Earlier this year, we considered How Will Irish Banks Deal With the Increase in Non-Performing Loans Post COVID-19?. The European Commission published a communication on 16 December 2020 outlining their EU-wide strategy to address the anticipated rise in NPLs post COVID-19. It focuses on the advantages of tackling NPLs early to avoid a renewed build-up on banks’ balance sheets and aims to ensure that banks can continue to support the economic recovery.

The strategy is divided into four main areas:

1. The development of secondary markets for distressed assets

2. The use of asset management companies

3. The reform of the EU’s insolvency and debt recovery frameworks, and

4. The use of the EU’s bank crisis management and State aid frameworks

The development of secondary markets for distressed assets

The necessity to set capital aside against possible NPLs reduces the capital banks have to lend. This affects the amount of credit banks can give to companies and individuals and this, in turn, impacts the economy and labour market. One of the core aims of the Commission is to develop a deep and liquid secondary market for distressed assets. The Commission has identified ways the secondary market can be developed:

1. The swift agreement and implementation of the Commission’s proposal on credit servicers, credit purchasers and the recovery of collateral which aims to ensure that consumer protection obligations are upheld across Member States irrespective of how NPLs are resolved

2. The implementation of the targeted improvements to the securitisation framework for banks’ non-performing exposures. This will enable the broader use of securitisations by banks to reduce non-performing exposures on banks’ balance sheets. See our related insight Combatting COVID-19 with Securitisation: the European Commission’s Proposal

3. Improving data quality and data comparability. In early 2021, the Commission proposes to mandate a review with buy and sell side market participants of the current European Banking Authority (EBA) standardised data templates for NPLs

4. Establishing data infrastructure at EU level to increase market transparency and to offer a platform for cooperation and coordination with a pan-European scope. The Commission intends to initiate a public consultation for the first half of 2021 to explore alternatives to establishing a data hub at European level and to determine the best way forward. Interestingly the data hub platform suggestion has previously been met with mixed reaction and is thought to be of assistance in smaller homogenous deals instead of larger deals

5. Developing guidance on a ‘best execution’ sales process. The Commission aims to develop this guidance with the EBA and other relevant stakeholders by Q3 of 2021. This tool guide for sellers of NPLs will aim to encourage good sell-side processes but will not be mandatory, and

6. Addressing regulatory impediments to banks purchasing NPLs. The current irregularity in the Capital Requirements Regulation which results in NPL buyers needing to apply a higher risk weight to the same unsecured NPLs than the seller applied, is flagged as one issue to be addressed. The Commission intends to work with the EBA in early 2021 to develop a suitable solution to this.

The use of asset management companies

The Commission highlighted that asset management companies (AMCs) or “bad banks” provide a very effective measure to treat NPLs in specific circumstances.

NAMA has operated effectively as an AMC in Ireland since 2014 and has previously been praised by the Commission for the fact that it actively managed its portfolio and generated increased fiscal returns. In our previous article we considered if NAMA could be repurposed to play a role in the current crisis by acquiring existing NPLs from the Irish banks to free up capital and capacity for the expected surge in NPLs. The Commission’s recent communication highlights some of the benefits of this approach. The Commission picked-up on one of the same limitations we had discussed - that AMCs are most effective for loans secured by commercial real estate and large corporate exposures. Therefore, NPLs are not the best solution for private dwelling house mortgages and other residential property loans. This asset class makes up a large proportion of the current NPL ratios in Irish banks and it is expected to increase as a proportion, given the impact on the labour market that this crisis has had.

On the query regarding who would pay for AMCs, the Commission suggested that market funding without a guarantee should be explored and if feasible, would be preferable to government-guaranteed funding. It also noted that it is a solution open to any bank and did not have to be in place at a national level in Member States.

Notably the Commission did not put forward any recommendation or mention a Eurozone bad bank as a potential solution.

The reform of the EU’s insolvency and debt recovery frameworks

The Commission has urged the European Parliament and the Council to promptly come to an agreement on the legislative proposal for the minimum harmonisation rules on accelerated extrajudicial collateral enforcement (AECE). Under the AECE procedure, in certain circumstances creditors would be authorised in an enforcement event, to either appropriate collateral or sell it through public auction or private sale. The procedure would not apply to consumer loans. The Commission notes that this procedure would assist economic recovery by facilitating SMEs’ access to bank finance and that its adoption should be a priority.

As previously announced, the Commission is working to harmonising certain insolvency laws across the EU as part of the 2020 Capital Markets Union Action Plan.

The use of the EU’s bank crisis management and State aid frameworks

Finally, the Commission advised that market-based solutions should remain the first and primary toolkit for addressing NPLs but noted that if the situation worsens, public support can be provided. By applying the EU’s bank crises and State aid frameworks, such support should remain targeted and limited and could not be used to bailout banks that were experiencing viability problems before the COVID-19 crisis.

Conclusion

It is positive that the Commission is considering the impact of COVID-19 on NPLs and proposing to work with relevant stakeholders and EU bodies to develop ways to assist banks with reducing risks associated with NPLs. It is clear that the view regarding the treatment of NPLs has evolved and the Commission is now proactively addressing this risk. Notably many of the measures suggested are to be discussed in 2021 and therefore are not immediate solutions.

From an Irish perspective, the proposals are not new or novel and Ireland is well placed to deal with NPLs:

• Irish banks have all completed EU mandated deleveraging projects over the last number of years, so there is an institutional familiarity with NPL sale and securitisation processes, although some teams may have been redeployed as the process evolved

• The Central Bank of Ireland is ahead of the curve regarding ‘best execution’ processes and it wrote to relevant industry participants regarding its expectations in respect of sales, securitisations, purchases and transfers of residential mortgage loans in August 2019 and has been engaging with relevant stakeholders since then

• Ireland has a credit servicing regime in place although it is likely that this will need to be amended in line with the EU Credit Servicing Directive, a point that we made in a previous article, and

• NAMA is already established and has the infrastructure and employees in place to be repurposed if required.

However, the pool of bidders in Ireland for NPL trades has become smaller in recent years and any measures implemented which would bolster the secondary market and encourage new investors and new servicer into the Irish market would no doubt be welcomed by Irish banks and would assist with post COVID-19 NPL issues.

For more information on the Commission’s strategy and how it may have a bearing on your organisations operations in 2021, contact a member of our Financial Services team.

The content of this article is provided for information purposes only and does not constitute legal or other advice.