Since 2008, the amount of deteriorated exposures has essentially quadrupled, while the ratio between gross NPLs and bank loans (roughly equal to GDP) has more than quadrupled, now standing at more than 10%.
Given the systemic impacts of the problem, it is natural that the Supervisory Authority and the Government are actively looking at this issue. On the one hand, they are urging banks to organize themselves to manage the issue and strengthen Data Quality for the monitoring and management of NPLs, and on the other hand they are encouraging the selling off of NPLs and acceleration of collection process.
For example, the ECB has recently drawn up the “Guidance to Banks” on NPL management, clarifying Banking Supervision expectations for the future. The Bank of Italy has joined the field to explain to international observers the specific features of the Italian context, while the Italian Banking Association (ABI) has asked for greater fairness between banks in different countries. The EBA (European Banking Authority) has put forward guidelines and standards to reach uniform definitions of “bad debts” and “non-performing exposures” which are valid across the whole European Union.
Despite some difficulties, the NPL transaction market has proved to be lively, and has seen the active involvement of specialist investors, banks and special servicing companies.
The conference, “Non-performing loans, between supervisory policies and the market”, supported by the Università Cattolica alongside thecreditriskclub.it community and CRIF, a leader in credit reporting system management and credit management solutions, was set up to compare the positions of these different players, facilitating a technical discussion to support the search for solutions and tools to overcome emergencies.
What are there so many bad debts on banks' balance sheets?
The elevated NPL stock derives from the growth in new bad debts and from the largely stable settlement rates. The first aspect relates to the earning capacity and assets of debtors; from this point of view, the situation remains critical, since the unemployment rate was 11.5% at the end of 2016 (third last in the Euro Area), although it has fallen slightly in the last three years, while the number of bankruptcies in 2016 was double that of 2007, albeit below the 2014 peak (around 13,500 compared with 15,300).
The stability of settlement rates reflects the high average duration (around 7 years) of collection procedures, in part due to the slowness of the Italian judicial system. This latter issue has been dealt with through new legislation (such as Italian Legislative Decrees 83/2015 and 59/2016) and investments in digitization (such as the new services on the Ministry of Justice portal). According to the data presented by CRIF, the average duration of bankruptcy proceedings was about five years in 2016, 3% down on the previous year. For real estate enforcement proceedings, on the other hand, the average duration is also 5.0 years (4.4 in the North, 6.4 in the South), more or less stable compared with 2015. Stable and substantial improvements will require time and further investments.
What can banks do?
As well as reducing the timescale for litigation, banks naturally need to equip themselves to maximize collection, which depends on the characteristics of the bad debts. Considering that many NPLs are secured by real estate (34.6% of households with bad debts own at least one property, which rises to 36.0% for legal entities), it is essential that the current modest recovery in real estate prices, for now concentrated in metropolitan areas, is consolidated.
It is also necessary to improve coordination between individual banks, since analysis carried out on the basis of EURISC information - the credit reporting system managed by CRIF which collects data on more than 80 million credit positions - found that around 36.5% of NPLs involve more than one institution.
In order to generate higher recovery rates, and therefore fewer losses for the profit and loss account, it is necessary to improve the efficiency of the processes used and the quality of the available information.
Is there a problem with electronic archives?
“The data associated with NPLs are often still of poor quality,” explained Alberto Sondri, Servicing Director at CRIF. “This is due to the limited computerization of litigation management processes which characterized the years covering the peak of the crisis, since banks and specialist operators have increased IT investments only in recent years. This has weakened the ability to efficiently monitor the collection and systematization of information regarding credit contracts, procedures and guarantees”.
Deficiencies in the quality of available data often underlie the gap between supply and demand pricing, limiting the development of securitization transactions. In fact investors, faced with inadequate information, encounter difficulties in understanding the real characteristics of transferred credit, and therefore servicers are required to estimate future proceeds in the modeling of collection processes (for example, in terms of discount rates and risk premium). Many institutions, being aware of this need, are trying to convert this into an opportunity, initiating a 'clean-up' of existing databases and structural investments in information platforms and processes.
“Outsourcers” and “servicers”: what can they do?
The need to get results which can be monetized in the short term may lead to the overloading of internal NPL management teams, making it more difficult to design monitored and efficient collection processes. For this reason, many banks are assessing whether to address the deficiencies in production capacity through the transfer of NPLs without recourse (including securitization) and/or outsourcing of collection processes. In both cases, credit management involves servicing specialist, appointed by sellers or by the bank itself.
According to industry statistics, the top 15 servicers manage a nominal value of around € 150 billion in NPLs; given that there are still around another € 200 billion on bank balance sheets, the industry may see a significant increase in activity over the coming years. Given the need for efficient processes and contained costs, this needs to happen through lean structures, guided by 'industrial' approaches and supported by organizational as well as technical abilities. It is essential to maintain quality without the bureaucratic excesses that have sometimes characterized banking structures.
According to Andrea Resti, Professor at Bocconi University, consultant to the European Parliament and CRIF Senior Advisor, “By working for several banks, servicers can gain more experience and information on NPL portfolios, providing investors with qualitative/quantitative benchmarks to help forecast cash flow and improve pricing accuracy”.
In this way, they can bring indirect, but fundamental, benefits to the NPL market in terms of a reduction in the gap between supply and demand pricing. So, for banks, outsourcing may also become a benchmarking tool for collection performance within its internal structures, since (as set out in ECB Guidelines) they must set and pursue quantitative targets to reduce the NPL stock.
