Ernst & young studie zum npl-markt 2011


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Ernst & young studie zum npl-markt 2011

  1. 1. EuropeanNon-Performing Loan Report 2011Restructuring follows strategy — a review of the European loan portfolio market
  2. 2. Contents
  3. 3. Introduction 4Foreword 6The economic and political situation and a perspectiveon the financial environment• The economic and political situation in the Eurozone 9• Heavy turbulence in the banking sector 12• Basel III — reshaping the future landscape 19Loan portfolio trading• Recent market developments 25• Future market trends 27Country sections• Germany 28• United Kingdom 38• Ireland 46• Spain 52• Italy 58• Turkey 64• Greece 72• Portugal 80• Poland 86• Russia 92• Ukraine 98• Kazakhstan 104Services 110Contacts 112
  4. 4. Introduction 4 Ernst & Young European Non-Performing Loan Report 2011
  5. 5. Nora von Obstfelder, Thomas Griess, Ana-Cristina Grohnert, Daniel MairRestructuring follows strategyThe global financial crisis has exposed the weaknesses of the banking industry around theworld and banks need to redefine their strategies to meet the challenges ahead. Thishas widened the pool of non-core loan portfolios and banks need to do more than sell theirnon-performing loans (NPL) to achieve their desired balance sheet structure.Ernst & Young’s Strategic Portfolio Solutions team has been around in the “good old NPLyears” before the financial crisis, being directly involved in a large number of loan portfoliotransactions, and has been busy advising financial institutions and investors on theirrespective activities during the last few years.We believe that the coming years will offer historic opportunities and rewards for bothfinancial institutions executing their post-financial crisis strategy as well as investors in non-core and non-performing assets. Ernst & Young European Non-Performing Loan Report 2011 5
  6. 6. Foreword 6 Ernst & Young European Non-Performing Loan Report 2011
  7. 7. Much has happened since the publication of our European Non-Performing Loan Report 2008.Back in April 2008, the global credit crisis had already started with the bailout of Bear Stearnsand was just picking up some speed, whereas significant events such as the demise of LehmanBrothers, the sale of Merrill Lynch to Bank of America, the conservatorship of Fannie Mae andFreddie Mac and the bail-out of AIG were just around the corner, but seemed unthinkable.Ireland, Portugal and Spain were considered the growth engines of the Eurozone. Iceland andGreece were financing their national debt at similar interest rate levels to Germany or the UK.Sovereign risk was a political, not a financial term.In the Eurozone and the UK, we saw the failure or nationalization of large financial institutions,the creation of “bad banks” and the arrival of multi-trillion euro stabilization schemes for thefinancial sector in countries throughout Europe.Three years later, it appeared that the financial sector in Europe had stabilized and started toheal. High leverage and debt had moved from the private sector to the public sector. As mostof the dust in the financial sector appeared to have settled, we decided to take a fresh lookat the situation and the potential future development of the loan market in Europe.At the time of publishing this report, European Union leaders are scrambling together withnational governments to put in place a sustainable financial stabilization scheme for theEurozone countries. Unsustainable levels of sovereign debt have already resulted in bailoutsbeing agreed for Greece, Ireland and Portugal, and European institutions are collaborating toprevent the resulting contagion severely impacting Spain and Italy.Compared to our 2008 report, we have broadened our perspective and our 2011 reportcovers non-performing, sub-performing and performing (non-core) loan markets. Whereasactivity in the European NPL markets has been very subdued since our last report, as the marketparticipants, especially sellers, have been focusing on managing their portfolios during the mostchallenging financial crisis since the Great Depression, we believe that the coming years will seea much higher level of activity, as transactions are a major step in deleveraging and repairingthe financial system.We completed our report in mid September and therefore have not covered the most recentdevelopments after that date such as the fears of another freeze of the interbank lendingmarket, the rating downgrade of several European banks and the recent rescue of Dexia.The potential impact of such developments on the non-core and non-performing loan marketsin the short or longer term remain to be seen. Ernst & Young European Non-Performing Loan Report 2011 7
  8. 8. The economic and political situationand a perspective on the financial environment
  9. 9. The economic and political situationin the EurozoneEconomic overview Bond yieldsThe global economy was hit hard by the financial crisis and therecovery remains unbalanced with advanced economies growing 20% ▬ Greeceat only 2.5%, while emerging economies grow at a much higher 18% ▬ Italy6%.1 In the emerging economies, the crisis typically left no lasting 16% ▬ Irelandwounds. Their fiscal and financial positions were generally stronger 14% ▬ Portugaland hence, the negative impact of the crisis was less intense. 12% ▬ SpainHigh underlying growth has strengthened domestic demand and 10% 8%compensated a shortfall in exports. Better growth prospects and 6%interest rate levels above that of advanced economies have turned 4%capital outflows into capital inflows. Meanwhile, in a number of 2%advanced economies the recovery shows signs of weakening. 0% Mar 08 Sep 08 Mar 09 Sep 09 Mar 10 Sep 10 Mar 11 Sep 11In Europe, there is a growing divergence in economicperformance between the north and south. While economic Figure 1 | Source: Oxford Economics; Haver Analyticsgrowth remains more reasonably robust in the northern partof the Eurozone — with the exception of Ireland — the south is Peripherals debtsuffering from pre-crisis excesses and crisis wounds: increasing Gross government debt in % of GDPborrowing costs, falling house prices, a crash in the construction 180 ▬ Greece Projectionsindustry and high unemployment rates led to a steep increase 160 ▬ Irelandof NPLs on banks’ balance sheets, resulting in a deterioration 140 ▬ Portugalof capital ratios and liquidity positions. 120 100European governments placed a protective umbrella over their 80banks, expecting that, with the return of economic growth, bank 60profits would increase and balance sheets would improve to 40solve the problem. However, the post-crisis economic recovery is 20weaker than governments had hoped and, worse still, recovery 0is weakest where the debts are highest. The sovereign debt 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015markets of the “PIGS” countries (Portugal, Ireland, Greece,Spain) are under strong tensions, indicated by a surge in Figure 2 | Source: Oxford Economics; IMF; Irish Dept. of Financegovernment bond yields. A bank solvency problem thus turnedinto a sovereign solvency problem. Peripherals interest burden Debt interest in % of government revenuesIn 2010, the European Financial Stability Facility (EFSF) was 30%created to provide liquidity to countries that struggle to refinance ■ Greeceat the capital markets. But its remit remains restricted, particularly 25% ■ Irelandon the purchase of government bonds. A number of proposals ■ Portugal 20%on economic governance have been made, which go in the rightdirection but fall short of a significant move toward fiscal transfers. 15%This underlines the fact that, as yet, there is no all-encompassingcrisis resolution path. Individual member countries remain keen to 10%limit their own financial exposure, but the multitude of solutions 5% 14.0% 16.1% 15.6% 16.1% 18.0% 19.6% 19.8% 25.1% 22.0% 25.5% 21.9% 25.1%they offer do not constitute a coherent approach that could explain 7.6% 8.2% 8.6% 8.6% 8.5% 8.4%how and when debt sustainability is likely to be achieved in the 0%Eurozone’s peripheral countries. 2010 2011 2012 2013 2014 20151 World Economic Outlook, IMF, April 2011. Figure 3 | Source: Oxford Economics; IMF; Irish Dept. of Finance Ernst & Young European Non-Performing Loan Report 2011 9
  10. 10. The economic and political situation and a perspectiveon the financial environmentEconomic outlook Forecast of the Eurozone economyThe opinion on the Eurozone’s immediate economic outlook is (Annual percentage changes unless specified)sharply divided. Earlier this year, confidence indicators painted 2010 2011 2012 2013 2014 2015an almost euphoric picture, with the Ifo Business Climate Index GDP 1.7 1.6 1.1 1.9 2.0 2.0in Germany reaching an all-time high in February this year. In thewake of sovereign debt crisis and softening economic indicators • Private consumption 0.8 0.5 0.7 1.3 1.5 1.6in some key markets, economists have been lowering their • Fixed investment −1.0 2.3 1.8 3.7 4.0 3.6expectations for economic growth and fears of a double-diprecession are rising. • Stockbuilding (% of GDP) 0.6 0.6 0.5 0.7 0.7 0.8 • Government consumption 0.5 0.3 −0.2 0.5 0.9 1.1In our Ernst & Young Eurozone Forecast2, we see a significantrisk of the Eurozone economy slipping back into recession as the • Exports of goods and services 10.6 6.4 4.6 6.0 5.9 5.3sovereign debt crisis shows no sign of abating. We revised our • Imports of goods and services 8.9 4.8 3.7 6.0 5.9 5.4GDP forecast to 1.6% this year instead of previously projected 2%,before slowing to an “anemic” 1.1% in 2012. Consumer prices 1.6 2.6 1.8 1.8 1.8 1.8 Unemployment rate (level) 10.1 10.0 9.9 9.6 9.2 8.9Earlier this summer, our forecast was a fairly benign scenario inthree main respects. First, our Ernst & Young Eurozone Forecast Current account balance (% of GDP) −0.5 −0.8 −0.5 −0.3 −0.3 −0.3assumed no further escalation to tensions in the Middle East. Government budget (% of GDP) −6.0 −4.2 −3.1 −2.3 −1.8 −1.4Second, it assumed that the financial market environment is benignas fiscal adjustment proceeds further and governments take some Government debt (% of GDP) 85.5 86.9 88.0 87.9 87.8 87.6decisions that reassure investors as regards their ability to avoid ECB main refinancing rate (%) 1.0 1.3 1.2 2.6 3.5 3.9and deal with future sovereign debt crisis (however, during August,investors certainly did not afford governments such breathing Euro effective exchange rate (1995 = 100) 120.7 121.1 120.4 119.4 115.4 113.5room). Third, our forecast assumed that the Eurozone banking Euro/US dollar exchange rate ($per €) 1.33 1.41 1.38 1.33 1.27 1.24sector restructures gradually and avoids widespread disruptions.However, we now expect that the Eurozone sovereign debt crisiswill worsen further, in turn undermining growth prospects. Figure 4 | Source: Oxford Economics Growing risk of disorder Markets remain unconvinced by the two bail-out packages agreed for Greece. It is possible that similar sentiment could spread and once again impact the borrowing costs of Ireland and Portugal. Without a rapid improvement in their competitiveness, all three economies, as well as Spain and Italy, will be challenged by low levels of economic growth, further hampered by unsustainable debt servicing burdens. One of the most disturbing problems in this context is the unemployment among young people and how it affects the society and the younger generation’s ability to become established in the labor market. The latest available statistics are alarming: in Spain, nearly 45% of citizens under 25 are unemployed. The figure for Greece is 36% — this is far too many young people who are not using their insights, energy and ideas to build and develop future businesses and public services.10 Ernst & Young European Non-Performing Loan Report 2011
  11. 11. Both the finance markets and the political leadership in Europe Businesses prefer to reduce debt and banks keep credit tightfear that after Greece, Portugal and Ireland, Italy and Spain The recovery in domestic activity is forecast to continue atmight also fail and the deepening crisis would strike hard against a slow pace. Strong export performance has not yet beenEuropean banks, especially in Germany and France. sufficiently sustainable to make companies in the Eurozone as a whole confident enough to raise investment at a robustThis creates a potentially dangerous economic and political pace. Even in Europe’s recently top performing economy,context for business over the next 12 months, and one that is not Ernst & Young’s study of the German lending market3 supportsgeographically limited to Europe either. We have seen that the this finding, as the majority of polled companies are still reluctantvoluntary participation of the private sector in the second rescue to invest. This is mainly attributable to the need for utilizationpackage for Greece has led to a downward rally of European of technical capacities, which were considered weak at thatstock markets, and diminishing confidence among banks is time. Nevertheless, given ample amounts of cash available toraising fears of a second credit crunch on the interbank market. the business sector on aggregate, our Ernst & Young EurozoneA wider orderly sovereign debt restructuring could rock global Forecast sees Eurozone business investment to rise by 2.7% thisfinancial markets and a deeper default than the one in July on year and 2.6% in 2012. This would leave the level of investment atGreek sovereign debt now looks unavoidable. Economic recovery the end of next year still around 10% below pre-crisis levels. In thein Europe falters as confidence in the euro and the solidity of the UK, demand for credit is reported to be similarly weak.Eurozone weakens. Consumer confidence, by no means robust inthe Eurozone at present, will be weakened further. Into this bleak We think that the corporate balance sheet restructuring andoutlook, we should also factor in growing uncertainty over the deleveraging that has been a main focus of companies over thedirection of US economic policy, doubts over the US economic past year will continue to weigh on investments for some time.recovery, the risk of oil prices remaining at current high levels and Business investment is not expected to return to pre-crisisthe possibility of even higher, and fluctuating, commodity prices. levels before 2014.The discussion about the best way of solving the Eurozone Moreover, Eurozone banks are keeping a tight lid on lending assovereign debt problem between the EU and the European Central they restructure their own balance sheets and reduce theirBank (ECB) has been hard and reveals a strong disagreement exposure to the riskier sectors and countries. As banks continueover what measures need to be taken. The Eurozone financial to deal with a significant corporate refinancing burden, thecrisis is a great challenge for its governments and central banks, outlook for new lending remains muted. The Q2 results of thebut this is not only about creating consensus at the EU level. All ECB’s Bank Lending Survey show that only banks in core countriesgovernments in the Eurozone and their political opponents have a (Germany, France, Austria, Belgium, Netherlands) have startedgreat responsibility when it comes to finding common strategies to unwind the tightening of credit standards imposed during theto lift their countries out of the crisis and to secure Europe’s crisis and, even in these countries, this unwinding is slow.future as a strong single market.2 For further information please refer to the full reports under A Study of the lending market — September 2010, Ernst & Young, Ernst & Young European Non-Performing Loan Report 2011 11
  12. 12. The economic and political situation and a perspectiveon the financial environmentHeavy turbulence in the banking sectorLiquidity Sovereign risk is casting a shadow over the banking sector …The global credit crisis was triggered by the US subprime mortgage The sovereign debt crisis remains a defining theme for both thecrisis, followed by a liquidity shortfall in the US banking system. Eurozone economy and the banking sector. Credit default swapWith the collapse of Lehman Brothers and other systemically (CDS) spreads for Greece, Ireland, Portugal, and more recentlyimportant financial institutions, the bail-out of banks by national Spain and Italy, have risen to new highs, which is translatinggovernments and downturns in stock markets around the world, to higher funding costs that banks are finding difficult to passthis quickly emerged into a global financial and economic crisis, on to borrowers in these countries. Concerns about possiblewhich exceeded all previous crises since the Great Depression. sovereign debt defaults have led to a sharp rise in the perceived counterparty risk of banks in the troubled countries, withDespite the fact that the Eurozone banking sector is gradually banks elsewhere in the Eurozone and beyond reducing theirrecovering from the global financial crisis and recession, the exposures to banks considered to be most effected. Due to theoutlook remains challenging. As described in the first section interdependence of bank and sovereign creditworthiness, accessof this report, economic growth in the Eurozone is expected to to wholesale funding is likely to remain significantly restricted inremain uneven; household and business balance sheets remain these economies. This is illustrated by the forecast for 10-yearstretched in many member states. Ongoing sovereign debt crises government bond yields, which are expected to remain close toand lingering uncertainty about the asset quality of many banks 4% in Germany and France this year, as opposed to 5.5% in Spainis hampering access to wholesale funding markets at reasonable and more than 15% in Greece.cost (although the ECB is playing a crucial role in providingfinancing to certain banks). At the same time, banks’ profitability This drain of liquidity has left peripheral country banksin the region is facing headwinds from a broad range of increasingly reliant on the ECB for funding. In January 2011,regulatory reform initiatives that are currently under way at both banks from Greece, Ireland, Portugal and Spain borrowed aroundthe EU and global levels. Against this background, the outlook for €320b from the ECB, down from €378b in July 2010, but stillthe Eurozone banking sector remains highly uncertain. well above the typical levels of around €50b before the crisis.ECB lending to the periphery€ billion400 ■ Ireland ■ Portugal350 ■ Spain ■ Greece300250200150100500 2007 2008 2009 2010 2011Figure 5 | Source: Oxford Economics; Haver Analytics12 Ernst & Young European Non-Performing Loan Report 2011
  13. 13. Banks‘ NPLs% of total loans8 Forecast ▬ Eurozone7 ▬ Italy6 ▬ Spain5 ▬ Germany43210 2007 2009 2011 2013 2015Figure 6 | Source: Oxford Economics; World BankAnd in February 2011, two Irish banks, that had to sell assets lower collateral values. This legacy of bad loans willto restructure their balance sheets, had to resort to the ECB’s hamper banks’ ability to normalize credit conditions toovernight lending facility, pushing the amount borrowed by support the economic recovery in these regions.Eurozone banks to around €15b for a few days compared withonly a few hundred millions usually. Total ECB lending to Portugal, In light of our underlying forecasts for subdued economicIreland, Greece and Spain amounted to around €350b in April. growth and multiyear deleveraging in the private sector, weWithin this total, lending to Ireland has expanded significantly expect lending and profitability to remain muted, with theover the past year due to the intensification of their banking likelihood that some banks will need to raise capital to meet newcrisis. By contrast, ECB lending to Spain had, until recently, been Basel III standards as well as address elevated asset quality risk.contracting in line with improved investor sentiment. But the There is also a risk that margins will generally remain weakerintensification of the sovereign debt crisis has seen financing than for banks in the core due to the higher cost of funds. On thecosts for Spanish banks rise again, forcing them to borrow from other hand, our forecast for a gradual normalization of monetarythe ECB rather than access capital markets. policy by the ECB will see the yield curve flatten within the core Eurozone over the next few years, which is also likely to squeeze… underscoring the north/south divide in performance margins for banks in these economies.Besides a funding squeeze, uncertainty remains about theasset quality of many of the banks in the peripheral economies,particularly their exposures to the depressed residential andcommercial property sectors. The impact of ongoing fiscalausterity measures on economic growth, employment and creditquality will continue to represent a significant downside risk to theperformance of banks in these economies for some time, wherethey have significant local exposure.Persistently high NPL ratios in the periphery economies willmean that provisions for bad loans will remain at elevated levels,dampening earnings and profitability. In countries such as Spain,where we expect house prices to continue falling through to2014, the negative collateral effect on bank balance sheets will becompounded, as mortgages will have to be written off net of much Ernst & Young European Non-Performing Loan Report 2011 13
  14. 14. The economic and political situation and a perspectiveon the financial environmentCapitalThe financial crisis also revealed major shortcomings in the way Across the EU over €2,800b capital was deployed by nationalthe banks had been operating: the capital ratios were insufficient governments to stabilize and support financial institutions. Ofand the capital they held was of insufficient quality. What began the support measures deployed, around €2,100b was providedas a credit issue on US subprime mortgages spread to several in state guarantees (76% of total measures), 16% were deployedother asset classes as the recession took hold, leading to the to assume risk positions and 8% were deployed to recapitalizesignificant impairment of banks’ balance sheets. To fulfill capital financial institutions. The Irish Government dedicated the highestrequirements and improve liquidity positions, banks had to raise amount toward state guarantees, which accounted for 82% of thenew capital or reduce assets exposures. total value of support provided by the Government. Across the EU and Switzerland, funds allocated for state guarantee schemesGovernments were required to intervene with massive and were primarily used to provide guarantees for bonds issued byunprecedented rescue packages for both the economy and financial institutions.the financial sector, preserving both financial stability and thefunctioning of the internal markets. Globally, governments have In terms of country-specific measures, the UK Governmentadopted a variety of measures to achieve this, ranging from provided the highest value of country support with a totalfull-scale nationalization of financial institutions to providing amount of around €585b. The Irish Government deployed theinsurance for impaired assets. second-highest value of measures — marginally behind the UK at ca. €540b and Germany at around €480b. In many countries, mainly Eastern Europe but also including Italy, governmentsGovernment intervention schemes State guarantees • State guarantees were provided to selected financial ► Recapitalization • Capital injection in selected financial institutions ► instruments issued by financial institutions was provided to strengthen the capital base of these • Typically, senior unsecured medium-term (three to five ► institutions years) instruments were guaranteed • Most of the government recapitalization during ► • State guarantees were provided across the majority of ► the financial crisis occurred through non-dilutive the countries researched — notably in Ireland, where instruments such as preferred shares, non-voting around €440b of state guarantees were provided to the securities, mandatory convertible instruments or major banks subordinated debt securities • France is the only case where guarantee was provided ► • Recapitalization measures were used widely across the ► to a government-owned entity (Société de Financement EU Member States — in particular, in Germany de l’Economie Française) that further provided loans to financial institutions Nationalization • Nationalization is a special case of recapitalization ► under which the government becomes sole or majority Assumption of • The scheme involved the acquisition of risk positions ► owner of the financial institution risk positions through purchase or guarantee of legacy assets • This step was generally undertaken for severely ► • Asset purchases involved acquisition of assets, ► distressed financial institutions to enable smooth securities, rights and obligations arising out of credit restructuring and eventual re-entry into the market commitments and/or holdings; for example, the National Asset Management Agency (NAMA) in Ireland, that • Key examples include the nationalizations of Northern ► Rock in the UK, Allied Irish Bank, Hypo Real Estate in acquired toxic property assets of banks at a heavily Germany and Parex Bank in Latvia discounted rate in return for government bonds • Asset guarantees were also deployed to provide ► protection from potential losses. These programs were generally customized according to the beneficiary Deposit guarantee • The scheme primarily involved increasing the limit ► for protection of retail and SME deposits in financial institution; for example, the Asset Protection institutions Scheme in the UK, which provides RBS with protection against future credit losses in return for a fee • The majority of countries researched increased the level ► of protection provided by depositor protection schemesFigure 7 | Source: Ernst & Young research14 Ernst & Young European Non-Performing Loan Report 2011
  15. 15. Total value government aid per country€ billion600 585 540500 480400 341300 220200 157 150100 90 54 48 35 24 20 20 12 7 30 al y g UK nd y ce s en n ria d nd k m ce ia nd ar an ur ar ai an ug en iu an ee ed la la st Sp nm ng bo la rm nl lg ov rt Ire er Au Fr Gr Sw er Fi Be Hu m Po itz De Ge Sl th xe Sw Ne LuFigure 8 | Source: Ernst & Young researchwere not required to introduce formal anti-crisis schemes; guarantees, around US$420b was deployed to recapitalizehowever, deposit guarantee schemes have been widely financial institutions, and around US$40b was deployed tointroduced by these governments. assume risk positions.Across the EU region, a total of 94 financial institutions received Limited ratings migration to the benefit of most creditors ofsome form of government assistance. France supported the highest these banks, as well as the improvement of banks’ capitalnumber of institutions — 13 in total. This is followed by Germany, ratios, reflect the effects of these capital interventions in additionAustria, Portugal and Greece who supported seven institutions to profitability improvements and deleveraging efforts. The staterespectively. In most of Eastern Europe, as well as Italy, no direct aid measures were linked to major restructuring and reorganizationsupport was provided to any institution — primarily because, in requirements for banks in order to establish robust banking modelsmost of the Eastern European countries, the banking industry is that show higher resistance to shocks to the financial markets.dominated by foreign players who received support from their Restructuring of the Eurozone banking sector is ongoing, withrespective home countries’ governments. During 2008, the US measures such as the consolidation of Spanish cajas (savingsGovernment, along with the Federal Reserve, Federal Deposit bank) or the split-up of German Landesbanken (federal state banks).Insurance Corporation (FDIC) and the US Treasury, launchedvarious schemes, under the Emergency Economic StabilizationAct of 2008 and Troubled Asset Relief Program (TARP),to stabilize the financial system. Of the support measures However, progress on banking restructuring is slow and it isdeployed, more than US$1,000b was provided in state as yet uncertain as to whether these measures are enough to solidify the banking system and make it a contributor to growth rather than a restraint. Nevertheless, management boards, including those of banks owned by the state, are willing to rethink the bank’s business model, improve risk management and are keen to present their shareholders cleaned-up balance sheets. Ernst & Young European Non-Performing Loan Report 2011 15
  16. 16. The economic and political situation and a perspectiveon the financial environmentWhy are some banks more resilient to stress than others? The question as to what makes the difference between aThe financial crisis has had far-reaching impacts on financial successful and a less successful business model and whetherinstitutions across the globe. However, while numerous institutions there is a “best practice” business model in banking, has beenfailed or had to be bailed out by impressive governmental rescue addressed in various research papers and analyzed in recentschemes, other financial institutions maneuvered better through years; yet, we find that the following key factors seem to playthe crisis years and came out in much better shape. a role in most of the analyses:Largest European listed banks4 that have not required Sound business model. A key factor enabling sustained financialgovernmental aid to date success also in periods of stress is a sound business model. Key elements include a clear focus on product, markets and client€ billion Market* Total assets** Rating*** capitalization strategy, established riskmanagement processes and last, but not least, an established set of values across the organization.HSBC Holdings 122.7 1,870.0 Aa2/AA−/AABanco Santander 67.2 1,231.9 Aa2/AA/AA A key element differentiating performance of financial institutions has been the appetite for risk, which is closelyDeutsche Bank 37.8 1,850.0 Aa3/A+/AA− linked to the business model. In general, we find that financial institutions lacking a solid, sustainable and competitive businessBarclays 34.8 1,661.9 A1/A+/AA− model were more likely to take on excessive risks to improveBBVA 36.8 568.7 Aa2/AA/AA− profitability than others.Credit Suisse 32.8 814.9 Aa2/A/AA− A recent study of US banks revealed that those banks that performed poorly during the Asian crisis of 1998, were harder hitUniCredit Group 28.2 918.8 Aa3/A/A by the global financial crisis of 2007 to 20095. This phenomenonNordea Bank 29.9 593.2 Aa2/AA−/AA− seemed to be independent of the people in charge, and has been explained largely by sustained weaknesses of those banks’Svenska Handelsbanken 13.2 244.1 Aa2/AA−/AA− business model.SEB 12.3 238.8 A1/A/A+ A fundamental element of sound business models is a state-Swedbank 13.4 190.7 A2/A/A of-the-art risk management. Risk management practices of top performers have been summarized as combining variousBanco Popular Español 5.5 130.4 A2/A−/A− elements, such as effective firm-wide risk identification and analysis; consistent application of valuation practices; anFigure 9 | Source: Forbes 2000 list; Bloomberg; banks‘ interim financial effective management of funding liquidity, capital and the statements; balance sheet; and informative and responsive risk measurement * Market capitalization as of 30 June 2011 (Bloomberg) and management reporting.6 Those banks that priced risk ** Total assets as of 30 June 2011 (interim financial statements) appropriately, and/or took early action to reduce high-risk *** Latest available rating Moody‘s/S&P/Fitch/ positions as the crisis unfolded, performed significantly better FX rates as of 30 June 2011 provided by in the crises. A high degree of non-interest income can drive profits, but does lead to higher volatility of income. However, if risks are rightly managed, a higher portion of non-interest income should not be viewed as a critical issue of a bank’s business model per se. Underperforming business models, an increasing appetite for risk, coupled with inadequate risk management routines, may all have played a role in numerous banks’ accumulation of significant exposure to toxic assets in their credit books during pre-crisis years.16 Ernst & Young European Non-Performing Loan Report 2011
  17. 17. On one hand, institutions that limited their structured creditinvestments emerged as winners from the crisis. SpanishBanco Santander, today Eurozone’s largest bank by marketcapitalization, and BBVA, benefited from low exposure to suchinstruments, in part due to limitations imposed by the Spanishcentral bank, and instead focused on growing in retail bankingand in international growth markets in Latin America.7 Likewise,French banks, in general, maneuvered better through the crisisthan most peers, supported by their business models focused ontraditional retail and corporate clients. Somewhat in contrast tothe aforementioned study results on US banks, Swedish banks for The crisis has revealed that even the most liquid funding marketstheir part seem to have learnt a lesson from their banking crisis can break down within days, making business models relying tooin the early 1990s, and in general were in much better shape to heavily on non-deposit funding much more risky and non-resilientaddress the challenges of the financial crisis. to stress. As a consequence, a key focus of Basel III has been rightly placed on funding liquidity risks.On the other hand, those institutions that were particularlyaffected by the crisis often revealed shortcomings in their Capitalization. Financial institutions with strong core capitaltraditional business model. A high degree of non-interest income, positions are outperforming peers with weaker increasing appetite for risk, and inadequate risk management Recent studies during the financial crisis indicate that highlymay all have played a significant role in leading to increased leveraged financial institutions tended to limit their lendingearnings volatility and an exposure to higher-risk assets. more substantially9 but also underperformed in terms of stockRegarding investment banks, the (near-) collapse of several market price development.10 Financial institutions with excessiveWall Street players hints toward excessive risk-taking partially leverage tended to be viewed more critically by counterpartiesincentivized by a business model focused too heavily on short- with respect to their business model and overall solvency.term profitability and inadequate risk-management techniques Again, Basel III has identified the core capital issue as a majorin light of new and complex financial products. As a second hard- focus area.hit group, several German Landesbanken suffered massive lossesin the crisis as they had accumulated a significant exposure to In summary, we view those institutions well-positioned to facetoxic assets in pre-crisis years. In search of a viable (and more future challenges that pursue a sound and viable business model,profitable) business model, several players invested excess are sufficiently capitalized and have a robust and balancedliquidity heavily in seemingly attractive foreign securities.8 funding mix in place. The Basel III initiatives do provide regulatory guidance and create additional momentum about banks’ focusRobust funding mix. Many of the hardest-hit institutions relied on core capital and funding liquidity risks. Meanwhile, severaltoo heavily on wholesale funding and short-term money markets institutions have taken steps to re-shape their business model andor securitization activity as a funding source, in many occasions adapt to a more risk-averse environment, strengthen core capitalfor longer-term, often illiquid assets (which increasingly were and recalibrate their funding profiles to better manage fundingfaced with uncertainty over value). liquidity risk going forward.4 Largest private banks based on Forbes Global 2000 Leading Companies list.5 “This time is the same: Using the events of 1998 to explain bank returns during the financial crisis”, Swiss Finance Institute Research Paper No. 11–19, Fahlenbrach, R., Prilmeier, R., Stulz, R. (2011).6 “Risk Management Lessons from the Global Banking Crisis of 2008”, Senior Supervisors Group (2009).7 “A Spanish Bank Emerges as a Winner in Global Crisis”, Spiegel Online, Scott, M. (2008).8 “The German Banking System: Lessons from the Financial Crisis”, OECD Economics Department Working Papers, No. 788, OECD Publishing, Hüfner, F. (2010).9 “The Bank Lending Channel Lessons from the Crisis”, ECB Working Paper Series No. 1335, May 2011, Gambacorta, L., Marques-Ibanez, D. (2011).10 “Why did some banks perform better during the credit crisis? A cross-country study of the impact of governance and regulation”, Charles A Dice Center Working Paper No. 2009–12, Beltratti, A., Stulz, R. (2009). Ernst & Young European Non-Performing Loan Report 2011 17
  18. 18. The economic and political situation and a perspectiveon the financial environment Stress tests To improve banking supervision in the European Union, the For some critics, the applied capital definition and benchmark European Banking Authority (EBA) was established as of to pass the most recent stress test is not sufficient enough, 1 January 2011 and has taken over all existing and ongoing although they are more stringent than in the 2010 stress tasks and responsibilities from the Committee of European test. Silent participations are no longer included in the capital Banking Supervisors (CEBS). definition, which is applied to all participants regardless of any specific national distinctions in banks’ capital definitions. The stress tests carried out by EBA in 2010 and 2011 This was especially criticized by some German Landesbanken. constitute hypothetical (what if) analyses of negative shocks to the banking sector. Both stress testing exercises were The stress test is supposed to show a bank’s resilience focused on credit and market risks, including a specific focus against a worst-case scenario as well as increase the on the exposures to sovereign risk (applied to the trading transparency of the institutions to investors. However, the book). Liquidity risks were not specifically assessed during release of the results by the EBA, on 15 July 2011, did not the stress testing exercise. reassure the market and European bank shares recorded the biggest drop in 11 months. Only 8 out of 90 banks failed One of the major points of criticism was that no sovereign the stress test and fell beneath the threshold of 5% Core default is included in the stress test. Instead of a sovereign Tier 1 Ratio (CT1R). But the perceived positive outcome is default, there is a significant sovereign stress, which affects somewhat misleading as there is still a severe need for banks the price of foreign debt and the cost of funding. For most to raise capital. The eight banks that failed the test alone critics this is not going far enough, especially with regards to need to raise a total amount of €2.5b to reach a 5% CT1R. the economic situation in the PIGS countries. Furthermore, under the adverse scenario, 33 banks are below the intended 7% CT1R and will need to raise capital to Furthermore, the banking book that contains those sovereign improve capital ratios as well. bonds that are held until maturity is not within the scope of the additional sovereign stress. Comparison of the 2010 and 2011 stress tests 2010 2011 Benchmark 6% 5% Capital definition Tier 1 capital Core Tier 1 capital Forecast EU Commission Spring forecast 2010 (worse) Autumn forecast 2011 (better) GDP growth over stress testing period EU: −3% points EU: −4% points Probability of occurrence of the adverse scenario Higher Lower18 Ernst & Young European Non-Performing Loan Report 2011
  19. 19. Basel III — reshaping the future landscapeIntroduction to Basel IIIThe Basel III framework was endorsed by the G20 leadersin November 2010 in South Korea. The goal of this newset of regulations is to enhance bank and banking sectorresilience to unexpected shocks and thereby promote financialstability. The combination of microprudential approaches andmacroprudential measures to address procyclicality and systemicrisk is a key element of Basel III. Therefore, Basel III does notreplace the Basel II and Basel I frameworks. It complementsthe existing regulation, simplifies and strengthens areas leftlargely unchanged by Basel II and introduces components on amacroprudential level.On 16 December 2010, the Basel Committee of BankingSupervision issued the Basel III rules, which represent the detailsof regulatory standards on an international level for financialinstitutions. This broad set of measures aims to:• Improve the banking sector’s ability to absorb shocks from financial and economic stress, whatever the source might be• Improve risk management and governance• Strengthen banks’ transparency and disclosure11The main thrust of the reforms involves raising the quantity aswell as the quality of regulatory capital and enhancing the riskcoverage of the capital framework.12 The reform package furtherincludes a number of new instruments such as capital buffers,a leverage ratio and enhanced liquidity standards.For the European market, the EU Commission adopted theBasel III framework as standard-setting guidelines and publisheda corresponding framework: Capital Requirements Directive(CRD) IV, consisting of a Directive and a Regulation replacingthe current Capital Requirements Directives (2006/48and 2006/49).11 www.bis.org12 Basel III: A global regulatory framework for more resilient banks and banking systems, BCBS (Basel Committee on Banking Supervision), December 2010. Ernst & Young European Non-Performing Loan Report 2011 19
  20. 20. The economic and political situation and a perspectiveon the financial environmentBasel III changes on capital requirements Different elements of the current capital requirements willThe current Basel minimum standard for bank capital of 8% be phased out — this includes Tier 3 and innovative hybrid capitalof risk-weighted assets (with 4% Tier 1, equity and equivalent instruments with an incentive to redeem. The phase out periodinstruments, and 4% Tier 2, which includes subordinated debt) is 2013–2021.has remained largely unchanged since the original 1988 BaselAccord. But the crisis highlighted the need for banks to hold The capital requirements for trading books are changinghigher-quality capital. One of the key aspects of Basel III is the sharply with the introduction of stress models for market riskincreased focus on equity with a new Common Equity Tier 1 and counterparty risk, credit value adjustment (CVA) charges(CET1) component that will be almost double the previous Tier 1 as well as large increases in requirements for exposures tominimum. There will be two requirements for CET1, a floor level large banks. Overall trading book capital requirements go up byof 4.5% and then an additional capital conservation buffer of between three and four times.2.5% bringing the total to 7%. If a bank is not able to meet thefull conservation buffer, there will be limitations on pay out of The timelines for adopting the new capital requirements areearnings through dividends, share buy-backs and bonuses. quite long — see below — and the phase out of the capitalA countercyclical buffer of up to 2.5% can, by national descretion, instruments will take place over an even longer period. But therealso be added in any national market that is overheating. are already market pressures on banks to comply. More than €500b additional capital may be needed across the EuropeanIn addition to the higher CET1 requirements, a number of new banking industry relative to end 2009 and, of this, around halfdeductions will be made from the accounting definition of capital. has been raised to date.Examples include goodwill, deferred tax assets (DTAs) (where non-timing difference DTAs will have to be deducted and others will besubject to a limit) and intangibles. A new stricter approach tothe inclusion of minority interests within consolidated capital isalso being introduced.Timeline for the new capital requirement • Additional capital conservation buffer of 2.5% • Countercyclical buffer (0%-2.5%) in national discretion Countercyclical buffer 0%-2.5% 0%-2.5% 0%-2.5% 0%-2.5% Capital conservation buffer 2.5% 1.875% 0.625% 1.25% 8% 8% 8% 8% 8% 8% 8% 8% Total capital 6% 6% 6% 6% 6% 5.5% T1 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4% 4% 3.5% 2% CET 1 Until 2012 2013 2014 2015 2016 2017 2018 From 2019Figure 10 | Source: Ernst & Young research20 Ernst & Young European Non-Performing Loan Report 2011
  21. 21. Enhanced liquidity standards Stock of high-quality liquid assetsThe introduction of minimum quantitative measures for The LCR is: Total net cash outflows over the next 30 calendar days ≥100 %bank liquidity represents a major departure from previousinternational prudential standards. The focus in the past has beenon minimum levels of capital and Basel II represents the first The NSFR is designed to provide incentives for banks to seekinternationally harmonized standard for liquidity. Under Basel III, more stable forms of funding. It will be a monitoring tool initiallytwo separate requirements will be introduced: the liquidity but a decision will be taken in 2017 regarding its use as acoverage ratio (LCR), which will require a liquid assets buffer to minimum requirement. To meet the requirement, a bank wouldbe held, and the Net Stable Funding Ratio (NSFR), which will limit have to fund 100% of illiquid exposures with stable funding,longer-term lending unless it is fully backed by stable funding. unless the loan is a mortgage where the requirement would be reduced to 60% stable funding. To calculate stable funding, theThe LCR will prescribe a minimum level of high-quality liquid liabilities of the bank would be weighted by different factors toassets a bank must have at any given time. The minimum liquid reflect their relative stickiness.assets buffer will be driven by a stress test calculation of cashinflows and outflows and must be sufficient to cover the net cash Available amount of stable fundingoutflows over a 30-day period. The NSFR is: >100 % Required amount of stable fundingThe liquid assets buffer must comprise of a proscribed set of assets: Banks will have until 2015 before the introduction of the LCR• 60% must consist of “level 1” assets — high-quality and 2018 before the NSFR will be considered as a minimum sovereign instruments and cash requirement rather than a monitoring tool (see Figure 10). However, the capital market will impose pressure on banks to• Up to 40% can consist of “level 2” assets — a wider range of comply with these new regulations much earlier. good quality liquid bonds after a haircutLiquidity timeline Bank reporting to regulators starts LCR minimum standard NSFR minimum standard LCR observation period Introduce LCR minimum standard Introduce NSFR minimum NSFR observation period standard 2x further QIS LCR final amendments European/national implementation NSFR final amendments Jan 11 Jan 12 Jan 13 Jan 14 Jan 15 Jan 16 Jan 17 Jan 18 Jan 19 Jan 20 Jan 21Figure 11 | Source: Ernst & Young research Ernst & Young European Non-Performing Loan Report 2011 21
  22. 22. The economic and political situation and a perspectiveon the financial environmentLeverage ratioOne feature of the crisis was the excessive on- and off-balancesheet leverage in the banking system, which was not detectedwith the existing risk-based ratios. Therefore, the measuresstrengthening the quantity and quality of capital are underpinnedby a leverage ratio that serves as a backstop to the risk-basedcapital measures. The leverage ratio is intended to constrainexcess leverage in the banking system and provide an extra layerof protection against model risk and measurement error.13The ratio will require a minimum percentage of Tier 1 to grosson- and off-balance-sheet assets. The minimum Tier 1 leverageratio is set at 3% for the observation period. The quantitativeimpact study (QIS) carried out by the Basel Committee showedthat many banks would not have been able to meet thisrequirement at the end of 2009. The higher capital buffers willmake it easier but it will be a constraint when markets pick up.13 Basel III: A global regulatory framework for more resilient banks and banking systems, BCBS (Basel Committee on Banking Supervision), December 2010.22 Ernst & Young European Non-Performing Loan Report 2011
  23. 23. ConclusionBasel III and the strategic implications Impact on costsBanks are reassessing their strategies in the light of the crisis Private sector estimates show that the capital and liquidityand changes to risk appetite, but also in response to the change could lead to a fall in ROE of as much as 40% if banks doBasel III regime finalized at end 2010. The Basel III framework not change business models. The size of the capital increases insubstantially increases the cost of different types of activity. some areas mean that banks will have to exit from some types ofAlthough the basic credit risk treatments for loans are largely activity and it is almost certain that some proprietary tradingunchanged (still based on Basel II) the quality of capital needed to will move to hedge funds.cover the requirements and the total amount of capital requiredis radically changed by Basel III. There is a much greater focus on However, widespread adjustment of balance sheets andequity capital, with the phase out of other instruments as well as strategies will be needed. The Basel Committee has calculatedmore deductions from accounting capital. In addition, the total that, assuming an ROE of 15% going forward, each one percentagesize of the capital buffers is being increased. Overall, banks will point increase in the capital required will require a 13 basis pointneed between 40% and 100% more equity capital. Other changes increase in spreads to cover the cost, and the liquidity standardin Basel III also have a fundamental effect on the economics of will require a 25 basis point increase in spreads to cover thedifferent business units or loan portfolios. Basel III introduces cost. Overall, banks are looking at the margin on loans rising byliquidity requirements (which translate into the need for high, between 1 percentage point and 2.5 percentage points. This willquality liquid assets buffers), which also increase costs. A further be achievable in some market segments but not in others.change under Basel III that will affect strategy is the introduction Retail customers and small companies have fewer alternativeof a leverage ratio. Banks that are under a leverage constraint avenues for funding and an increase in margin is possible, butwill have to consider the most profitable areas of business on the same is not true of large corporates. A careful assessmentwhich to focus. of the likely profitability of each business line is needed and then a restructuring of the business to exit less profitableOverall, Basel III will be a major change for the industry. The areas and portfolios.magnitude of the capital changes and the need to hold largeliquid assets buffers will place considerable pressure on rate of Banks will have to scrutinize costs across the business andreturn on equity. Many banks are already lowering their targets, legal entity restructuring could play an important part inand further downward revision will happen going forward. economizing on capital and liquidity as well as other costs.Basel III includes long timelines for implementation. However, the However, restructuring programs will have to weigh up carefullyadjustment period is likely to be compressed because of pressure the different costs and benefits from a range of sources — tax,from the ratings agencies and the market regulatory capital, liquidity requirements, regulatory intensityto demonstrate early compliance. and business effectiveness.Some banks will be winners and some will be left behind in themove to change business models and design an effective strategy.The changes being considered by banks are far reaching. Somehave already announced that they will be leaving particularmarkets, many have identified portfolios that they wish to sell andothers are streamlining legal entity structures to optimize use ofcapital. But this period of change could also give opportunities forsome banks to gain a foothold in new markets — some banks will beaffected more than others and not all will respond effectively tothe challenges giving opportunities for takeover or merger. Ernst & Young  European Non-Performing Loan Report 2011 23
  24. 24. Loan portfolio trading
  25. 25. Recent market developmentsMarket activity Non-core loan portfoliosIn the years 2008 to 2011, loan portfolio market activity in The global financial and credit crisis, and the failure orEurope was subdued. This was mainly due to the turmoil in the nationalization of large financial institutions, put pressure onfinancial sector during these years, as high levels of uncertainty banks to focus on core lending activities and exit non-coreand volatility offered extraordinary returns on comparatively and non-performing businesses. Despite this, transactionsafe investments, such as bank bonds and hybrid capital or activity in the European loan portfolio markets has been veryeven sovereign bonds. A lot of trading occurred in CDOs, CLOs slow as financial institutions have focused on wider run-off orand called B-Notes of mortgage-backed securities (CMBS and restructuring plans in place of wide-scale disposals. In general,RMBS) and therefore investing was often replaced by trading. this strategy has been applied to non-core and non-performingNevertheless, as the dust is settling, we believe that there will be assets as well as non-core markets and product lines. And whilea significant increase in investment market activity in the quarters this has resulted in financial institutions being ahead of plan onand years to come. their NPL targets, they are facing increasing challenges with their plans for non-core but performing loans. There still remainMost European banks are quite advanced in defining their strategy significant barriers to investment in performing loan portfolios,for the future after the financial and debt crisis, both concerning primarily funding requirements and leveraging limitations,the regional footprint as well as the focus customer groups and resulting in vendors being offered unattractive discounts to booksolutions and products. We expect that institution after institution value from potential investors.will assess non-strategic and non-core business segments, whichwill be offered for sale or run down and liquidated, as well as Current market activityanalyze which non-performing or sub-performing assets are We are seeing early market activity, such as US investmentbetter held onto and worked out, or monetized through a sales banks actively selling non-standard UK mortgage loans. Limitedtransaction. This continuing strategic reassessment will create activity in sales of small portfolios of commercial and residentialample supply of loan portfolios and other assets to come to mortgages is picking up as It is our expectation that the restart of the market willtake place in early 2012. In addition, we see that European banks, which have decided to exit certain markets, are starting to offer loan portfolios to theFrom a demand side, there are a large number of newly raised market, such as Irish banks offering US loan portfolios, UK banksprivate equity, opportunity, debt, mezzanine and distressed debt offering continental European exposure, Dutch banks offeringfunds that are starting to deploy and invest their capital. As the German loans and similar assets. If these transactions prove tolast two years did not see a sufficient supply on the market, we be realizable, we expect the market activity to pick up speed andexpect the appetite of investors to grow quarter by quarter and to see Spanish banks exiting non-core and NPL portfolios as wellprovide a significant demand for loan portfolios. as German banks exiting activities both domestically and abroad.As a consequence of the strategic realignment and the financial We see a large quantity of refinancing and restructuring activityand debt crisis, European banks currently hold in excess of in the market, both originating from balance sheet lenders,€1,000b of non-core loan assets. In addition, NPLs held by as well as CMBS and RMBS platforms. More and more banksbanks throughout Europe have grown to over €750b. This will are enforcing on non-performing real estate loans and areresult in financial institutions increasing the supply of non-core subsequently selling the loans or the security collateral.assets and loan portfolios over the coming years. As regulatorychanges, especially Basel III, will require institutions to keep morecapital against assets, it is to be expected that a large range ofrestructuring and sales activity will take place across the entiresector, including banking, principal investments, insurance orinvestment management. Ernst & Young European Non-Performing Loan Report 2011 25
  26. 26. Loan portfolio trading Pricing gap Pricing has often been cited as the main barrier to loan portfolio trading, whereby a significant gap exists between buyer valuation and that required by a seller for transactions to be capital accretive or even neutral. This pricing gap is due to a combination of factors, such as: Low yields on assets written in very competitive markets • Margins on newly originated business are significantly higher than those earned on historical portfolios (generated before the financial crisis). In many cases, margins on historical portfolios are not even sufficiently high enough to cover operating costs and credit losses and therefore are not contributing to overall retained earnings. Higher funding costs • Despite some recent improvements in the availability of finance (i.e., there are some initial signs that securitization markets are returning), liquidity remains scarce and expensive for most institutions outside of central bank liquidity facilities (which themselves will need to be scaled down and removed in time). Lack of leverage available to investors • Due in part to limited access to leverage, loan portfolio buyers often have to bid with equity, offering a price below the value of the asset on the vendor’s balance sheet. • Banks could offer leverage to the buyer (and this has enabled some deals to be completed); however, often this option does not, in whole, allow a vendor to reduce risk-weighted assets. Vendor’s reluctance or inability to realize losses on sales through P&L • Vendors are often capital constrained and are unwilling or unable to crystallize loan portfolio losses, without eroding their capital base. If buyers and sellers can bridge this price gap, significant volumes of loan portfolio transactions could be unlocked. As described above, there are a number of triggers that will move the expectations of buyers and sellers, which will result in a larger supply coming to market, where it will meet an enormous demand for investment opportunities. As the two sides are currently moving in each other’s direction, it can only be a matter of quarters before supply and demand will meet and result in a long- lasting wave of loan portfolio transactions.26 Ernst & Young European Non-Performing Loan Report 2011