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French bad loan market set to heat up, as Europe-wide NPL purge continues

As regulators continue to push for the faster cleanup of bank bad debt across Europe, nonperforming loan sales will increasingly spread to underdeveloped markets like France alongside active ones like Italy and Greece, according to market observers.

Over four years, European banks have off-loaded nearly half of their NPL stock, cutting it to €636 billion as of June 30, 2019, from €1.15 trillion as of June-end 2015, according to data from the European Banking Authority. The deleveraging has been mainly concentrated in markets with high ratios of nonperforming loans to total loans, such as Italy, Greece, Portugal, Spai, and Ireland.

NPL ratios remain high in some of those markets and bad-loan sales are expected to continue there in the coming years.

But there are also indications that other markets will open up to NPL sales as early as 2020 amid mounting regulatory pressure and continued strong investor appetite for distressed assets.

French market to heat up

Most notably, the French market is expected to see more activity, with auditing firm Deloitte predicting NPL sales will more than double by 2021 compared to 2019 levels.

France accounts for about 20% of the remaining NPLs in Europe, and despite being the second-largest holder of bad loans after Italy, it has not seen NPL sales at the levels observed in its southeastern neighbor.

With €103.6 billion NPL transactions in 2018, Italy accounted for more than half of the total of €205 billion NPL sales for that year, while NPL sales in France stood at €3.5 billion, according to estimates by global law firm Ashurst and Deloitte.

This is partly down to the low average NPL ratio at French banks. While the country held about €124 billion in total as of June 30, 2019, it was spread across myriad banks with the largest total loan volume in Europe, of €4.72 trillion. So the average NPL ratio was 2.6%, lower than 3% across Europe as a whole, and far lower than Italy's 7.9%, the European Banking Authority data shows. Greece's level is 39.2%.

French banks have also traditionally focused on addressing delinquency at the early stages of loans' default, rather than on NPL sales, Deloitte said in a report on deleveraging in France. The market for loan portfolios in France is still underdeveloped in comparison to Europe, predominantly comprising direct sales of smaller portfolios rather than big competitive tenders, Deloitte said.

"There has historically been less pressure on, and incentives for, the French banks to dispose of their NPLs — French banks have been better capitalized than their European counterparts and have been able to calibrate their balance sheets through a careful combination of noncore disposals and strategic acquisitions," Hyder Jumabhoy, partner at law firm White & Case, said in an interview.

But this is expected to change over the next few years as European regulators continue to step up measures to reduce the existing stock and curtail the future buildup of bank NPLs.

Despite the progress made in recent years, it is of "the utmost importance" that NPLs are reduced further and "in a swift manner while economic conditions are still favorable," the European Central Bank said in August 2019 when it introduced provision rules for newly formed NPLs.

"With NPL resolution strategies targeting a rapid clean-up of banks' balance sheets, an acceleration of NPL disposals is forecast despite the overall low NPL ratio in France," Deloitte said.

The firm sees French NPL sales surging to €7 billion in 2020 from €4.5 billion in 2019, and then to €10 billion in 2021 and €11 billion in 2022. For 2023 and 2024, the total transaction amount should stand at around €9 billion and €10 billion, respectively, Deloitte has projected.

Investor appetite

Another important factor that could drive NPL sales across more European markets is the continued investor appetite for distressed debt and the growing sophistication of investors.

NPLs offer "excellent double-digit returns" at a time when performance in the active asset management industry has been subdued, partly due to the low interest rate environment, Deutsche Bank said in a report on European NPL exposures.

Asset managers have been particularly active in European NPL transactions in recent years.

U.S. groups Cerberus Capital Management LP and Lone Star Funds were among the top three biggest buyers of European bad debt in 2018, with €29.7 billion and €15.1 billion of NPLs acquired over the period, respectively, according to Ashurst estimates. Swedish debt collection and restructuring platform Intrum AB (publ) was the fourth-largest buyer with €13.7 billion purchased in 2018.

Cerberus and Intrum, alongside peers, remained active in 2019 too.

Cerberus agreed to acquire €358 million of NPLs from Spain's Kutxabank SA in December 2019 and was one of the buyers of a €150 million real estate-backed Bank of Ireland Group PLC NPL portfolio earlier in the year, according to data by White & Case. Intrum took over €865 million of consumer and corporate NPLs of Spain's CaixaBank SA, the data showed.

Financial sponsors

Financial sponsors, including private credit funds, hedge funds and debt restructuring specialists, will play a key role in the spread of NPL sales to new markets as well. Both regulators and the banks selling distressed assets recognize the added value such firms can bring to NPL transactions, according to Jumabhoy.

"Financial sponsors have a lot to offer in the NPL space — in addition to fresh capital, sponsors can also bring highly sophisticated debt collection technology and human resource skills, honed through the experience of NPL servicing across southern and western Europe," Jumabhoy said.