Resolving the issue of Non-performing Loans (NPLs) is not just a regulatory problem to address but a way to manage a bank’s balance sheet and increase profitability. Sound management of non-performing loans means that these would be replaced by new, sound exposures. Interest income would be boosted as a result, as rates charged on new business would substitute for the lower earnings from non-performing loans. Other benefits would include lower funding cost or lower capital requirements that would be forthcoming from a reduction of NPLs.
A clear strategy is essential to deal with the NPL problem. This entails the following:
1. Operational assessment
The operational assessment involves assessing the internal capabilities and resources within the bank to deal with the problem. Often external help is sought. In addition, an assessment of the external environment is conducted to analyse the conditions and market appetite for NPLs as for any solution the bank to consider the balance sheet implications. Besides analysing the regulatory implications, the accounting treatment has also to be considered. With the introduction of IFRS 9 and more forward-looking provisioning rules could be conducive to faster recognition of losses.
2. Strategic development
The NPL strategy must include specific targets to be achieved over different time horizons, typically short, medium and long terms. Both qualitative and quantitative targets should be set. Detailed quantitative modelling allows the bank to not only set realistic targets but also consider the changes in Risk Weighted Assets and other important implications.
3. Implementation planning
As a direct result of the operational assessment, the operational plan is implemented and may not only include bolstering the internal resources but even altering the internal organisational structure of the bank.
4. Embedding the strategy
Embedding the strategy entails having a proper governance structure within the bank to have the necessary management processes to enable regular reviews and independent monitoring.
Potential Solutions to the NPL Problem
Banks with more than 15% in NPLs are now considered to have a high NPL position. Although there are different ways to reduce this percentage, a clear process must be followed to reach an optimal decision. Internal workout by the bank originally holding the impaired asset marks one end of the spectrum of options and should always feature highly in any broader resolution scheme. On the opposite end, direct sales to investors offer an opportunity to dispose of NPLs quickly. At one end of the spectrum there is an “on-balance sheet” solution, while at the other end lies an off-balance sheet one. These include:
- internal workout
- asset protection scheme
- asset management company
- direct sale
Improvements to bank practices and to data quality and availability are also going to take time before progress becomes tangible.
How we can help
At Grant Thornton we have significant capabilities and expertise to assist you in managing your NPL portfolios across their life cycle. We combine our quantitative risk, capital markets, accounting, IT and regulatory expertise to assist you in several ways:
- Develop your NPL strategy and help you execute and implement this,
- Restructure your NPL portfolios and transact accordingly
- Provide you with due diligence advice
- Build or validate your quantitative models and stress test these as necessary
- Provide you with support to assess the quality of your collateral
- Assist you in any regulatory reviews including the ECB’s AQRs
- Specialist accounting support for financial reporting purposes
Our professionals bring a wealth of experience which includes advising banks and regulators on NPLs and other troubled assets:
- Advised the European Commission on the implementation of the Asset Relief Programme for troubled European Banks in relation to the Global Financial Crisis, covering banks from the UK, Germany, France, Belgium and the Netherlands. Banks’ exposures included retail and commercial loans to structured products (CDOs, CLOs, CDOs^2, CBMS and RMBS).
- Advised a European banking group on the acquisition of several distressed loan portfolios collateralised through real estate assets. Provided advice relating to the impact on risk-weighted assets, capital adequacy and liquidity of the bank as a result of the acquisitions and overall portfolio restructuring.
- Advised a Southern European bank on balance sheet restructuring which included developing and executing a strategy to reduce NPLs. Part of the NPL portfolio was sold to a fund.
- Expertise in segregating non-performing assets into a “Bad” bank.
- Participated in several asset quality reviews across the Eurozone.