 0.5 0.7 1.3 1.5 1.6
in some key markets, economists have been lowering their
• Fixed investment −1.0 2.3 1.8 3.7 4.0 3.6
expectations for economic growth and fears of a double-dip
recession are rising. • Stockbuilding (% of GDP) 0.6 0.6 0.5 0.7 0.7 0.8
• Government consumption 0.5 0.3 −0.2 0.5 0.9 1.1
In our Ernst & Young Eurozone Forecast2, we see a significant
risk of the Eurozone economy slipping back into recession as the • Exports of goods and services 10.6 6.4 4.6 6.0 5.9 5.3
sovereign debt crisis shows no sign of abating. We revised our
• Imports of goods and services 8.9 4.8 3.7 6.0 5.9 5.4
GDP forecast to 1.6% this year instead of previously projected 2%,
before slowing to an “anemic” 1.1% in 2012. Consumer prices 1.6 2.6 1.8 1.8 1.8 1.8
Unemployment rate (level) 10.1 10.0 9.9 9.6 9.2 8.9
Earlier this summer, our forecast was a fairly benign scenario in
three main respects. First, our Ernst & Young Eurozone Forecast Current account balance (% of GDP) −0.5 −0.8 −0.5 −0.3 −0.3 −0.3
assumed no further escalation to tensions in the Middle East.
Government budget (% of GDP) −6.0 −4.2 −3.1 −2.3 −1.8 −1.4
Second, it assumed that the financial market environment is benign
as fiscal adjustment proceeds further and governments take some Government debt (% of GDP) 85.5 86.9 88.0 87.9 87.8 87.6
decisions that reassure investors as regards their ability to avoid
ECB main refinancing rate (%) 1.0 1.3 1.2 2.6 3.5 3.9
and deal with future sovereign debt crisis (however, during August,
investors certainly did not afford governments such breathing Euro effective exchange rate (1995 = 100) 120.7 121.1 120.4 119.4 115.4 113.5
room). Third, our forecast assumed that the Eurozone banking
Euro/US dollar exchange rate ($per €) 1.33 1.41 1.38 1.33 1.27 1.24
sector restructures gradually and avoids widespread disruptions.
However, we now expect that the Eurozone sovereign debt crisis
will worsen further, in turn undermining growth prospects. Figure 4 | Source: Oxford Economics
Growing risk of disorder
Markets remain unconvinced by the two bail-out packages agreed
for Greece. It is possible that similar sentiment could spread and
once again impact the borrowing costs of Ireland and Portugal.
Without a rapid improvement in their competitiveness, all three
economies, as well as Spain and Italy, will be challenged by low
levels of economic growth, further hampered by unsustainable
debt servicing burdens.
One of the most disturbing problems in this context is the
unemployment among young people and how it affects
the society and the younger generation’s ability to become
established in the labor market. The latest available statistics
are alarming: in Spain, nearly 45% of citizens under 25 are
unemployed. The figure for Greece is 36% — this is far too many
young people who are not using their insights, energy and ideas
to build and develop future businesses and public services.
10 Ernst & Young European Non-Performing Loan Report 2011
11. Both the finance markets and the political leadership in Europe Businesses prefer to reduce debt and banks keep credit tight
fear that after Greece, Portugal and Ireland, Italy and Spain The recovery in domestic activity is forecast to continue at
might also fail and the deepening crisis would strike hard against a slow pace. Strong export performance has not yet been
European banks, especially in Germany and France. sufficiently sustainable to make companies in the Eurozone
as a whole confident enough to raise investment at a robust
This creates a potentially dangerous economic and political pace. Even in Europe’s recently top performing economy,
context for business over the next 12 months, and one that is not Ernst & Young’s study of the German lending market3 supports
geographically limited to Europe either. We have seen that the this finding, as the majority of polled companies are still reluctant
voluntary participation of the private sector in the second rescue to invest. This is mainly attributable to the need for utilization
package for Greece has led to a downward rally of European of technical capacities, which were considered weak at that
stock markets, and diminishing confidence among banks is time. Nevertheless, given ample amounts of cash available to
raising fears of a second credit crunch on the interbank market. the business sector on aggregate, our Ernst & Young Eurozone
A wider orderly sovereign debt restructuring could rock global Forecast sees Eurozone business investment to rise by 2.7% this
financial markets and a deeper default than the one in July on year and 2.6% in 2012. This would leave the level of investment at
Greek sovereign debt now looks unavoidable. Economic recovery the end of next year still around 10% below pre-crisis levels. In the
in Europe falters as confidence in the euro and the solidity of the UK, demand for credit is reported to be similarly weak.
Eurozone weakens. Consumer confidence, by no means robust in
the Eurozone at present, will be weakened further. Into this bleak We think that the corporate balance sheet restructuring and
outlook, we should also factor in growing uncertainty over the deleveraging that has been a main focus of companies over the
direction of US economic policy, doubts over the US economic past year will continue to weigh on investments for some time.
recovery, the risk of oil prices remaining at current high levels and Business investment is not expected to return to pre-crisis
the possibility of even higher, and fluctuating, commodity prices. levels before 2014.
The discussion about the best way of solving the Eurozone Moreover, Eurozone banks are keeping a tight lid on lending as
sovereign debt problem between the EU and the European Central they restructure their own balance sheets and reduce their
Bank (ECB) has been hard and reveals a strong disagreement exposure to the riskier sectors and countries. As banks continue
over what measures need to be taken. The Eurozone financial to deal with a significant corporate refinancing burden, the
crisis is a great challenge for its governments and central banks, outlook for new lending remains muted. The Q2 results of the
but this is not only about creating consensus at the EU level. All ECB’s Bank Lending Survey show that only banks in core countries
governments in the Eurozone and their political opponents have a (Germany, France, Austria, Belgium, Netherlands) have started
great responsibility when it comes to finding common strategies to unwind the tightening of credit standards imposed during the
to lift their countries out of the crisis and to secure Europe’s crisis and, even in these countries, this unwinding is slow.
future as a strong single market.
2
For further information please refer to the full reports under www.ey.com/eurozone.
3
A Study of the lending market — September 2010, Ernst & Young, http://www.ey.com/DE/DE/home/library.
Ernst & Young European Non-Performing Loan Report 2011 11
12. The economic and political situation and a perspective
on the financial environment
Heavy turbulence in the banking sector
Liquidity Sovereign risk is casting a shadow over the banking sector …
The global credit crisis was triggered by the US subprime mortgage The sovereign debt crisis remains a defining theme for both the
crisis, followed by a liquidity shortfall in the US banking system. Eurozone economy and the banking sector. Credit default swap
With the collapse of Lehman Brothers and other systemically (CDS) spreads for Greece, Ireland, Portugal, and more recently
important financial institutions, the bail-out of banks by national Spain and Italy, have risen to new highs, which is translating
governments and downturns in stock markets around the world, to higher funding costs that banks are finding difficult to pass
this quickly emerged into a global financial and economic crisis, on to borrowers in these countries. Concerns about possible
which exceeded all previous crises since the Great Depression. sovereign debt defaults have led to a sharp rise in the perceived
counterparty risk of banks in the troubled countries, with
Despite the fact that the Eurozone banking sector is gradually banks elsewhere in the Eurozone and beyond reducing their
recovering from the global financial crisis and recession, the exposures to banks considered to be most effected. Due to the
outlook remains challenging. As described in the first section interdependence of bank and sovereign creditworthiness, access
of this report, economic growth in the Eurozone is expected to to wholesale funding is likely to remain significantly restricted in
remain uneven; household and business balance sheets remain these economies. This is illustrated by the forecast for 10-year
stretched in many member states. Ongoing sovereign debt crises government bond yields, which are expected to remain close to
and lingering uncertainty about the asset quality of many banks 4% in Germany and France this year, as opposed to 5.5% in Spain
is hampering access to wholesale funding markets at reasonable and more than 15% in Greece.
cost (although the ECB is playing a crucial role in providing
financing to certain banks). At the same time, banks’ profitability This drain of liquidity has left peripheral country banks
in the region is facing headwinds from a broad range of increasingly reliant on the ECB for funding. In January 2011,
regulatory reform initiatives that are currently under way at both banks from Greece, Ireland, Portugal and Spain borrowed around
the EU and global levels. Against this background, the outlook for €320b from the ECB, down from €378b in July 2010, but still
the Eurozone banking sector remains highly uncertain. well above the typical levels of around €50b before the crisis.
ECB lending to the periphery
€ billion
400
■ Ireland
■ Portugal
350
■ Spain
■ Greece
300
250
200
150
100
50
0
2007 2008 2009 2010 2011
Figure 5 | Source: Oxford Economics; Haver Analytics
12 Ernst & Young European Non-Performing Loan Report 2011
13. Banks‘ NPLs
% of total loans
8 Forecast
▬ Eurozone
7
▬ Italy
6 ▬ Spain
5 ▬ Germany
4
3
2
1
0
2007 2009 2011 2013 2015
Figure 6 | Source: Oxford Economics; World Bank
And in February 2011, two Irish banks, that had to sell assets lower collateral values. This legacy of bad loans will
to restructure their balance sheets, had to resort to the ECB’s hamper banks’ ability to normalize credit conditions to
overnight lending facility, pushing the amount borrowed by support the economic recovery in these regions.
Eurozone banks to around €15b for a few days compared with
only a few hundred millions usually. Total ECB lending to Portugal, In light of our underlying forecasts for subdued economic
Ireland, Greece and Spain amounted to around €350b in April. growth and multiyear deleveraging in the private sector, we
Within this total, lending to Ireland has expanded significantly expect lending and profitability to remain muted, with the
over the past year due to the intensification of their banking likelihood that some banks will need to raise capital to meet new
crisis. By contrast, ECB lending to Spain had, until recently, been Basel III standards as well as address elevated asset quality risk.
contracting in line with improved investor sentiment. But the There is also a risk that margins will generally remain weaker
intensification of the sovereign debt crisis has seen financing than for banks in the core due to the higher cost of funds. On the
costs for Spanish banks rise again, forcing them to borrow from other hand, our forecast for a gradual normalization of monetary
the ECB rather than access capital markets. policy by the ECB will see the yield curve flatten within the core
Eurozone over the next few years, which is also likely to squeeze
… underscoring the north/south divide in performance margins for banks in these economies.
Besides a funding squeeze, uncertainty remains about the
asset quality of many of the banks in the peripheral economies,
particularly their exposures to the depressed residential and
commercial property sectors. The impact of ongoing fiscal
austerity measures on economic growth, employment and credit
quality will continue to represent a significant downside risk to the
performance of banks in these economies for some time, where
they have significant local exposure.
Persistently high NPL ratios in the periphery economies will
mean that provisions for bad loans will remain at elevated levels,
dampening earnings and profitability. In countries such as Spain,
where we expect house prices to continue falling through to
2014, the negative collateral effect on bank balance sheets will be
compounded, as mortgages will have to be written off net of much
Ernst & Young European Non-Performing Loan Report 2011 13
14. The economic and political situation and a perspective
on the financial environment
Capital
The financial crisis also revealed major shortcomings in the way Across the EU over €2,800b capital was deployed by national
the banks had been operating: the capital ratios were insufficient governments to stabilize and support financial institutions. Of
and the capital they held was of insufficient quality. What began the support measures deployed, around €2,100b was provided
as a credit issue on US subprime mortgages spread to several in state guarantees (76% of total measures), 16% were deployed
other asset classes as the recession took hold, leading to the to assume risk positions and 8% were deployed to recapitalize
significant impairment of banks’ balance sheets. To fulfill capital financial institutions. The Irish Government dedicated the highest
requirements and improve liquidity positions, banks had to raise amount toward state guarantees, which accounted for 82% of the
new capital or reduce assets exposures. total value of support provided by the Government. Across the
EU and Switzerland, funds allocated for state guarantee schemes
Governments were required to intervene with massive and were primarily used to provide guarantees for bonds issued by
unprecedented rescue packages for both the economy and financial institutions.
the financial sector, preserving both financial stability and the
functioning of the internal markets. Globally, governments have In terms of country-specific measures, the UK Government
adopted a variety of measures to achieve this, ranging from provided the highest value of country support with a total
full-scale nationalization of financial institutions to providing amount of around €585b. The Irish Government deployed the
insurance for impaired assets. second-highest value of measures — marginally behind the UK at
ca. €540b and Germany at around €480b. In many countries,
mainly Eastern Europe but also including Italy, governments
Government intervention schemes
State guarantees • State guarantees were provided to selected financial
► Recapitalization • Capital injection in selected financial institutions
►
instruments issued by financial institutions was provided to strengthen the capital base of these
• Typically, senior unsecured medium-term (three to five
► institutions
years) instruments were guaranteed • Most of the government recapitalization during
►
• State guarantees were provided across the majority of
► the financial crisis occurred through non-dilutive
the countries researched — notably in Ireland, where instruments such as preferred shares, non-voting
around €440b of state guarantees were provided to the securities, mandatory convertible instruments or
major banks subordinated debt securities
• France is the only case where guarantee was provided
► • Recapitalization measures were used widely across the
►
to a government-owned entity (Société de Financement EU Member States — in particular, in Germany
de l’Economie Française) that further provided loans
to financial institutions
Nationalization • Nationalization is a special case of recapitalization
►
under which the government becomes sole or majority
Assumption of • The scheme involved the acquisition of risk positions
► owner of the financial institution
risk positions through purchase or guarantee of legacy assets
• This step was generally undertaken for severely
►
• Asset purchases involved acquisition of assets,
► distressed financial institutions to enable smooth
securities, rights and obligations arising out of credit restructuring and eventual re-entry into the market
commitments and/or holdings; for example, the National
Asset Management Agency (NAMA) in Ireland, that
• Key examples include the nationalizations of Northern
►
Rock in the UK, Allied Irish Bank, Hypo Real Estate in
acquired toxic property assets of banks at a heavily
Germany and Parex Bank in Latvia
discounted rate in return for government bonds
• Asset guarantees were also deployed to provide
►
protection from potential losses. These programs were
generally customized according to the beneficiary Deposit guarantee • The scheme primarily involved increasing the limit
►
for protection of retail and SME deposits in financial
institution; for example, the Asset Protection
institutions
Scheme in the UK, which provides RBS with protection
against future credit losses in return for a fee
• The majority of countries researched increased the level
►
of protection provided by depositor protection schemes
Figure 7 | Source: Ernst & Young research
14 Ernst & Young European Non-Performing Loan Report 2011
15. Total value government aid per country
€ billion
600 585
540
500 480
400
341
300
220
200
157 150
100 90
54 48 35 24 20 20 12 7 3
0
y
UK
nd
y
ce
s
en
n
ria
d
nd
k
al
g
m
ce
ia
nd
ar
an
ur
ar
ai
an
ug
en
iu
an
ee
ed
la
la
st
Sp
nm
ng
bo
la
rm
nl
lg
ov
rt
Ire
er
Au
Fr
Gr
Sw
er
Fi
Be
Hu
m
Po
itz
De
Ge
Sl
th
xe
Sw
Ne
Lu
Figure 8 | Source: Ernst & Young research
were not required to introduce formal anti-crisis schemes; guarantees, around US$420b was deployed to recapitalize
however, deposit guarantee schemes have been widely financial institutions, and around US$40b was deployed to
introduced by these governments. assume risk positions.
Across the EU region, a total of 94 financial institutions received Limited ratings migration to the benefit of most creditors of
some form of government assistance. France supported the highest these banks, as well as the improvement of banks’ capital
number of institutions — 13 in total. This is followed by Germany, ratios, reflect the effects of these capital interventions in addition
Austria, Portugal and Greece who supported seven institutions to profitability improvements and deleveraging efforts. The state
respectively. In most of Eastern Europe, as well as Italy, no direct aid measures were linked to major restructuring and reorganization
support was provided to any institution — primarily because, in requirements for banks in order to establish robust banking models
most of the Eastern European countries, the banking industry is that show higher resistance to shocks to the financial markets.
dominated by foreign players who received support from their Restructuring of the Eurozone banking sector is ongoing, with
respective home countries’ governments. During 2008, the US measures such as the consolidation of Spanish cajas (savings
Government, along with the Federal Reserve, Federal Deposit bank) or the split-up of German Landesbanken (federal state banks).
Insurance Corporation (FDIC) and the US Treasury, launched
various schemes, under the Emergency Economic Stabilization
Act of 2008 and Troubled Asset Relief Program (TARP),
to stabilize the financial system. Of the support measures However, progress on banking restructuring is slow and it is
deployed, more than US$1,000b was provided in state as yet uncertain as to whether these measures are enough to
solidify the banking system and make it a contributor to growth
rather than a restraint. Nevertheless, management boards,
including those of banks owned by the state, are willing to rethink
the bank’s business model, improve risk management and are
keen to present their shareholders cleaned-up balance sheets.
Ernst & Young European Non-Performing Loan Report 2011 15
16. The economic and political situation and a perspective
on the financial environment
Why are some banks more resilient to stress than others? The question as to what makes the difference between a
The financial crisis has had far-reaching impacts on financial successful and a less successful business model and whether
institutions across the globe. However, while numerous institutions there is a “best practice” business model in banking, has been
failed or had to be bailed out by impressive governmental rescue addressed in various research papers and analyzed in recent
schemes, other financial institutions maneuvered better through years; yet, we find that the following key factors seem to play
the crisis years and came out in much better shape. a role in most of the analyses:
Largest European listed banks4 that have not required Sound business model. A key factor enabling sustained financial
governmental aid to date success also in periods of stress is a sound business model. Key
elements include a clear focus on product, markets and client
€ billion Market* Total assets** Rating***
capitalization
strategy, established riskmanagement processes and last, but not
least, an established set of values across the organization.
HSBC Holdings 122.7 1,870.0 Aa2/AA−/AA
Banco Santander 67.2 1,231.9 Aa2/AA/AA
A key element differentiating performance of financial
institutions has been the appetite for risk, which is closely
Deutsche Bank 37.8 1,850.0 Aa3/A+/AA− linked to the business model. In general, we find that financial
institutions lacking a solid, sustainable and competitive business
Barclays 34.8 1,661.9 A1/A+/AA−
model were more likely to take on excessive risks to improve
BBVA 36.8 568.7 Aa2/AA/AA−
profitability than others.
Credit Suisse 32.8 814.9 Aa2/A/AA− A recent study of US banks revealed that those banks that
performed poorly during the Asian crisis of 1998, were harder hit
UniCredit Group 28.2 918.8 Aa3/A/A
by the global financial crisis of 2007 to 20095. This phenomenon
Nordea Bank 29.9 593.2 Aa2/AA−/AA− seemed to be independent of the people in charge, and has
been explained largely by sustained weaknesses of those banks’
Svenska Handelsbanken 13.2 244.1 Aa2/AA−/AA− business model.
SEB 12.3 238.8 A1/A/A+
A fundamental element of sound business models is a state-
Swedbank 13.4 190.7 A2/A/A of-the-art risk management. Risk management practices of
top performers have been summarized as combining various
Banco Popular Español 5.5 130.4 A2/A−/A− elements, such as effective firm-wide risk identification and
analysis; consistent application of valuation practices; an
Figure 9 | Source: Forbes 2000 list; Bloomberg; banks‘ interim financial effective management of funding liquidity, capital and the
statements; www.oanda.com balance sheet; and informative and responsive risk measurement
* Market capitalization as of 30 June 2011 (Bloomberg) and management reporting.6 Those banks that priced risk
** Total assets as of 30 June 2011 (interim financial statements) appropriately, and/or took early action to reduce high-risk
*** Latest available rating Moody‘s/S&P/Fitch/ positions as the crisis unfolded, performed significantly better
FX rates as of 30 June 2011 provided by www.oanda.com in the crises.
A high degree of non-interest income can drive profits, but does
lead to higher volatility of income. However, if risks are rightly
managed, a higher portion of non-interest income should not be
viewed as a critical issue of a bank’s business model per se.
Underperforming business models, an increasing appetite for risk,
coupled with inadequate risk management routines, may all have
played a role in numerous banks’ accumulation of significant
exposure to toxic assets in their credit books during pre-crisis years.
16 Ernst & Young European Non-Performing Loan Report 2011
17. On one hand, institutions that limited their structured credit
investments emerged as winners from the crisis. Spanish
Banco Santander, today Eurozone’s largest bank by market
capitalization, and BBVA, benefited from low exposure to such
instruments, in part due to limitations imposed by the Spanish
central bank, and instead focused on growing in retail banking
and in international growth markets in Latin America.7 Likewise,
French banks, in general, maneuvered better through the crisis
than most peers, supported by their business models focused on
traditional retail and corporate clients. Somewhat in contrast to
the aforementioned study results on US banks, Swedish banks for The crisis has revealed that even the most liquid funding markets
their part seem to have learnt a lesson from their banking crisis can break down within days, making business models relying too
in the early 1990s, and in general were in much better shape to heavily on non-deposit funding much more risky and non-resilient
address the challenges of the financial crisis. to stress. As a consequence, a key focus of Basel III has been
rightly placed on funding liquidity risks.
On the other hand, those institutions that were particularly
affected by the crisis often revealed shortcomings in their Capitalization. Financial institutions with strong core capital
traditional business model. A high degree of non-interest income, positions are outperforming peers with weaker positions.
an increasing appetite for risk, and inadequate risk management Recent studies during the financial crisis indicate that highly
may all have played a significant role in leading to increased leveraged financial institutions tended to limit their lending
earnings volatility and an exposure to higher-risk assets. more substantially9 but also underperformed in terms of stock
Regarding investment banks, the (near-) collapse of several market price development.10 Financial institutions with excessive
Wall Street players hints toward excessive risk-taking partially leverage tended to be viewed more critically by counterparties
incentivized by a business model focused too heavily on short- with respect to their business model and overall solvency.
term profitability and inadequate risk-management techniques Again, Basel III has identified the core capital issue as a major
in light of new and complex financial products. As a second hard- focus area.
hit group, several German Landesbanken suffered massive losses
in the crisis as they had accumulated a significant exposure to In summary, we view those institutions well-positioned to face
toxic assets in pre-crisis years. In search of a viable (and more future challenges that pursue a sound and viable business model,
profitable) business model, several players invested excess are sufficiently capitalized and have a robust and balanced
liquidity heavily in seemingly attractive foreign securities.8 funding mix in place. The Basel III initiatives do provide regulatory
guidance and create additional momentum about banks’ focus
Robust funding mix. Many of the hardest-hit institutions relied on core capital and funding liquidity risks. Meanwhile, several
too heavily on wholesale funding and short-term money markets institutions have taken steps to re-shape their business model and
or securitization activity as a funding source, in many occasions adapt to a more risk-averse environment, strengthen core capital
for longer-term, often illiquid assets (which increasingly were and recalibrate their funding profiles to better manage funding
faced with uncertainty over value). liquidity risk going forward.
4
Largest private banks based on Forbes Global 2000 Leading Companies list.
5
“This time is the same: Using the events of 1998 to explain bank returns during the financial crisis”, Swiss Finance Institute Research Paper No. 11–19,
Fahlenbrach, R., Prilmeier, R., Stulz, R. (2011).
6
“Risk Management Lessons from the Global Banking Crisis of 2008”, Senior Supervisors Group (2009).
7
“A Spanish Bank Emerges as a Winner in Global Crisis”, Spiegel Online, Scott, M. (2008).
8
“The German Banking System: Lessons from the Financial Crisis”, OECD Economics Department Working Papers, No. 788, OECD Publishing, Hüfner, F. (2010).
9
“The Bank Lending Channel Lessons from the Crisis”, ECB Working Paper Series No. 1335, May 2011, Gambacorta, L., Marques-Ibanez, D. (2011).
10
“Why did some banks perform better during the credit crisis? A cross-country study of the impact of governance and regulation”, Charles A Dice Center Working Paper
No. 2009–12, Beltratti, A., Stulz, R. (2009).
Ernst & Young European Non-Performing Loan Report 2011 17
18. The economic and political situation and a perspective
on the financial environment
Stress tests
To improve banking supervision in the European Union, the For some critics, the applied capital definition and benchmark
European Banking Authority (EBA) was established as of to pass the most recent stress test is not sufficient enough,
1 January 2011 and has taken over all existing and ongoing although they are more stringent than in the 2010 stress
tasks and responsibilities from the Committee of European test. Silent participations are no longer included in the capital
Banking Supervisors (CEBS). definition, which is applied to all participants regardless of
any specific national distinctions in banks’ capital definitions.
The stress tests carried out by EBA in 2010 and 2011 This was especially criticized by some German Landesbanken.
constitute hypothetical (what if) analyses of negative shocks
to the banking sector. Both stress testing exercises were The stress test is supposed to show a bank’s resilience
focused on credit and market risks, including a specific focus against a worst-case scenario as well as increase the
on the exposures to sovereign risk (applied to the trading transparency of the institutions to investors. However, the
book). Liquidity risks were not specifically assessed during release of the results by the EBA, on 15 July 2011, did not
the stress testing exercise. reassure the market and European bank shares recorded
the biggest drop in 11 months. Only 8 out of 90 banks failed
One of the major points of criticism was that no sovereign the stress test and fell beneath the threshold of 5% Core
default is included in the stress test. Instead of a sovereign Tier 1 Ratio (CT1R). But the perceived positive outcome is
default, there is a significant sovereign stress, which affects somewhat misleading as there is still a severe need for banks
the price of foreign debt and the cost of funding. For most to raise capital. The eight banks that failed the test alone
critics this is not going far enough, especially with regards to need to raise a total amount of €2.5b to reach a 5% CT1R.
the economic situation in the PIGS countries. Furthermore, under the adverse scenario, 33 banks are
below the intended 7% CT1R and will need to raise capital to
Furthermore, the banking book that contains those sovereign improve capital ratios as well.
bonds that are held until maturity is not within the scope of
the additional sovereign stress.
Comparison of the 2010 and 2011 stress tests
2010 2011
Benchmark 6% 5%
Capital definition Tier 1 capital Core Tier 1 capital
Forecast EU Commission Spring forecast 2010 (worse) Autumn forecast 2011 (better)
GDP growth over stress testing period EU: −3% points EU: −4% points
Probability of occurrence of the adverse scenario Higher Lower
18 Ernst & Young European Non-Performing Loan Report 2011
19. Basel III — reshaping the future landscape
Introduction to Basel III
The Basel III framework was endorsed by the G20 leaders
in November 2010 in South Korea. The goal of this new
set of regulations is to enhance bank and banking sector
resilience to unexpected shocks and thereby promote financial
stability. The combination of microprudential approaches and
macroprudential measures to address procyclicality and systemic
risk is a key element of Basel III. Therefore, Basel III does not
replace the Basel II and Basel I frameworks. It complements
the existing regulation, simplifies and strengthens areas left
largely unchanged by Basel II and introduces components on a
macroprudential level.
On 16 December 2010, the Basel Committee of Banking
Supervision issued the Basel III rules, which represent the details
of regulatory standards on an international level for financial
institutions. This broad set of measures aims to:
• Improve the banking sector’s ability to absorb shocks from
financial and economic stress, whatever the source might be
• Improve risk management and governance
• Strengthen banks’ transparency and disclosure11
The main thrust of the reforms involves raising the quantity as
well as the quality of regulatory capital and enhancing the risk
coverage of the capital framework.12 The reform package further
includes a number of new instruments such as capital buffers,
a leverage ratio and enhanced liquidity standards.
For the European market, the EU Commission adopted the
Basel III framework as standard-setting guidelines and published
a corresponding framework: Capital Requirements Directive
(CRD) IV, consisting of a Directive and a Regulation replacing
the current Capital Requirements Directives (2006/48
and 2006/49).
11
www.bis.org
12
Basel III: A global regulatory framework for more resilient banks and banking systems, BCBS (Basel Committee on Banking Supervision), December 2010.
Ernst & Young European Non-Performing Loan Report 2011 19
20. The economic and political situation and a perspective
on the financial environment
Basel III changes on capital requirements Different elements of the current capital requirements will
The current Basel minimum standard for bank capital of 8% be phased out — this includes Tier 3 and innovative hybrid capital
of risk-weighted assets (with 4% Tier 1, equity and equivalent instruments with an incentive to redeem. The phase out period
instruments, and 4% Tier 2, which includes subordinated debt) is 2013–2021.
has remained largely unchanged since the original 1988 Basel
Accord. But the crisis highlighted the need for banks to hold The capital requirements for trading books are changing
higher-quality capital. One of the key aspects of Basel III is the sharply with the introduction of stress models for market risk
increased focus on equity with a new Common Equity Tier 1 and counterparty risk, credit value adjustment (CVA) charges
(CET1) component that will be almost double the previous Tier 1 as well as large increases in requirements for exposures to
minimum. There will be two requirements for CET1, a floor level large banks. Overall trading book capital requirements go up by
of 4.5% and then an additional capital conservation buffer of between three and four times.
2.5% bringing the total to 7%. If a bank is not able to meet the
full conservation buffer, there will be limitations on pay out of The timelines for adopting the new capital requirements are
earnings through dividends, share buy-backs and bonuses. quite long — see below — and the phase out of the capital
A countercyclical buffer of up to 2.5% can, by national descretion, instruments will take place over an even longer period. But there
also be added in any national market that is overheating. are already market pressures on banks to comply. More than
€500b additional capital may be needed across the European
In addition to the higher CET1 requirements, a number of new banking industry relative to end 2009 and, of this, around half
deductions will be made from the accounting definition of capital. has been raised to date.
Examples include goodwill, deferred tax assets (DTAs) (where non-
timing difference DTAs will have to be deducted and others will be
subject to a limit) and intangibles. A new stricter approach to
the inclusion of minority interests within consolidated capital is
also being introduced.
Timeline for the new capital requirement
• Additional capital conservation buffer of 2.5%
• Countercyclical buffer (0%-2.5%) in national discretion
Countercyclical buffer 0%-2.5%
0%-2.5%
0%-2.5%
0%-2.5%
Capital conservation buffer 2.5%
1.875%
0.625%
1.25%
8% 8% 8% 8% 8% 8% 8% 8%
Total capital
6% 6% 6% 6% 6%
5.5%
T1 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%
4% 4%
3.5%
2%
CET 1
Until 2012 2013 2014 2015 2016 2017 2018 From 2019
Figure 10 | Source: Ernst & Young research
20 Ernst & Young European Non-Performing Loan Report 2011
21. Enhanced liquidity standards Stock of high-quality liquid assets
The introduction of minimum quantitative measures for The LCR is: Total net cash outflows over the next 30 calendar days
≥100 %
bank liquidity represents a major departure from previous
international prudential standards. The focus in the past has been
on minimum levels of capital and Basel II represents the first The NSFR is designed to provide incentives for banks to seek
internationally harmonized standard for liquidity. Under Basel III, more stable forms of funding. It will be a monitoring tool initially
two separate requirements will be introduced: the liquidity but a decision will be taken in 2017 regarding its use as a
coverage ratio (LCR), which will require a liquid assets buffer to minimum requirement. To meet the requirement, a bank would
be held, and the Net Stable Funding Ratio (NSFR), which will limit have to fund 100% of illiquid exposures with stable funding,
longer-term lending unless it is fully backed by stable funding. unless the loan is a mortgage where the requirement would be
reduced to 60% stable funding. To calculate stable funding, the
The LCR will prescribe a minimum level of high-quality liquid liabilities of the bank would be weighted by different factors to
assets a bank must have at any given time. The minimum liquid reflect their relative stickiness.
assets buffer will be driven by a stress test calculation of cash
inflows and outflows and must be sufficient to cover the net cash Available amount of stable funding
outflows over a 30-day period. The NSFR is: >100 %
Required amount of stable funding
The liquid assets buffer must comprise of a proscribed set of assets:
Banks will have until 2015 before the introduction of the LCR
• 60% must consist of “level 1” assets — high-quality and 2018 before the NSFR will be considered as a minimum
sovereign instruments and cash requirement rather than a monitoring tool (see Figure 10).
However, the capital market will impose pressure on banks to
• Up to 40% can consist of “level 2” assets — a wider range of comply with these new regulations much earlier.
good quality liquid bonds after a haircut
Liquidity timeline
Bank reporting to regulators starts LCR minimum standard NSFR minimum standard
LCR observation period Introduce LCR minimum standard
Introduce NSFR minimum
NSFR observation period
standard
2x further QIS LCR final amendments
European/national implementation NSFR final amendments
Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 Jan 17 Jan 18 Jan 19 Jan 20 Jan 21
Figure 11 | Source: Ernst & Young research
Ernst & Young European Non-Performing Loan Report 2011 21
22. The economic and political situation and a perspective
on the financial environment
Leverage ratio
One feature of the crisis was the excessive on- and off-balance
sheet leverage in the banking system, which was not detected
with the existing risk-based ratios. Therefore, the measures
strengthening the quantity and quality of capital are underpinned
by a leverage ratio that serves as a backstop to the risk-based
capital measures. The leverage ratio is intended to constrain
excess leverage in the banking system and provide an extra layer
of protection against model risk and measurement error.13
The ratio will require a minimum percentage of Tier 1 to gross
on- and off-balance-sheet assets. The minimum Tier 1 leverage
ratio is set at 3% for the observation period. The quantitative
impact study (QIS) carried out by the Basel Committee showed
that many banks would not have been able to meet this
requirement at the end of 2009. The higher capital buffers will
make it easier but it will be a constraint when markets pick up.
13
Basel III: A global regulatory framework for more resilient banks and banking systems, BCBS (Basel Committee on Banking Supervision), December 2010.
22 Ernst & Young European Non-Performing Loan Report 2011
23. Conclusion
Basel III and the strategic implications Impact on costs
Banks are reassessing their strategies in the light of the crisis Private sector estimates show that the capital and liquidity
and changes to risk appetite, but also in response to the change could lead to a fall in ROE of as much as 40% if banks do
Basel III regime finalized at end 2010. The Basel III framework not change business models. The size of the capital increases in
substantially increases the cost of different types of activity. some areas mean that banks will have to exit from some types of
Although the basic credit risk treatments for loans are largely activity and it is almost certain that some proprietary trading
unchanged (still based on Basel II) the quality of capital needed to will move to hedge funds.
cover the requirements and the total amount of capital required
is radically changed by Basel III. There is a much greater focus on However, widespread adjustment of balance sheets and
equity capital, with the phase out of other instruments as well as strategies will be needed. The Basel Committee has calculated
more deductions from accounting capital. In addition, the total that, assuming an ROE of 15% going forward, each one percentage
size of the capital buffers is being increased. Overall, banks will point increase in the capital required will require a 13 basis point
need between 40% and 100% more equity capital. Other changes increase in spreads to cover the cost, and the liquidity standard
in Basel III also have a fundamental effect on the economics of will require a 25 basis point increase in spreads to cover the
different business units or loan portfolios. Basel III introduces cost. Overall, banks are looking at the margin on loans rising by
liquidity requirements (which translate into the need for high, between 1 percentage point and 2.5 percentage points. This will
quality liquid assets buffers), which also increase costs. A further be achievable in some market segments but not in others.
change under Basel III that will affect strategy is the introduction Retail customers and small companies have fewer alternative
of a leverage ratio. Banks that are under a leverage constraint avenues for funding and an increase in margin is possible, but
will have to consider the most profitable areas of business on the same is not true of large corporates. A careful assessment
which to focus. of the likely profitability of each business line is needed and
then a restructuring of the business to exit less profitable
Overall, Basel III will be a major change for the industry. The areas and portfolios.
magnitude of the capital changes and the need to hold large
liquid assets buffers will place considerable pressure on rate of Banks will have to scrutinize costs across the business and
return on equity. Many banks are already lowering their targets, legal entity restructuring could play an important part in
and further downward revision will happen going forward. economizing on capital and liquidity as well as other costs.
Basel III includes long timelines for implementation. However, the However, restructuring programs will have to weigh up carefully
adjustment period is likely to be compressed because of pressure the different costs and benefits from a range of sources — tax,
from the ratings agencies and the market regulatory capital, liquidity requirements, regulatory intensity
to demonstrate early compliance. and business effectiveness.
Some banks will be winners and some will be left behind in the
move to change business models and design an effective strategy.
The changes being considered by banks are far reaching. Some
have already announced that they will be leaving particular
markets, many have identified portfolios that they wish to sell and
others are streamlining legal entity structures to optimize use of
capital. But this period of change could also give opportunities for
some banks to gain a foothold in new markets — some banks will be
affected more than others and not all will respond effectively to
the challenges giving opportunities for takeover or merger.
Ernst & Young European Non-Performing Loan Report 2011 23
25. Recent market developments
Market activity Non-core loan portfolios
In the years 2008 to 2011, loan portfolio market activity in The global financial and credit crisis, and the failure or
Europe was subdued. This was mainly due to the turmoil in the nationalization of large financial institutions, put pressure on
financial sector during these years, as high levels of uncertainty banks to focus on core lending activities and exit non-core
and volatility offered extraordinary returns on comparatively and non-performing businesses. Despite this, transaction
safe investments, such as bank bonds and hybrid capital or activity in the European loan portfolio markets has been very
even sovereign bonds. A lot of trading occurred in CDOs, CLOs slow as financial institutions have focused on wider run-off or
and called B-Notes of mortgage-backed securities (CMBS and restructuring plans in place of wide-scale disposals. In general,
RMBS) and therefore investing was often replaced by trading. this strategy has been applied to non-core and non-performing
Nevertheless, as the dust is settling, we believe that there will be assets as well as non-core markets and product lines. And while
a significant increase in investment market activity in the quarters this has resulted in financial institutions being ahead of plan on
and years to come. their NPL targets, they are facing increasing challenges with
their plans for non-core but performing loans. There still remain
Most European banks are quite advanced in defining their strategy significant barriers to investment in performing loan portfolios,
for the future after the financial and debt crisis, both concerning primarily funding requirements and leveraging limitations,
the regional footprint as well as the focus customer groups and resulting in vendors being offered unattractive discounts to book
solutions and products. We expect that institution after institution value from potential investors.
will assess non-strategic and non-core business segments, which
will be offered for sale or run down and liquidated, as well as Current market activity
analyze which non-performing or sub-performing assets are We are seeing early market activity, such as US investment
better held onto and worked out, or monetized through a sales banks actively selling non-standard UK mortgage loans. Limited
transaction. This continuing strategic reassessment will create activity in sales of small portfolios of commercial and residential
ample supply of loan portfolios and other assets to come to mortgages is picking up as well.
market. It is our expectation that the restart of the market will
take place in early 2012. In addition, we see that European banks, which have decided to
exit certain markets, are starting to offer loan portfolios to the
From a demand side, there are a large number of newly raised market, such as Irish banks offering US loan portfolios, UK banks
private equity, opportunity, debt, mezzanine and distressed debt offering continental European exposure, Dutch banks offering
funds that are starting to deploy and invest their capital. As the German loans and similar assets. If these transactions prove to
last two years did not see a sufficient supply on the market, we be realizable, we expect the market activity to pick up speed and
expect the appetite of investors to grow quarter by quarter and to see Spanish banks exiting non-core and NPL portfolios as well
provide a significant demand for loan portfolios. as German banks exiting activities both domestically and abroad.
As a consequence of the strategic realignment and the financial We see a large quantity of refinancing and restructuring activity
and debt crisis, European banks currently hold in excess of in the market, both originating from balance sheet lenders,
€1,000b of non-core loan assets. In addition, NPLs held by as well as CMBS and RMBS platforms. More and more banks
banks throughout Europe have grown to over €750b. This will are enforcing on non-performing real estate loans and are
result in financial institutions increasing the supply of non-core subsequently selling the loans or the security collateral.
assets and loan portfolios over the coming years. As regulatory
changes, especially Basel III, will require institutions to keep more
capital against assets, it is to be expected that a large range of
restructuring and sales activity will take place across the entire
sector, including banking, principal investments, insurance or
investment management.
Ernst & Young European Non-Performing Loan Report 2011 25
26. Loan portfolio trading
Pricing gap
Pricing has often been cited as the main barrier to loan portfolio trading, whereby
a significant gap exists between buyer valuation and that required by a seller for
transactions to be capital accretive or even neutral. This pricing gap is due to a
combination of factors, such as:
Low yields on assets written in very competitive markets
• Margins on newly originated business are significantly higher than those earned on
historical portfolios (generated before the financial crisis). In many cases, margins on
historical portfolios are not even sufficiently high enough to cover operating costs
and credit losses and therefore are not contributing to overall retained earnings.
Higher funding costs
• Despite some recent improvements in the availability of finance (i.e., there are
some initial signs that securitization markets are returning), liquidity remains scarce
and expensive for most institutions outside of central bank liquidity facilities
(which themselves will need to be scaled down and removed in time).
Lack of leverage available to investors
• Due in part to limited access to leverage, loan portfolio buyers often have to bid with
equity, offering a price below the value of the asset on the vendor’s balance sheet.
• Banks could offer leverage to the buyer (and this has enabled some deals to be
completed); however, often this option does not, in whole, allow a vendor to reduce
risk-weighted assets.
Vendor’s reluctance or inability to realize losses on sales through P&L
• Vendors are often capital constrained and are unwilling or unable to crystallize loan
portfolio losses, without eroding their capital base.
If buyers and sellers can bridge this price gap, significant volumes of loan portfolio
transactions could be unlocked. As described above, there are a number of triggers
that will move the expectations of buyers and sellers, which will result in a larger
supply coming to market, where it will meet an enormous demand for investment
opportunities. As the two sides are currently moving in each other’s direction, it can
only be a matter of quarters before supply and demand will meet and result in a long-
lasting wave of loan portfolio transactions.
26 Ernst & Young European Non-Performing Loan Report 2011
27. Future market trends
Although recent market activity has been restricted, there Basel III
are promising signs for future activity, with the following European banks are preparing for the implementation of the
transaction drivers expected to fuel transactions in the sector new Basel III rules, which will radically affect the banks’ costs
in the coming years. of doing business. Financial institutions are being forced to
reassess their strategies in response to the new capital and
Bridging the price gap liquidity requirements set out in the Basel III framework. This
Transaction activity has been minimal to date, despite a requires the adoption of a new approach to strategic planning and
pressing need for government-funded institutions to reduce optimization of strategy across capital, liquidity and leverage. In
their balance sheets and the desire of independent banks to order to strengthen regulatory capital and funding positions, a
dispose of low margin lending generated during competitive greater focus will fall on optimizing portfolio structures and the
pre-credit crisis markets. development of credible strategies for non-core operations. We
are already seeing banks take decisions to concentrate on core
The lack of disposals is largely explained by the price expectation business, exiting certain markets or sectors, and this will intensify.
gap, as detailed earlier in this report. We expect that this pricing To get the strategy right, banks will need new, more sophisticated,
gap, which we believe to be on average 10%–20%, will be bridged planning tools.
by both buyers and sellers lowering their pricing expectations
over time, as they come under increasing pressure to respectively Recovering economies
invest funds raised and execute disposal programs. Over the medium term, when economies begin to recover, banks
will need to raise and generate more capital to fund the recovery.
EU-mandated disposals It is likely that, as this capital could be released directly from
Several European financial institutions have been set aggressive non-core assets, banks will increase their willingness to sell at a
disposal mandates, focused on deleveraging their balance sheets. discount in order to increase their ability to focus on growth.
These targets were set with the aim of ensuring fair competition,
with the potential effects on capital not fully considered. In order We also expect that the drag on earnings from legacy run-off
to reach their disposal targets in the timescale specified, there is a books, driven by increased servicing costs and instability
danger that financial institutions will be forced to accelerate asset of servicing platforms, will make raising fresh capital more
sales in place of asset restructuring or run-off strategies. challenging. As bank’s turn to shareholders to raise further capital
to lend in a recovering economy, banks will become more active in
Ireland has recently demonstrated the impact this can have disposing of non-core assets in order to mitigate this risk.
on a bank’s capital base. We expect to see a renegotiation of
these targets in the next few years, with a potential option
allowing financial institutions to move these assets into a non-
core area where they must either sell or run-off, but over
a longer period of time.
Market outlook
In our opinion, we believe the loan portfolio market is beginning to gather
momentum and, particularly in light of recent EU-mandated disposals and
Basel III capital requirements, expect to see a significant increase in both
the volume and size of transactions in the coming years.
Ernst & Young European Non-Performing Loan Report 2011 27