Misleadingly low figures for non-performing loans

Non-performing loans are seen as a looming threat, posing risks to both the economy and banks. However, despite inflation and economic uncertainties, the ratios have not yet shown an increase. Market participants are now anticipating a reversal of this trend.

Misleadingly low figures for non-performing loans

The weak economy and higher interest rates are taking their toll. This is leaving traces in the banks' loan portfolios. However, it has not reached that point yet. "According to risk managers, the levels of non-performing loans (NPLs) are expected to rise in all asset classes," says Christoph Schalast, Chairman of the Advisory Board of the Federal Association of Loan Purchasing and Servicing (Bundesvereinigung Kreditankauf und Servicing – BKS).

Through a survey among banks on NPLs, BKS, in collaboration with the Frankfurt School of Finance, evaluates how NPL market activities have developed in the past and what developments market participants expect.

From the respondents' perspective, both the current and expected values of the NPL barometer reached the highest levels ever measured in the fall. This means that more banks than ever before see increasing NPL levels and declining sale prices of NPL portfolios. Most respondents also expect an increase in the stock of non-performing loans.

Stagnant figures

In contrast to the survey, estimates for NPL volumes in German banks by the end of 2023 and the end of 2024 appear relatively low. For the end of 2023, €36.1 billion of non-performing loans is expected, rising to €41.6 billion by the end of next year. For comparison, in June 2023, the EBA reported €33.6 billion.

The estimates for NPL ratios are also reassuring. For unsecured consumer loans, an average ratio of 2.5% is expected by the end of 2023. By the end of 2024, participants anticipate an average ratio of 2.8%. "It is generally noticeable that Germany has shown very low NPL ratios in the past ten years, and the current increases are therefore measured from a low level," notes Schalast.

The BKS values align with the European Central Bank's data. The ECB released figures from its banking supervision for major institutions for the second quarter of 2023. The ECB's ratio of non-performing loans (NPL ratio) without balances at central banks and other sight deposits (as defined by the ECB) remained stable at 2.3% in the second quarter of 2023.

Focus on stage-2 loans

In this context, the stock of non-performing loans in banks supervised by the ECB increased by €4 billion to €343 billion. Notably, the proportion of aggregated stage-2 loans to total loans decreased to 9.2% from 9.3% in the previous quarter. Stage-2 loans indicate a significant deterioration in credit quality and are a precursor to NPLs.

"I would have expected the situation in the banking sector to deteriorate significantly. This has not happened. The negative trend is still comparatively weak," states Marc Knothe, Germany Chief of credit and debt collection service provider Intrum. However, to interpret the ECB's NPL ratios, one must consider that the European Central Bank looks at major banks and not smaller providers and financial services. "Therefore, we see significantly more negative signs than the ECB, especially because we also consider other industries where negative signals may occur earlier or more strongly, such as energy and e-commerce."

Declining NPL transactions

The market for securitizing NPL loans is dwindling. "The number of investors is decreasing. Buyers are also becoming more selective," observes Knothe. Transaction prices have significantly fallen in recent months. Overall, the mood in the transaction market for securitizations or portfolio sales has worsened.

This trend is confirmed by BKS. The development in NPL is reflected in decreasing sale prices for portfolio transactions of non-performing loans. The market for non-performing loans now shows a shift from a seller's market to a buyer's market – thus, a decline in prices. Jürgen Sonder, President of BKS, states: "But there are qualified tools to handle this responsibly, as the EU Commission and ECB have installed an effective setup for NPL management in Europe in recent years, which is currently being implemented in Germany as well."

New EU Rules

With the new EU directive on credit servicers and credit purchasers (often referred to as the NPL Directive), which member states must implement by the end of December, banks should find it easier to remove non-performing loans from their balance sheets. The EU is closely monitoring whether there are signs of a possible increase in loan defaults against the backdrop of a weak economy, affecting not only large companies and SMEs but also specific segments such as commercial real estate.

Regulatory authorities have learned from the 2008 financial crisis when EU banks accumulated over €1 trillion in non-performing loans. Supervisors are now putting pressure on banks to act early and securitize or sell NPL portfolios. A focal point of the new regulation is the development of a more efficient secondary market.

From the end of December, a bank selling an NPL portfolio must provide more detailed information about loans than before. The goal is to expand the group of institutional investors. Currently, the market is dominated by a small group of alternative managers such as Bain Capital, Cerberus, and LCM.

"The new EU securitization regulation is positive as it creates more transparency and clarity. On the other hand, it brings more work for the respective parties involved. I believe that regulation will drive consolidation in the market," is the assessment of Intrum manager Knothe.

Consumers under pressure

While banks are under pressure from regulators to quickly get rid of NPL loans, conditions for lending on site look quite different. There is a general tightening of credit standards and a decreasing demand for credit. According to the BKS analysis, 39% of respondents observed a strong or slight decline in demand for consumer loans.

Intrum found that 55% of German consumers who did not pay a bill in the last twelve months are doing so more frequently. "In the past, Germany has consistently been in the middle range regarding payment behavior in the Intrum-ECPR study. This year, Germany has slipped to the second to last place in Europe," says Knothe.

In the consumer credit sector, there is a growing number of cases with payment difficulties. "Here, we see younger consumers in payment arrears, who are indebting themselves with relatively low consumer loans, BNPL."

Overindebtedness still stable

The still-low NPL ratios correspond with Creditreform's data on overindebtedness. "Without statistical special effects, we are measuring an increase in overindebtedness for the first time since 2019," notes Patrik-Ludwig Hantzsch, Head of Economic Research at Creditreform.

The increase in overindebtedness is still marginal. However, this could change. "Consumer overindebtedness is closely linked to economic developments. Economic prospects are uncertain, but generally gloomy," states Hantzsch.