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Ernst & young studie zum npl-markt 2011

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    Ernst & young studie zum npl-markt 2011 Ernst & young studie zum npl-markt 2011 Document Transcript

    • EuropeanNon-Performing Loan Report 2011Restructuring follows strategy — a review of the European loan portfolio market
    • Contents
    • 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
    • Introduction 4 Ernst & Young European Non-Performing Loan Report 2011
    • 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
    • Foreword 6 Ernst & Young European Non-Performing Loan Report 2011
    • 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
    • The economic and political situationand a perspective on the financial environment
    • 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
    • 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
    • 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 www.ey.com/eurozone.3 A Study of the lending market — September 2010, Ernst & Young, http://www.ey.com/DE/DE/home/library. Ernst & Young European Non-Performing Loan Report 2011 11
    • 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
    • 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
    • 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
    • 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
    • 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; www.oanda.com 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 www.oanda.com 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
    • 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 positions.an 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • 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
    • Loan portfolio trading
    • 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 well.market. 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
    • 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
    • Future market trendsAlthough recent market activity has been restricted, there Basel IIIare promising signs for future activity, with the following European banks are preparing for the implementation of thetransaction drivers expected to fuel transactions in the sector new Basel III rules, which will radically affect the banks’ costsin the coming years. of doing business. Financial institutions are being forced to reassess their strategies in response to the new capital andBridging the price gap liquidity requirements set out in the Basel III framework. ThisTransaction activity has been minimal to date, despite a requires the adoption of a new approach to strategic planning andpressing need for government-funded institutions to reduce optimization of strategy across capital, liquidity and leverage. Intheir balance sheets and the desire of independent banks to order to strengthen regulatory capital and funding positions, adispose of low margin lending generated during competitive greater focus will fall on optimizing portfolio structures and thepre-credit crisis markets. development of credible strategies for non-core operations. We are already seeing banks take decisions to concentrate on coreThe lack of disposals is largely explained by the price expectation business, exiting certain markets or sectors, and this will intensify.gap, as detailed earlier in this report. We expect that this pricing To get the strategy right, banks will need new, more sophisticated,gap, which we believe to be on average 10%–20%, will be bridged planning tools.by both buyers and sellers lowering their pricing expectationsover time, as they come under increasing pressure to respectively Recovering economiesinvest funds raised and execute disposal programs. Over the medium term, when economies begin to recover, banks will need to raise and generate more capital to fund the recovery.EU-mandated disposals It is likely that, as this capital could be released directly fromSeveral European financial institutions have been set aggressive non-core assets, banks will increase their willingness to sell at adisposal mandates, focused on deleveraging their balance sheets. discount in order to increase their ability to focus on growth.These targets were set with the aim of ensuring fair competition,with the potential effects on capital not fully considered. In order We also expect that the drag on earnings from legacy run-offto reach their disposal targets in the timescale specified, there is a books, driven by increased servicing costs and instabilitydanger that financial institutions will be forced to accelerate asset of servicing platforms, will make raising fresh capital moresales in place of asset restructuring or run-off strategies. challenging. As bank’s turn to shareholders to raise further capital to lend in a recovering economy, banks will become more active inIreland has recently demonstrated the impact this can have disposing of non-core assets in order to mitigate this risk.on a bank’s capital base. We expect to see a renegotiation ofthese targets in the next few years, with a potential optionallowing financial institutions to move these assets into a non-core area where they must either sell or run-off, but overa longer period of time. Market outlook In our opinion, we believe the loan portfolio market is beginning to gather momentum and, particularly in light of recent EU-mandated disposals and Basel III capital requirements, expect to see a significant increase in both the volume and size of transactions in the coming years. Ernst & Young European Non-Performing Loan Report 2011 27
    • Germany The German economy grew faster than the world’s other major economies last year and, with GDP growth at 3.5%, enjoyed its strongest performance since the 2000 IT boom. The main drivers behind this growth rate, despite the extreme fall in 2009, are the strong export situation and a surge in domestic demand for capital goods. In a globalized economy, Germany’s supplier countries are also profiting as imports increase at a similar pace. Germany is reaping the benefits of the structural reforms implemented during the previous decade, which have greatly improved the competitiveness of its business sector. But the turnaround in the German economy remains surprisingly imbalanced between a buoyant business sector and a muted consumer sector. Sustainable, strong growth in Germany requires that some of the benefits of the strong recovery are passed on to households. With rapid improvement in the labor market, one could expect wage increases to add to energy and food price pressures to push up headline inflation. However, recent pay settlements have been remarkably moderate given the strength of economic activity. In this context, we expect inflation to drop below 2% while the energy effects disappear. Furthermore, the opening up of the labor market to Eastern immigrants may relieve many of the economic tensions that could otherwise emerge in the German labor market. Contributions to GDP growth (GDP: Germany vs. rest of Eurozone) ▬ Germany ▬ Other Eurozone 6% Forecast 4% 2% 0% −2% −4% −6% −8% 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 Figure 12 | Source: Oxford Economics While the outlook for the German economy was very positive until mid 2011, with an expected average GDP growth of 2% per year in the five years ahead, major economic research institutes have lowered their forecasts for GDP growth significantly as the turbulences on the global financial markets threaten to spill over to the real economy. Ernst & Young European Non-Performing Loan Report 2011 29
    • GermanyOverview of the banking sectorThe global credit crisis, which started to spill over to Germany reserved and risk averse, many of them have been affectedin mid 2007, hit the German banks hard and relentlessly pointed heavily by the financial crisis through investing in the US subprimeout existing weaknesses in the German banking system. The mortgage markets and other structured financial products. Asaftermath of the financial crisis calls for changes in the German investments turned toxic, many of them lost billions of euros and,banking system, and the European Union is imposing pressure as a consequence, some of them required bailouts or billion euroon Germany to take the necessary steps for change. state guarantees.Germany’s post-war banking system relies on three pillars, According to Bloomberg, German banks accounted for aroundnamely the commercial sector, the savings bank sector and the 7% of global write-downs on toxic structured credit securities incooperative bank sector. the period January 2007 to October 2009. Even though almost all groups of banks have been affected, the LandesbankenThe first pillar includes big commercial banks, which combine have been hit hardest.retail and corporate banking business with investment bankingactivities, regional private banks, which often specialize in The third pillar comprises the largest number of individualindustry financing and wealth management, and foreign institutions of all three pillars. Led by their head institutionsbank subsidiaries. Since the acquisition of Dresdner Bank by DZ BANK and WGZ Bank (Genossenschaftliche Zentralbanken),Commerzbank in 2008 and Postbank’s by Deutsche Bank, which the cooperative sector comprises over 1,100 credit cooperatives,became effective end of 2010, the three major commercial banks which together account for around 17% of the lending market toin Germany are Deutsche Bank, Commerzbank and UniCredit.14 non-banks. The ownership shares of the credit cooperatives areThese big banks account for around two-thirds of the commercial mostly held by depositors and creditors. The organization of thesector, while the remaining sector is quite fragmented with cooperative sector is similar to the savings bank sector, with localspecialized local banks that are very often niche players. Those institutes covering regions of differing sizes, and the two headbanks that relied heavily on wholesale funding, i.e., the pure institutions taking a similar role as the Landesbanken.interbank market, and those with direct exposure to the US realestate market and its related structured credit products, tended In addition, the statistics of Deutsche Bundesbank separatelyto be most affected by the financial crisis. group mortgage banks, building and loan associations and special purpose banks, which come from all three pillars.The second pillar comprises the public and free savings banks(Sparkassen) and the Landesbanken, which are mainly owned Loans to non-banksby the respective federal states and the savings banks. Withlimited regional activity and a core business in retail banking € billionand relationship banking mainly to SMEs, the savings banks 600generate more than two-thirds of their profit from lending anddeposit business and are thus particularly reliant on maturity 500transformation income. Hence, they benefited considerably in2009 from the increasing spread between short- and long-term 400capital market rates, which resulted in higher margins. Savingsbanks were not that strongly affected by the turbulences on the 300financial markets because only a few invested heavily in complexfinancial products that turned toxic. However, as some savings 200banks are significant shareholders of the Landesbanken, theywere indirectly affected by their exposures. 100 435 407 107 441 478 160 214 67 52The role of the Landesbanken has notably changed from being a 0central institution for the savings banks and serving as main bank Commercial bank sector Savings bank sector Cooperative bank sectorfor the respective federal state, to operating in similar ways to ■ Corporate loans ■ Housing loans ■ Consumer loansprivate commercial banks on an international scale. Even thoughthe approach of the Landesbanken has been traditionally more Figure 13 | Source: Deutsche Bundesbank, June 201130 Ernst & Young European Non-Performing Loan Report 2011
    • Overall, the number of banks in Germany has seen a decline over The consolidation of the German banking sector continuesthe past few years; especially in the fragmented savings bank and in 2011 but at a slower pace. However, there will be furthercooperative sector where the number of institutions has reduced bank transactions to come as the EU has imposed certainsignificantly. The consolidation process was fueled by the financial restructuring requirements on banks such as WestLB to sellcrisis and we have seen a number of prominent deals, such as the real estate bank WestImmo; Commerzbank to sell Eurohypo,acquisition of IKB by US investor Lone Star (2008); the acquisition which was acquired only in 2006; and several Landesbankenof Dresdner Bank by Commerzbank (2008); the acquisition of to dispose of non-core assets and non-strategic subsidiaries,Sal. Oppenheim by Deutsche Bank (2009); the merger of DEPFA such as the proposed sale of LBBW’s billion euro realand Hypo Real Estate before the nationalization of HRE (2009); estate portfolio.the purchase of the insolvent Düsseldorfer Hyp by Lone Star;the acquisition of the German retail operations of SEB by Banco Savings and cooperative banks still dominate the market forSantander (2010) and the acquisition of a majority stake in residential construction loans to private individuals, but in thePostbank by Deutsche Bank (2010). consumer credit market, the commercial banks have taken the market leadership. The retail lending market sees increasingTotal assets of banks in Germany according to price sensitivity and decreasing customer loyalty with increasingDeutsche Bundesbank but still limited competition through foreign players with lean operating models and aggressive pricing strategies. Nº of reporting € billion Total assets* institutions Since the beginning of the financial crisis, the commercial Commercial banks 286 2,809.9 banking sector has suffered from a significant loss in reputation • Big banks15 4 1,858.3 with a shift of customers and assets to savings banks and credit cooperatives. • Regional private banks 169 743.7 • Branches of foreign banks 113 207.8 Landesbanken 10 1,362.5 Savings banks 428 1,068.5 Cooperative head institutions 2 264.9 Regional institutions of credit cooperatives 1,138 706.1 Mortgage banks 18 630.7 Building and loan associations 23 197.5 Special purpose banks 18 893.7 Total 1,923 7,933.8Figure 14 | Source: Deutsche Bundesbank, June 2011 * The assets of foreign branches, of money market funds (which are also classified as MFIs) and of the Bundesbank are not included14 Formerly Bayerische Hypo- und Vereinsbank (HVB).15 Deutsche Bank, Dresdner Bank (until 2008), Commerzbank, Unicredit (formerly Bayerische Hypo und Vereinsbank), Postbank. Ernst & Young European Non-Performing Loan Report 2011 31
    • GermanyThe Financial Market Stability AgencyIn addition to the Eurosystem’s extensive stabilization measures, In addition to the below instruments, the FSMA introduced thethe German Government introduced further measures to keep possibility for banks to spin-off structured securities as well asthe German financial system operational during the financial other risk positions — such as non-performing or sub-performingcrisis. In October 2008, the Financial Market Stabilization Fund loans — and non-core business units into a separate resolution(SoFFin) was set up, which was controlled by the Financial Market agency (sometimes referred to as “bad bank”), to provide balance-Stability Agency (FMSA16), and was equipped with funds of up sheet relief for the remaining bank and to allow an organized run-to €480b (€400b for guarantees and €80b for recapitalization off of such assets. Two institutions have seized this opportunity,measures) to directly support banks to strengthen their capital namely Hypo Real Estate Group (HRE) and WestLB, and havebase and bridge liquidity shortages. transferred large amounts of their non-core portfolio to such resolution agencies.SoFFin’s purpose was the restoration of mutual confidenceamong banks and the confidence of society at large and These resolution agencies are public law entities, held bybusiness in the financial sector. During the financial crisis, the same shareholders as the transferring entity. Due to theSoFFin supported numerous financial institutions with loss compensation and liquidity guarantee by its shareholders,guarantees and recapitalization measures. At the end of both resolution agencies have top ratings from all three2010, SoFFin ceased to grant new benefits. However, it rating agencies, allowing the resolution agencies to refinancecontinues to assume responsibilities and control the measures’ at the capital market at favorable conditions. The resolutionconditionality with regard to existing stabilization measures. agencies do not hold a banking license because their focusIn addition, the funding of existing resolution agencies can be is solely on the run-off of the existing portfolios. They havereplenished. Since 2010, several banks have already reduced hired highly skilled workout specialists, who are working outor repaid the funds received from SoFFin through capital the portfolios by standardized resolution strategies “hold,”market measures. “restructure” and “sell.”Instruments of SoFFin Guarantees Guarantees by the fund up to an overall maximum of €400b for bond issues and other liabilities of financial institutions in return for a fee of 0.5% to 2%. Recapitalization Instruments to strengthen the capital base of financial institutions through newly issued shares, silent participations or other equity instruments up to a maximum of €10b for any single financial institution. The fund obtains remuneration at market prices for deposited capital. Assumption of risk Assumption of risk positions by the fund to obtain a balance sheet relief at the financial institution up to a maximum of €5b for any single financial institution.Figure 15 | Source: www.soffin.de16 The FMSA is a federal public law agency that was established in October 2008 as an instrument for resolving the financial market crisis. The FMSA reports to the Ministry of Finance. It manages the SoFFin and oversees the two German resolution agencies, EAA and FMS.32 Ernst & Young European Non-Performing Loan Report 2011
    • Erste Abwicklungsanstalt (EAA) was established in 2009 FMS Wertmanagement was established in 2010 and haswith the task to wind up WestLB’s risk exposures and non- acquired risk positions and non-strategic business units with astrategic businesses or assets originally with a total (nominal) total nominal amount of €174.3b18 (€60b loans and €114.3bvolume of ca. €77.3b:17 bonds) from HRE Group:Portfolio overview Portfolio overview 39.6% Loans ■ Real estate Structured and project financing, non- ■ Real estate workout strategic international syndicated and 11% ■ Public sector 22.9% bilateral loans (e.g., shipping, aviation, 4% 25% ■ Infrastructure hospitality, banking, leasing, leveraged finance) ■ Structured products 39.6% 4.4% 29.5% Phoenix 3.6% Refinancing notes 10% 22.9% Other securities 50% 29.5% Government and municipal bonds as well as debentures and bank bonds with good credit rating 4.4% Other ABS ■ USA Securitizations ■ Italy 32.7% ■ UK 3.6% European Super Senior ■ Germany 52.8% Super senior tranches of securitizations ■ PIGS ■ OtherFigure 16 | Source: www.aa1.de 27.5%17 As per December 2009 — reduction from originally €85b in June 2009. 25.2% 20.2% 15.9% Figure 17 | Source: www.fms-wm.de 18 As at 31 December 2010. Ernst & Young European Non-Performing Loan Report 2011 33
    • GermanyRegulatory aspectsAs a direct reaction to the global financial crisis, new regulations Capital. The implementation of the requirements of CRD II infor the financial services sector have been put in place to 2010 results in substantial changes to the German Banking Actavoid future crisis with such large-scale effects on the financial (KWG) with regard to hybrid capital instruments, securitizationsystem and to strengthen the resilience of the financial system instruments and the definition of borrower units. Furthermore,to systemic shocks. In November 2010, the G20 leaders the changes were made to the German Solvency Regulationhave endorsed the new regulatory framework — Basel III — (SolvV) with regard to securitization instruments, increasedon capital and liquidity requirements. Setting standards for trading book exposure and reporting requirements; and to thethe EU, the EU Commission adopted a legislative package to German Large Exposure Regulation (GroMiKV) with regard tostrengthen the regulation of the banking sector in July 2011. credit risk mitigation techniques, reporting requirements andThe Directive and the Regulation replace the current Capital fund exposures. CRD III, also implemented in 2010, addressesRequirements Directives (CRD), entailing more conservative trading book risks and introduces further capital requirements —capital requirements, higher requirements on risk and liquidity stressed value-at-risk (VaR) and incremental risk charge (IRC) —management and harmonized reporting requirements. as well as higher reporting requirement for such assets. With the new CRD IV framework, the Basel III framework is beingAt present, German regulatory supervision is focusing on Basel III/ transposed into EU regulation. The definition of own funds will beCRD activities, establishing new capital requirements and changed dramatically, increased risk-weighted assets and highercapital ratios, capital buffers, leverage ratio, higher-risk weights requirements for capital ratios will lead to increasing competitionfor selected exposures and central counterparties, increased for capital instruments. The new introduced leverage ratio isreporting requirements, a harmonized liquidity framework and expected to embank leverage on the balance sheets.further risk management requirements. Deutsche Bundesbankexpects an additional capital demand of approx. €50b until the Liquidity. Liquidity requirements in Germany had already beenend of 2018 due to the new regulations. Large internationally in place through the Liquidity Regulation (LiqV), which required aactive and systemically relevant banking institutions will require liquidity ratio of larger than one, calculated as the one-month ratiothe biggest share of such additional capital demand. of receivables and liabilities. With Basel III, this will be changed dramatically and banks are expected to increase their holdings ofNew requirements on OTC and other derivatives have been put in liquid assets, especially with regard to government bonds.place in the US (Dodd-Frank Act), having impact on internationallyactive German banking institutions. In the EU, a similar Directive — Risk management. The Pillar 2 requirements in Germanythe European Market Infrastructure Regulation (EMIR) — is expected are transformed into the Minimum Requirements on Riskto be adopted for 2011. The impact of these new regulations on Management (MaRisk). Changes to the MaRisk have been madeGerman banking institutions depends on its respective derivatives in December 2010 as a result of international developments: e.g.,portfolio and its activities on foreign (US) markets. the European Banking Authority has published the CEBS Guideline on Stress Testing (26 August 2010) and the High Level PrinciplesThe failure of large international banking institutions, such as for Risk Management (16 February 2010). Furthermore, increasedLehman Brothers, exposed the far-reaching effects of a collapse reporting requirements have been put in place as a result of theof system-relevant banks to the global financial system. With the ongoing supervision of BaFin and Bundesbank, which increase thebank levy (Bankenabgabe) and expected living wills requirements, importance of a sound risk management, especially of economicnew regulations have been developed to allow a restructuring or capital management.an orderly liquidation of troubled institutions and hence to limitspill-over effects to the banking system.Overall, increasing regulatory constraints as well as governance,transparency and reporting requirements for financial institutionsare expected to lead to a more competitive environment withinGerman banking institutions.34 Ernst & Young European Non-Performing Loan Report 2011
    • Ernst & Young  European Non-Performing Loan Report 2011 35
    • GermanyLoan marketThe last major recession, the global economic downturn following The German Financial Supervisory Agency BaFin has historicallythe collapse of the IT bubble in 2001, resulted in a steep increase defined the term NPL in their statistics as the gross exposure ofin corporate and private insolvencies in Germany. At the same impaired loans. In 2009, this definition was changed and has beentime, the housing market in Eastern Germany collapsed, leading aligned with international definitions of NPL — it now includesto a peak in default rates for mortgage loans. overdue loans not yet impaired. Hence, BaFin reports a steep increase in NPLs to €204b in 2009.As a consequence, banks experienced a surge in NPLs andespecially credit cooperatives and mortgage banks saw an In our 2008 European NPL Report, we estimated the Germanimmediate need to resolve their NPL problem. By disposing of their NPL market at €200b, including problem loans not covered byNPLs, German banks were able to reduce their non-performing the BaFin definition. Given the effects of the financial crisis onmortgage loans substantially and clean their balance sheets. the banking sector and the economy as a whole, we believe that the German NPL market has grown to around €250b.From 2003 to mid-2008 Germany was the most active NPLmarket in the world, with over 60 major portfolio transactions In addition, we estimate the magnitude of performing loanand a total volume in excess of €50b of face value. The market portfolios, which have been deemed non-core by their currentwas fueled by large amounts of liquidity and strong demand for holders, at €500b, bringing the magnitude of the German loanGerman NPLs mainly from international investors, which had portfolio market to a total of around €750b.come over from Asia, where the big NPL markets were maturing. However, no material loan portfoliosNPL market potential have traded in Germany and banks are still reluctant to bring portfolios to the€ billion250 10% market. The preparation and planning 9% of NPL portfolio transactions are rather200 8% time and cost intensive for the selling 7% institutions. Consequently, as long as no150 5.2% 6% breakthrough transaction occurs — which 5.0% 4.9% 4.6% can persuade other potential sellers that 4.0% 5% 210.0 (estimate) 250.0 (estimate) 100 3.4% 3.3% 4% the market is back — we expect the market 2.6% 2.8% 3% to remain subdued for another two to50 2% three quarters. As in other markets, the 195.7 215.7 226.9 210.6 190.3 157.7 135.5 141.7 204.0 1% main reason for transactions to fail, or not0 0% even to get offered in the market, is the 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 expected or perceived large gap between ■ NPL volume ▬ NPL ratio bid prices and banks’ price expectations. Since the beginning of this year, we haveFigure 18 | Source: BaFin; Deutsche Bundesbank; IMF seen transaction activity slightly increasing — although very quietly — with smallerDuring the global credit crisis, the NPL market in Germany portfolios being traded via electronic platforms as well as a fewfroze and close to no loan portfolio transactions were noted. larger transactions. These larger transactions have not yet beenMany investors were caught by the turmoil in the financial the breakthrough transaction in the German market as they allmarkets themselves and sellers were concentrating on surviving had rather specific backgrounds that relate to the respectiveand keeping their banks operating. transaction parties. There were purchases of three NPL portfolios by Colony Capital from IKB, Shinsei and BAG Hamm;Now the dust has settled and we see investors’ interest in German Apollo’s acquisition of a €2.8b European NPL portfolio fromloan portfolios returning. At the same time, the volume of NPLs Credit Suisse; and the recent acquisition of a €370m syndicatedon banks’ balance sheets have increased as a result of the CRE portfolio by Colony Capital. These recent transactions haveeconomic downturn and large volumes of non-core loans have received much attention in the market and can be considered thebeen identified as a result of the banks’ restructuring efforts in overture to the starting point of a NPL 2.0 wave in Germany.the wake of the financial crisis.36 Ernst & Young European Non-Performing Loan Report 2011
    • OutlookAs discussed, we expect a large NPL 2.0 wave of transactions that could start as early as thebeginning of 2012. We expect that NPL 2.0 will surpass the nominal €50b traded in Germanyduring the years 2003 until 2007 by a number of magnitudes. We expect the following sourcesof transactions:Foreign banks active in the German market. The partly politically motivated strategic shift ofUK, US and other foreign banks toward their home markets, and decisions to pull back from foreignmarkets, will result in the sale or wind down of their German loan exposures. We expect those banksto be among the first to offer large German loan portfolios on the market.CMBS/RMBS Special Purpose Vehicles. There are more than €25b in securitized loans (CMBS/RMBS) related to the German market, many of which are either sub-performing or non-performing,or will face performance issues during their fixed lifetime. There is already a high number of loansin restructuring and one restructuring strategy can be a sale of the loans. We expect the numberof transaction opportunities resulting from non-performing CMBS/RMBS to increase quickly, as thenumber of loans in special servicing is accelerating from quarter to quarter.Commercial banks and real estate banks. The new Basel III regulations impose pressure on banksto reassess their strategies across capital, liquidity and leverage. Banks will concentrate on corebusiness, exiting certain markets or sectors — we expect an increasing number of transactions in thismarket. As most of the commercial and mortgage banks have not fully agreed on the details of theirfuture strategic footprint, we expect it to take at least until mid-2012 before we will see significantdisposals of non-core or non-performing assets by this group of banks.Landesbanken. The EU has imposed pressure on Landesbanken to reduce their balance sheet andto dispose of non-core assets. We expect Landesbanken to exit and dispose of exposure in certaininternational markets or certain sectors (shipping, aviation, etc.) in the near future. We also expectto see NPL portfolios to come to the market, as the Landesbanken are not only under pressure fromthe EU, but just as much from their shareholders, who expect the return to profitability as quickly aspossible. Therefore, they should also be among the early seller groups.Savings banks. Due to their role in the German retail market, savings banks have not been an activeseller in the last NPL wave and are not expected to bring major portfolios to the market this time.Resolution agencies. Whereas resolution agencies in theory could be the natural born sellers ofnon-core and non-performing assets, we expect sales activities to remain subdued for a prolongedperiod of time. The setup of FMS and EAA as triple and double A-rated “non-banks” with extremelylow cost of capital and a resolution time horizon of 15 to 20 years, give incentives toward “holdand workout” strategies, rather than quick disposals. Unless there are assets where the resolutionsagencies’ management decides that earlier is a better time than later to dispose of certain specificor opportunistic assets, we do not expect significant disposals in the short term. As, in the end, theGerman taxpayer will have to cover any losses from the wind-down, we don’t expect the resolutionsagencies to sell portfolios at a discount in the short to medium term. These agencies have hired topwork-out specialists who are successfully running down the books, and there is currently no urgencyto sell in the absence of Basel III and other regulatory pressure. Ernst&Young Ernst & Young European Non-Performing Loan Report 2011 37
    • United Kingdom The United Kingdom is the sixth largest economy in the world and the third largest in Europe (after Germany and France). Prior to the global financial crisis in 2008, the UK experienced a prolonged period of growth since its last recession in 1991, driven by booming financial and property markets. The global financial crisis had a significant effect on the UK economy leading to the UK being the last of the major global economies to emerge from recession in the final quarter of 2009. For over a decade, the UK had been one of the strongest EU economies and recorded 60 consecutive quarters of growth from the fourth quarter of 1992 to the third quarter of 2008. This growth was driven by a rapidly expanding financial sector that, in conjunction with lax lending, fueled an unstable property bubble. The onset of the financial crisis hit the UK particularly hard, beginning with the collapse of Northern Rock in September 2007 and the initial £37b part nationalization of The Royal Bank of Scotland (RBS) and Lloyds Banking Group (LBG) in October 2008. Although the UK exited recession in the final quarter of 2009, its recovery is delicately poised, with the expectations of forecast GDP growth reduced to 1.1% in 2011, remaining sub-par next year at 1.8%, but accelerating to 2.3% in 2013. Despite £200b of quantitative easing by the Bank of England to date, the financial sector remains vulnerable and not in a position to support the recovery, forcing the UK Government to stake its reputation on restoring the public finances to balance the economy. However, with austerity measures now being implemented, this leaves the economic recovery totally dependent on exports and business spending, which are now threatened by developments in the Eurozone. Provided the problems facing the global economy can be resolved, the outlook for UK exports and investment remains encouraging, with business spending forecast to grow by 7.6% this year and 12.1% in 2012. Real GDP and real GDP growth rates US$ billion 3,000 15% 2,500 10% 2,000 3.0% 2.8% 2.7% 2.3% 2.5% 2.7% 5% 2.2% 1.8% 1.4% 1.1% −0.1% 1,500 0% −4.9% 1,000 −5% 2,230.8 2,279.3 2,342.9 2,405.8 2,404.2 2,287.0 2,318.0 2,342.5 2,384.3 2,438.3 2,500.0 2,568.2 500 −10% 0 −15% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 19 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 39
    • United KingdomOverview of the banking sectorThe severity of the financial crisis has led to substantial changes Total banking assetsin the UK banking landscape leading to the disappearance of someplayers and the restructuring of others. £ billion 8,000 4%The first victim of tighter capital markets was Northern Rock,which after receiving emergency liquidity support from the Bank 6,000 2.8% 3%of England in September 2007, was eventually taken into state 2.0%ownership in February 2008, following two unsuccessful bids to 4,000 2%take over the bank. As the crisis unfolded in July 2008, BancoSantander agreed to acquire Alliance & Leicester, who also relied 2,000 1% 6,790 6,981 7,124heavily on wholesale lending markets. This was closely followedby the nationalization of the Bradford & Bingley in September 0 0%2008 by the UK Government, with the simultaneous sale of the Dec 09 Dec 10 Jun 11deposits and branch network to Banco Santander, putting the ■ Total banking assets ▬ Growth ratemortgage lending book into run-off. These events culminatedin October 2008, when Lloyds TSB announced its acquisition of Figure 20 | Source: Bank of EnglandHBOS and the UK Government had to inject a total of £37b intothe newly formed Lloyds Banking Group (£17b) and RBS (£20b),as a result acquiring initial 40% and 58% stakes, respectively. Total loansAs a result of the nationalization of Northern Rock, the bank was £ billionseparated into two entities: a “good bank” that still underwrites 8,000 4%loans and accepts deposits (currently the subject of a sale 3.3%process), and a “bad bank” Northern Rock Asset Management 6,000 3%that was put into run-off, and which holds largely NPLs. NorthernRock Asset Management, together with Bradford & Bingley, is 4,000 2%currently held by UK Asset Resolution Ltd, a subsidiary of UKFinancial Investments Limited (UKFI), which was set up by HM 2,000 1% 0.8% 5,311 5,486 5,527Treasury in November 2008 to manage its shareholdings in bankssubscribing to its recapitalization fund. 0 0% Dec 09 Dec 10 Jun 11The aftermath of these events was a reduced number of market ■ Total loans ▬ Growth rateparticipants, who adopted more stringent and conservativelending criteria, resulting in a substantial reduction of lending Figure 21 | Source: Bank of Englandlevels. The UK banking sector has emerged from the crisis with areduced number of lenders, heavily reliant on state aid and witha substantial reduction of new business written.The emergence of new entrants, such as Virgin Money, MetroBank, Aldermore, Whiteaway Waidlaw and Walton & Co. has beenas a direct consequence of this reduction in competition. The UKGovernment will be looking to the imminent sale of Northern Rockand LBG’s Project Verde to do more to foster competition in theUK market.40 Ernst & Young European Non-Performing Loan Report 2011
    • Regulatory aspectsIn September 2011, the UK Independent Commission on Banking(ICB) published its final report that sets out recommendationson regulatory changes in the UK banking sector. The new ruleswould force banks to boost their capital and separate their coreretail operations from riskier trading and investment bankingactivities. The main objectives of the regulatory changes are toensure that:• Banks’ resilience to market fluctuations is improved by having a greater loss absorption capacity• It is less costly and easier to bail-out banks that are experiencing financial difficulties• Excessive risk-taking is discouraged• Retail depositors are protected from banks‘ failures• Competition among banks is encouraged, affording more choice to consumerAlthough the ICB in principle favors a separation of retailand investment banking, banks will be allowed to continueto operate a universal banking model as currently used byHSBC, Barclays and RBS, as long as retail operations arering-fenced. The final recommendations afforded banks oneconcession by allowing them to keep their corporate lendingactivities inside the ring-fenced retail operations and byresponding to bank concerns around a “one-size-fits-all” ring-fence by allowing a degree of flexibility in what banks canplace in the new entity. Retail and SME deposit taking andoverdraft provision are the only strictly mandated services thathave to be in the ring-fence, while most investment bankingactivities are prohibited from being in the ring-fence. Thatleaves significant retail, commercial and corporate operations(including lending, trade finance, project finance) at the banks’discretion regarding inclusion. The deadline for implementingthe reforms is 2019 and the Financial Times estimated that thecosts of compliance is likely to reach between £4b and £7b. Ernst & Young European Non-Performing Loan Report 2011 41
    • United KingdomLoan marketThe financial crisis and more stringent regulatory environment • EU remedy program for banks that have received state aidhave created a significant portfolio of non-core loans in the and consequently are required to reduce the size of theirUK banking system. It is a different scenario to traditional NPL operations due to competition concerns. RBS and LBG havemarkets we have seen emerge in the past, which will be resolved already commenced their non-core assets disposal programs.through numerous mechanisms, including loan portfolio sales.Key drivers have, and will continue to be: • There are a number of other banks who have not been required to restructure but which are undergoing strategic reviews aimed at raising returns on equity over the medium term. • An anticipated impact of Basel III may encourage banks to sell assets that are more capital intensive. • After raising capital for emergency stabilization purposes, and then to comply with increasing regulatory capital demands, banks will at some point have to raise capital to provide credit to a recovering economy (albeit unfortunately not a short- term concern). To attract capital, they will seek to provide a compelling argument around how legacy non-core loan books will not act as a drag on the returns expected on this additional capital. • The recent emergence, albeit at a limited level, of third-party debt for portfolio acquisitions will help to bridge the funding gap that has subdued portfolio trading activity in many sectors. • Pressure on margins arising from the low profitability of historic loan portfolios originated in 2006–2007 will lead to banks selling assets that do not meet their targeted return requirements. The recent financial crisis and the failure or nationalization of large financial institutions has put pressure on banks to focus on core lending activities and exit non-core and non-performing businesses. Despite this, transaction activity in the UK loan portfolio market has been very subdued, as financial institutions have focused on wider run-off or restructuring plans in place of disposals. However, in many cases, the decision has been taken because the price on offer in the market was unattractive. As the value gap between run-off versus sale narrows, we expect activity to increase. Over the last 18 months, there has been a number of publicly announced loan portfolio transactions in the UK.42 Ernst & Young European Non-Performing Loan Report 2011
    • Recent transactionsDate Target snapshot Seller Buyer Portfolio size (£ million)Sep 11 Loan portfolio (pending completion) Bank of Ireland Kennedy Wilson 1.500Jul 11 Commercial real estate loan portfolio RBS Group Blackstone 1.400Apr 11 Credit card loan portfolio MBNA Europe Bank (Bank of America) Barclays Group 130Mar 11 Credit card portfolio (pending completion) Egg Banking (Citigroup) Barclays Group 1.800Jan 11 Single corporate loan of Maxim Scheme LBG Cerberus Capital Management 95Jul 10 Retail portfolio LBG Legal & General 150Oct 10 Mezzanine loan portfolio RBS Group Various hedge funds 220Sep 10 Commercial real estate loan portfolio Unknown Westcore Europe 85Aug 10 Leveraged finance loan portfolio RBS Group Intermediate Capital Group 1.164 PL/NPL mortgage loans: US$1b loan portfolio and Apr 10 Ally (formerly GMAC) Fortress Investment Group 7.800 US$11b securitizationsFigure 22 | Source: Ernst & Young researchThe non-bank lending sector has been the most active source ofNPL transaction activity over the last two years. GMAC RFC was amajor seller in the market until it was acquired by Fortress in April2010; Credit Suisse has disposed of the majority of its mortgageexposures (performing and non-performing) over the course of2010; and other investment banks have offered portfolios to themarket but have not accepted the bids due to low prices. We seethis area of sale activity reducing going forward.Following the publication of the Financial Measures Program inMarch 2011, some Irish banks, e.g., Allied Irish Bank and Bankof Ireland, have announced their intention to sell or run-offportfolios of UK assets. There are numerous other non-UK banksand lending institutions that closed to new business over the pastnumber of years but they have, to date, largely elected to run-offtheir legacy portfolios rather than sell them.Several investors have reviewed assets at banks and otherlending institutions that are in administration. However, verylittle has been sold due largely to the large gap between the costof capital of investors and the underlying creditor groups behindthese administration situations. Ernst & Young European Non-Performing Loan Report 2011 43
    • United KingdomOf the UK lenders RBS has been the quickest to come to marketwith its disposal program selling leveraged finance portfolio andmezzanine loan books of a total value in excess of £1b in thesecond half of 2010. In July 2011 it sold £1.4b of commercialreal estate to Blackstone at a 30% discount.LBG has announced two loan disposal transactions in the UKin the last 12 months.Otherwise, UK banks and building societies have been slow totake loan portfolios to market. We attribute this limited activityto the following factors:• A persistent pricing gap, which has in turn been caused by: • A scarcity of capital causing potential vendors to have limited room to accept further losses on the sale of loan portfolios • Tight margins on legacy books, often rendering them unprofitable on current market cost of funds • A lack of funding capacity available to buyers to leverage their returns• There is a view that the level and quality of data available on many loan portfolios would have significant pricing implications or would add to overall transaction costs.• Banks have invested heavily to build up their internal work-out units.• At the smaller end of the market, a number of servicing companies have emerged providing a long-term third-party run-off option for banks.44
    • OutlookNotwithstanding the various limiting factors that have constrained From our conversations with a number of investors, we canactivity to date, we do expect the volume of portfolio sale activity see an increasing tendency to consider teaming up to bid forto increase over the next two to three years. non-core portfolios. NPL buyers are seeking to team with buyers of performing loans in recognition that vendors are often veryTransaction activity has been minimal to date, despite a pressing focused on balance sheet reduction and selling performingneed for government-funded institutions to reduce their balance loans, as well as non-performing, is the leading way of making asheets and the desire of independent banks to dispose of low- significant impact. We also expect a greater incidence of financialmargin lending generated during competitive pre-global credit investors partnering with lending institutions (as well as servicers)crisis markets. to make portfolio purchases and extract more out of the book than a pure run-off.From our discussions with many vendors, a reduction in grossassets is often the paramount objective in their non-core loan Specialist alternative investment firms have been traditionalstrategies. As the focus on capital, rather than balance sheet major buyers of NPL portfolios, which is a trend that is set tosize, becomes a more prominent strategic driver, we see this continue. We also see investment firms that are new to loanalso becoming the increasing focus for non-core loan strategies. portfolio acquisitions creating transaction capabilities to enable them to take advantage of the opportunity created. The firms’We envisage a shift in the relative importance of these triggers appetites vary vastly depending on the nature of the underlyingaway from mandated restructuring toward a capital strategy. assets. In addition, smaller lenders and new market entrants intoAs banking sector profits recover, banks will need to raise and the banking market have been expressing interest in specificgenerate more capital to fund the recovery. It is likely that, as potential acquisition opportunities that will allow them to growthis capital could be released directly from non-core assets, in a particular market segment. A selected number of debtbanks will increase their willingness to sell at a discount in order collectors have also been looking to benefit from the currentto increase their ability to focus on growth. market condition and actively seeking out specific consumer asset-backed NPL books.We also expect that the drag on earnings from legacy run-off books, driven by increased servicing costs and instability In our opinion, we believe the loan portfolio market isof servicing platforms, will make raising fresh capital more beginning to gather momentum, and particularly in light ofchallenging. As bank’s turn to shareholders to raise further recent EU-mandated disposals and Basel III capital requirements,capital to lend in a recovering economy, banks will become expect to see an increase in both the volume and size ofmore active in disposing of non-core assets in order to transactions in the next few years.mitigate this risk.Interest rates are finally expected to rise over the short tomedium term. We have seen evidence of the sensitivity ofborrowers to rate rises and would expect that this will putrenewed pressure on impairment levels.
    • Ireland Once described as the Celtic Tiger due to its unprecedented growth up until the global financial crisis in 2008, Ireland was the first Eurozone member to enter into recession. The crash in the property market and construction industry, along with recent concerns over its sovereign debt, has left the Irish economy in a precarious state. Between 2000 and 2008, the Irish economy grew significantly, driven by a boom in its construction industry and rising domestic demand. The global financial crisis had a severe effect on the Irish economy, resulting in a respective 3% and 7% decline in GDP in 2008 and 2009 and a 0.4% decline in 2010. In response to the financial crisis, Ireland injected close to €50b into the financial system to prop up the banking and property markets and ease the impact of construction and developer loan defaults. With borrowing costs pushed to record levels, the Irish Government was forced to agree a €85b bailout rescue package with the IMF in November 2010. Although the Irish economy returned to growth, with GDP increasing by 0.6% in the first quarter of 2011, GNP decreased by 4.3% over the same period. Real GDP and real GDP growth rates US$ billion 300 15% 250 10% 6.0% 4.6% 5.2% 200 2.6% 3.2% 5% 1.9% 2.2% 0.9% 0.6% −0.4% 150 0% −3.0% 100 −7.0% −5% 50 −10% 190.2 201.7 203.5 214.0 207.6 193.1 192.2 193.5 197.0 201.5 206.8 213.4 0 −15% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 23 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 47
    • IrelandOverview of the banking sectorIn September 2008, the Irish Government guaranteed the Following the announcement in March 2010 of the prices paid bycovered liabilities of all Irish banks to ensure the survival of the NAMA for the first tranche of property loans, the following capitalIrish banking system following the collapse of Lehman Brothers injections were made by the Government. Anglo was recapitalizedand the subsequent freezing of global wholesale capital markets. to the tune of €10.4b. Irish Nationwide Building Society (INBS) was recapitalized with €2.7b and nationalized through theIn January 2009, Anglo Irish Bank (Anglo) was nationalized by the provision of a special share to the Government. In May 2010,Irish Government due to its continuing weak funding position and Educational Building Society (EBS) was also provided withquestions pertaining to the Chairman’s personal loans with the bank additional capital requirements and given some time to secureand the reporting of deposit transactions (totaling €7.5b) between outside investment to address these needs. Throughout theAnglo and Irish Life and Permanent (IL&P). In February 2009, the summer months the performance of the economy deterioratedGovernment decided to recapitalize Allied Irish Bank (AIB) and and subsequently the impairment losses at the Irish banksBank of Ireland (BOI) to the tune of €3.5b each for a 25% stake, as continued to rise.the economic conditions continued to deteriorate and the fundingmarkets remained closed to the Irish banks. In September 2010, AIB was nationalized through the Government increasing its shareholding in the bank as management recognizedAs part of the conditions outlined in the budget in April 2009, they were not able to raise funds in the private marketplace.the National Asset Management Agency (NAMA) was established Taking into account the deteriorating performance of the Irishas a mechanism to take the non-performing property loans off banks and the impact of the sovereign debt crisis on the debtthe balance sheet of the Irish banks and therefore cleansing their markets, the Government was finding it increasingly difficult tobalance sheet to enable them to provide much needed credit into raise money in the bond market to fund the budget deficit. As thisa contracting economy. NAMA has currently received between situation continued to deteriorate further, the Government agreed€70b to €80b of property assets from the Irish banks at an a bailout package with the IMF/EU for €80b, €35b of which wasaverage haircut of 60%. NAMA will look to work these loans out earmarked to recapitalize the Irish banking sector.on behalf of the taxpayer over the next 10 years.Notional loan balances as at December 2010€ billion ■ Consumer and other loans140 ■ Corporate loans ■ CRE loans 5.4120 ■ Residential mortgages 20.4100 5.6 40.180 17.1 40.060 59.940 1.7 2.0 2.6 31.0 33.9 29.720 0.8 0.1 0.5 15.9 2.00 3.5 AIB BOI ILP EBS Anglo INBSFigure 24 | Source: Central Bank of Ireland — The Financial Measures Programme Report48 Ernst & Young European Non-Performing Loan Report 2011
    • Regulatory aspectsThis was followed by the collapse of the Government and a The recent financial crisis has had a profound impact on thegeneral election was held in March 2011. A new government was banking system and the regulatory environment. Since hisformed between Fine Gael and Labor. On 31 March 2011, the appointment in October 2009, the new regulator MatthewCentral Bank of Ireland (CBI) announced the results of the stress Elderfield has been working hard to increase the resources attests on the Irish banks performed by BlackRock Solutions. The his disposal to bolster his team’s enforcement capabilities.results of the stress tests identified that the Irish banks required The regulator has also been incorporated into the CBI structurean additional €24b in capital under a stressed scenario. The under the authority of the governor of the CBI. The new regulator’snew government also announced their plan to create two pillar main area of focus is to replace the existing bank boards and tobanks, which involved EBS being merged with AIB to form one increase the enforcement capacity of the regulator.pillar and BOI to be the other stand-alone pillar. Anglo and INBSwere merged together and put into run-off. In July 2011, the Liquidity. From a liquidity perspective, the Irish banks haveGovernment injected €2.3b into IL&P, effectively nationalizing been heavily reliant on the ECB for funding. At 30 June 2011, thethat institution. ECB has provided €103b in short-term liquidity funding to the Irish banking sector. As part of the bailout program, the Irish banksAlso, in July 2011, BOI raised capital from a group of institutional are required to deleverage €70b worth of assets to ensure theyinvestors, securing its independence. achieve a loan-to-deposit ratio of 122.5% by 2013. Capital requirements. As a consequence of applying conservative assumptions based on the stress test work performed by Black- Rock Solutions, Irish banks were required to raise a significant amount of additional capital to cover their projected losses. The minimum amount of capital the banks were required to raise was a total of €18.7b to ensure they achieve Core Tier 1 targets of 10.5% in the base case and 6% in the stress case scenario. In addition to these capital requirements, the CBI has added a further capital “buffer” of €5.3b. Operating activity. The banks have had their ability to collect residential mortgage debt impacted by government forbearance policies, which require banks not to commence legal action until a year after a customer has fallen into arrears on their mortgage. The Government has set the bank’s targets on SME lending, but they are struggling to achieve these targets. Deleveraging. In response to the stress test results, the Irish banks are required to identify core and non-core assets in order to dispose or run-off non-core assets and achieve a target loan- to-deposit ratio of 122.5%. Consequently, banks have been undertaking a lot of detailed work to split their balance sheets between core and non-core assets. It should be noted that the Irish banks have already transferred €71.4b of commercial property assets to NAMA. Ernst & Young European Non-Performing Loan Report 2011 49
    • IrelandLoan marketThe majority of loan portfolio transactions that have taken placein the Irish market relate to the €71.4b of assets transferred toNAMA from all the Irish guaranteed institutions. As the bankscommenced their deleveraging plans, the transactions belowhave taken place:Recent loan portfolio transactionsInstitution Transaction Size BuyerAIB Sale of Bank Zachodni WBK SA €3.1b Banco Santander SAAIB Sold 22.4% stake in M&T (US retail Bank) €2.6b Banco Santander SA State Street GlobalBOI Sale of BOI asset management €57m advisorsBOI Sale BOI Security Services €60m Northern Trust LtdBOI Sale of 50% in Paul Capital Investments LLC n/a Management TeamAnglo/INBS Merger initiated by Irish GovernmentAIB/EBS Merger initiated by Irish GovernmentFigure 25 | Source: Press and restructuring of Irish banking systemAt the time of writing, a number of loan portfolio transactionsinvolving the overseas assets of Irish banks were taking place.50 Ernst & Young European Non-Performing Loan Report 2011
    • OutlookThe outlook for the Irish economy is weak in the next few years as the Government implementsthe austerity measures as agreed with the Troika. The slowdown in the global economy willhave a negative impact on the Irish economy given the reliance on the export market. Consumerdemand will remain weak as households manage with decreasing disposable income andincreased unemployment.There has been a limited number of loan sale transactions in Ireland since the beginning ofthe financial crisis. However, all Irish banks are currently looking to dispose of non-core assetsas they execute their deleveraging strategies. At the time of the report, there is significantinterest in the assets of the Irish banks notably from international private equity investors andtrade buyers but the concern over the future performance of the loan portfolios and currentvaluations has ensured a depressed level of activity.The Government will implement their banking strategy and then aim to sell their stakes to foreignowners if possible. Hence, we expect the trends over the next two years to be that of increasedtransaction activity as the Irish banks execute their deleveraging strategies. With regard to variousloan books, they will either be run-off or sold to prospective buyers. Ernst & Young  European Non-Performing Loan Report 2011 51
    • Spain Spain experienced strong economic growth from 2000 to 2007, mainly driven by a booming construction industry as well as increased tourism. The economic crisis had significant impact on the Spanish financial system as well as the economy as a whole, resulting in a steep decline in GDP and a surge in the unemployment rate to as high as 21%, the highest in Europe. Spain has recently started to recover and expects a GDP growth of around 0.7% in 2011 and in 2012. However, the economic landscape remains fragile, with a rapid turnaround unlikely amid ongoing fiscal tightening, together with deleveraging in the private sector. Spain made good progress with its fiscal consolidation last year, cutting the budget deficit by 1.9 percentage points to 9.2% of GDP. Even more aggressive tightening is planned for 2011. Nevertheless, such achievements are threatened by political uncertainty, the surfacing of more deficits from local governments and slow progress with reforms. The economic outlook for Spain is still behind expectations by the EU and deteriorating financial conditions could further add to pressure on sovereign and bank funding costs. Real GDP and real GDP growth rates US$ billion 4.0% 1,400 3.6% 3.6% 4% 3.3% 1,200 3% 2.1% 0.9% 1.6% 2% 1,000 1.0% 0.7% 0.7% 1% 800 −0.1% 0% 600 −1% 400 −3,7% −2% 1,089.7 1,129.1 1,174.5 1,216.4 1,226.9 1,181.3 1,179.5 1,187.6 1,195.4 1,207.4 1,226.1 1,252.3 200 −3% 0 −4% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 26 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 53
    • SpainOverview of the banking sectorAfter almost a decade of unprecedented growth, driven by a After the failed merger of Caja de Ahorros des Mediterraneohousing market boom and European interest rates geared toward (CAM), Spain’s 10th largest lender, with three smaller banksthe slower growing core nations of Germany and France, the earlier in 2011, the bank received a €2.8b capital injection fromSpanish banking sector has been hit by the economic crisis. Due the FROB and Bank of Spain took a controlling stake in CAM.to the traditional retail banking model, the financial crisis had a Bank of Spain is expected to sell CAM to another lender, as itvery limited effect on most financial institutions, but impacted has done with two other nationalized cajas in recent years.liquidity due to global problems in the wholesale funding markets. The FROB has been a key instrument in the consolidation andThe economic crisis also had a significant impact on impaired recapitalization process in Spain. According to the Bank of Spain,asset quality, leading to further problems in the wholesale funding of the initial estimate of the Spanish financial system capitalmarkets and structural imbalances in the Spanish financial needs, €5,8b has been met through private investment and thesystem. This in turn has led to a sovereign debt crisis caused by an remaining €7,5b will be invested by FROB.increasing lack of confidence in public finances, despite austeritymeasures having been implemented, and led to a substantial Market share of the Spanish banking sectorincrease in funding costs and access to wholesale funding (by number of institutions)markets. ■ Savings banksConfidence in the Spanish banking system has improved over thepast few months, in part due to the major restructuring process 11% ■ Credit cooperativesunder way to consolidate Spain’s numerous cajas, which has been 26% ■ Specialized credit institutionsaided by the introduction of the Fund for Orderly Restructuring ■ Spanish limited liability companiesof the Banking Sector (FROB) in 2009. These new initiatives are 24% ■ Branches of foreign bankslikely to have an increasingly active role in implementing themuch-needed restructuring of the Spanish banking market andwill be a key factor for Spain returning to prosperous growth. 21% 18%In mid-2011, two of Spain’s cajas raised capital in an IPO to avoidpartial nationalization by the Spanish Government. The actionwas seen by the Government as an important step to reformingSpain’s damaged banking sector. Both IPO´s were succesful Figure 27 | Source: Bank of Spainthough, due to the escalation of European debt markets, valuationand prices were in the low range. Accessing private investors isseen as the preferred way to raise capital.54 Ernst & Young European Non-Performing Loan Report 2011
    • Regulatory aspectsFrom 2009 to 2011 a fundamental change process was Specifically RD 2/2011 set new capital requirements forinitiated to restructure part of the Spanish financial sector. institutions (8%-10% according to risk profile) and set an strategyRoyal Decrees 9/2009, 11/2010 and 2/2011 created FROB, and calendar for the recapitalization of these institutions whichenabled savings banks to exercise banking activity through needed to strenghthen their capital base. The process is setbanking license, changed the governance structure of savings to finish in autumn 2011.banks and established new capital requirements in Spain. Ernst & Young European Non-Performing Loan Report 2011 55
    • SpainLoan marketAcross the Spanish banking sector, the amount of NPLs as at The local market for NPL portfolio transactions is still immatureDecember 2009 was €93.3b and rose to €107.2b at December and far from the activity levels seen in neighboring countries. The2010, representing a 14% increase. The NPL ratio surged from market has started to pick up with a few transactions happening,0.9% in 2007 to 5.8% in 2010, a significant increase caused by but on the whole there is only limited information available withthe financial crisis. It is expected that the increase in NPLs will respect to these loan portfolio sales. Transaction activity is stillcontinue, though at a slower pace, for the next two years. The well below the expectations of trade players, and the main obstaclemajority of NPLs on the Spanish banks’ balance sheets relate remains the price gap between sellers and buyers.to construction and property development loans. In this sector,the NPL ratio is increasing significantly faster than that of other However, market participants remain cautiously optimistic aboutindustry sectors. the prospect of increased investment opportunities, given the Spanish macroeconomic environment and recent regulatoryRecent NPL transactions in the Spanish market measures taken by Bank of Spain and the Spanish Government that will impose additional pressure on local banks and cajas toSeller Buyer Asset type Face value Completion date strengthen their capital, by looking for capital increases and/orRBS PERELLA Commercial Real Estate €280m Mar 11 reducing risk-weighted assets.BBVA Confidential Retail Portfolio €200m Jan 11 The necessity of the financial sector to restructure its capitalOrange Confidential Telecoms Portfolio €250m Jan 11 basis and improve its solvency ratio will probably fuel theSantander LINDORF Retail Portfolio €600m Jan 11 divestment of non-core and NPLs especially by savings banks. The correction of housing prices continues and could needMBNA LINDORF Retail Portfolio €100m Sep 10 another adjustment resulting in further foreclosures an increase in NPLs.Figure 28 | Source: Ernst & Young research NPL developmentTaking into consideration the deflated property assets whencalculating the quality of loan portfolios, the NPL ratio would be € billioncloser to 9% according to IMF estimates. Beyond that, the NPL 2,500 8%ratio is expected to rise and the pressure on existing loans to 7%the construction and property development industry will again 107 63 93 2,000 16increase. 6% 11 5.8% 5% 1,500 3.4% 5.1% 4% 1,000 0.9% 0.7% 3% 2% 500 1,498 1,744 1,807 1,744 1,737 1% 0 0% 2006 2007 2008 2009 2010 ■ Performing loans ■ Doubtful loans ▬ NPL ratio Figure 29 | Source: Bank of Spain56 Ernst & Young European Non-Performing Loan Report 2011
    • Outlook The macroeconomic recovery in Spain is expected to continue in 2011. Although below the European average, the Spanish economy expects a slow upward trend, but is unlikely to recover before 2012. Spain is currently starting several reforms to achieve GDP growth such as the labor market reform, fiscal consolidation, cost cutting and the restructuring of the financial sector. Focusing on the credit market, the downward trend of credit toward all sectors has persisted. This development is driven by the economic situation and the tightening of credit standards by the Spanish banks due to customer credit liability. NPLs, as mentioned earlier, grew dramatically in the past two years and, especially in the areas of construction and property development, this is a significant risk for the banking sector. Looking at the funding of the Spanish banking sector, institutions mainly issued medium- and long-term debt in order to lower debt refinancing risk. Smaller institutions unable to access the senior debt market are instead obtaining funds from the Government and the ECB. Unfortunately, the profitability of the banking sector is offset by the impact of increasing loan loss provisions. On the whole, solvency remains good due to the high quality of own funds. We are confident that transaction activity in the NPL market will increase over the coming months, given the current deal volume in the savings banks space and increasing pressure from both new potential investors and Bank of Spain.Ernst&YoungErnst & Young European Non-Performing Loan Report 2011 57
    • Italy Since joining the Economic and Monetary Union (EMU) in 1998, Italy has consistently struggled to bring its budget deficit under the 3% ceiling set by the EMU and has continued to grapple with high public debts, which reached 120% of GDP in 2011. Italy was one of the worst-affected European countries by the global financial crisis, recording a 5.2% decrease in GDP in 2009, the largest decline since World War II. Italy’s economy grew an average of 0.8% over the period 2001 to 2008 and recorded a decrease of 1.3% in 2008 driven by the impact of the global financial crisis on exports and domestic demand. 2009’s record fall in GDP was followed by a steady increase in the unemployment rate, which totaled 8.5% in the fourth quarter of 2010. Since then, owing to support from budgetary policies, unprecedented injection of liquidity to sustain markets and international cooperation among authorities, Italy’s economy has begun its gradual path to recovery. During Q1 2011, a small acceleration in production has been recorded, as indicated by the slight recovery in industrial production, increased exports and a general increase business confidence. Italy’s slow recovery is projected to continue, driven by increasing world demand stimulating Italy’s export sector. Unemployment rates are expected to only decrease marginally, primarily due to initial improvements in labor demand being met by reduced use of short-time working. However, significant concerns still remain over the state of the Italian economy, in particular its high government debt (120% of GDP in 2011) and low growth rates. The Government’s National Reform Program contains an extensive list of priorities for reform; however, this must be effectively implemented to enhance the economy’s potential to reduce the debt burden and return to growth. Real GDP and real GDP growth rates US$ billion 3000 4% 2.1% 1.4% 1.4% 1.5% 2500 0.8% 1.2% 1.0% 1.2% 2% 0.7% 0.7% −1.3% 2000 0% 1500 −2% −5.2% 1000 −4% −6% 1,762.5 1,776.6 1,814.1 1,839.0 1,814.6 1,719.6 1,741.1 1,753.4 1,765.0 1,782.0 1,802.5 1,829.7 500 0 −8% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 30 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 59
    • ItalyOverview of Regulatory aspectsthe banking sectorThe Italian banking system was relatively unscathed by the global The new bodies envisaged by the reform of the European financialfinancial crisis in comparison with other European countries, due architecture became effective on 1 January 2011: the Europeanto its conservative lending culture and strong retail deposit base. Systemic Risk Board (ESRB), responsible for macroprudentialDirect exposure of Italian banks to US subprime products was also supervision, and the three microprudential Europeanlimited, further enabling Italy’s banking sector to emerge from the Supervisory Authorities (ESAs), one each for the banking,crisis in good shape. securities and insurance sectors. The reform lays the basis for closer coordination between national authorities and greaterDuring 2009, Italian banking activities declined by 0.7% compared convergence on supervisory rules and practices.with the previous year. This was mainly driven by a lack of liquidityin the banking system and a reduction in domestic demand Work is under way for the transposition of the Basel III prudentialresulting from a downturn in the property market but also from rules at European level. According to a research presented at thea decline in production and a reduction of investments. In the Italian Bank Association (ABI) conference,19 the impact of Basel IIIperiod 2008 to 2009, bank deposits continued to decline with only on the Italian banking system is estimated to be between €20b andmarginal growth recorded in 2010, mainly due to the prolonged €25b, i.e., additional capital to be raised, which should be lowerdecline in disposable domestic income triggered by the crisis. than in the rest of Europe, as the Italian system is characterized by a high liquidity and lower leverage compared with other EuropeanAccording to the publicly available financial reports of the five banking systems.largest Italian banking groups in 2010, bank profitability was broadlyin line with the previous year, and ROE increased by an average of To improve liquidity risk management, two quantitative rules will4% compared with 2009. However, net interest income remained be introduced: a liquidity coverage ratio requiring banks to holdweak, decreasing by 7% compared with the previous year. enough high-quality liquid resources to cope with situations of severe stress lasting 30 days without recourse to the market;There still remains significant concern within the Italian banking and a net stable funding ratio to prevent structural imbalance insector in relation to contagion risk from the Greece sovereign debt the composition of liabilities and assets for maturities up to onecrisis, which has led to 10-year government bond yields rising year. The instruments for monitoring liquidity were strengthenedto 5.5%, and has prompted fears that Italy may also be forced to from the early months of 2010 onward with a view to maintainingseek emergency funding from the IMF in the near future. strong safeguards against liquidity risk. Discussions with banks’ cash management and risk management units were intensified.Total banking assets Targeted inspections were often followed by calls for prompt€ billion corrective measures in view of, among other reasons, the new4,000 10% rules established by the Basel Committee. A new format for +9.1% reporting banking groups’ liquidity position was prepared, to 9% acquire additional information on structural characteristics and 8%3,000 facilitate comparison among intermediaries. 7% 6% Large Italian banks’ capital ratios continue to be generally low by2,000 5% international standards, partly owing to the very substantial public recapitalizations of the leading European banks. Basel III will have 4% a significant impact on the Italian banking system. However, the 3%1,000 +2% lengthy transition envisaged by the authorities will spread its +1.5% 2% effects over time, allowing the banks to move gradually into line 3,332 3,635 3,691 3,750 1% with the new standard, attenuating the possible restrictive effects0 0% on lending to firms. 2007 2008 2009 2010 ■ Total banking assets ▬ Growth rateFigure 31 | Source: Central Bank of Italy — Annual reports 2008, 2009 and 2010 19 Meeting ABI “Markets & Investment Banking Conference,” Milan, 7 June, 2010.60 Ernst & Young European Non-Performing Loan Report 2011
    • Ernst & Young  European Non-Performing Loan Report 2011 61
    • ItalyLoan marketIn recent years, the NPL market was important for banks’ Looking at 2010 figures for the Italian banking system andperformance, but the Italian banking system experienced a series comparing these with the previous year, NPL positions — past dueof significant changes, such as sector concentration, increased loans and overdrafts breached for more than 180 days (€12.1b),competition, the impact of new regulation on capital requirements restructured loans (€16b), substandard positions (€60b) and badand concentration on core activities. debts (€106.9b) — increased from 9.1% to 9.9% of total on-balance sheet exposures to customers. Around 82% of total bad debtItalian banks typically manage NPLs by resorting to legal action, was related to private individuals. At the year-end of 2010, write-irrespective of the type of credit, with progressively reduced downs on non-performing exposures amounted to 40.5% ofrecovery rates and a lengthy average recovery time of several face value.years. Out-of-court settlements, which carry a much betterrecovery ratio and faster recovery times, are normally obtainedonly at the debtor’s request. To address this problem, majorItalian banks have spun off their collections process, creatingspecialized companies for servicing intermediaries and keepingthe management of the bad debts under control, and for checkingthe costs of the credit portfolio.In the past two years, credit quality has significantly worsened.In 2009, this resulted in an increase in delinquent debtors, whichsaw the overall NPL ratio rise from 6.5% to 9.1%.20 With referenceto defaulted debtors only, the share of bad loans within total loansincreased from 1.4% at March 2009 to 2.4% at December 2010.21Furthermore, the ratio of new bad debts to outstanding loansremained high in 2010 (1.9%) but in line with the average of2009–2010 (average of 1.1% in 2007 to 2008).22 The outlook oncredit quality appears to be still uncertain and only a few signs ofimprovement can be detected, but these are not evenly reflectedacross all types of credit classes (corporate, retail, etc).Loans to non-banks€ billion2,000 46.2% 50% 40.2% 40.5% 40%1,500 30%1,000 20%500 10% 1,424 1,286 1,380 513 378 139 387 163 21 96 28 320 0% Companies Individuals Companies Individuals Companies Individuals 2008 2009 2010 ■ Performing ■ Non-performing ▬ NPL provision rate (%) 20 Annual Report, Bank of Italy, 2009. 21 ABI Monthly Outlook, Economics and Financial and credit Markets, May 2011.Figure 32 | Source: Bank of Italy; Ernst & Young research 22 Economic Bulletin n° 64, Bank of Italy, April 2011.62 Ernst & Young European Non-Performing Loan Report 2011
    • Outlook Prior to the global financial crisis, Italy had an active NPL market. This activity is continuing, but at a much slower pace. During 2012, a change in trend is expected and NPL deals could become more attractive. This is likely to depend on banks’ profitability, new high-quality capital and liquidity requirements, the adoption of internal ratings and risk-adjusted pricing models and adjustments to provisions on NPL portfolio accounted for in the banks’ financial statements. These factors would be expected to trigger banks to dispose of their NPL portfolios or seek operators specialized in credit recovery. Currently, there are some significant deals in the pipeline. Furthermore, certain foreign players could try to enter the Italian NPL market either directly or through the acquisition of (or partnership with) Italian specialist players.Ernst & Young  European Non-Performing Loan Report 2011 63
    • Turkey The Turkish economy has undergone a transformational process through economic, political and social reforms in response to the financial and economic crisis in 2001. Turkey recorded an average annual GDP growth of nearly 7% over the period 2003 to 2007 and the reforms put in place in response of the 2001 crisis ensured that the effects of the recent global financial crisis were limited. Turkey has established itself as Eurasia’s rising tiger and, among others, was identified as a suitable destination for foreign investments. Capital inflows to Turkey increased, the economy continued to grow on the back of domestic demand, and unemployment rates declined while industrial production and capacity utilization increased. However, the rapid recovery in the economy has raised concerns about excessive borrowing in Turkey. With the capacity utilization rate still at low levels, and production volume hovering below its potential due to weak external demand, there is increasing pressure on inflation. Although there is currently no overheating in the economy in terms of aggregate demand, the divergence of growth rates of internal and external demand along with short-term capital inflows causes concerns over financial stability. In this context, the Central Bank of the Republic of Turkey (CBRT) implements a new policy mix consisting of low policy rates, a wide interest corridor and higher reserve requirement ratios, with a view to contain the rise in credits and current account deficit and reduces short- term capital inflows to ward off concerns over financial stability. However, key concerns still remain over the medium term, with a current account deficit indicating possible overheating of the economy. The current account deficit declined to 2.3% of GDP at end-2009 due to the global turmoil, and economic contraction started to rise again with the economic recovery reaching 6.6% of GDP by the end of 2010. Increasing further in 2011, the current account deficit climbed from US$48.4b in 2010 to US$60.5b year on year in March 2011. GDP growth came in at 8.8% in Q2 2011, surprising once again on the upside, stronger than the market consensus of 6.4%. Real GDP and real GDP growth rates US$ billion 1,200 15% 9.4% 8.9% 1,000 8.4% 10% 6.9% 7.4% 4.7% 4.6% 4.5% 5.0% 4.6% 800 5% 0.7% 600 0% −4.8% 400 −5% 200 −10% 444.9 482.3 515.5 539.6 543.2 517.0 563.2 605.0 632.7 661.4 694.2 728.1 0 −15% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 33 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 65
    • TurkeyOverview of the banking sectorTurkey’s recent growth has been underpinned by a robust Total banking assets in Turkey increased to TRY1,008bbanking sector, which has shown great resilience during the global (€488b) in December 2010, a 20.8% growth on the previousfinancial crisis, announcing record profits during 2009 and 2010. year, and represented 80.4% of the total financial sector assetsMajor Turkish banks overcame the crisis by maintaining relatively as at September 2010. However, when compared with Eurozonelow levels of debt and following a conservative asset allocation countries, Turkey’s total asset to GDP ratio remains wellstrategy. In addition, their liabilities are significantly weighted to a below average.traditional deposit structure and levels of external leverage havebeen kept within a sustainable range. Turkish banks are generally As at December 2010, the total number of banks in Turkeywell capitalized, with average capital adequacy ratios of 18.9% as totaled 49. While 32 of these are deposit banks, 4 areat December 2010. The current position of Turkish banks makes participation banks and the remaining 13 are development andthe country’s banking system comparatively more stable than investment banks. Total loans increased by 31.7% comparedother emerging European countries. In addition, Turkish banks with the previous year and amounted to TRY546b (€265b) indid not have material exposures to US subprime mortgages, or December 2010. The growth in loan portfolio was mainly drivenassociated structured assets and, as a consequence, the Turkish by recovering economic activity, a low interest rate environment,banking sector has not experienced the level of loan impairments increased deferred consumption demand and increasingand value adjustments seen in other economies. competition between banks. The macroeconomic recovery in Turkey is expected to continue into 2011 and beyond.Although the Turkish banking system proved to be resilient,the global financial crisis affected the banking sector in two ways. Share of loans by business lineFirstly, deteriorating external markets have put pressure on boththe Turkish export sector as well as foreign capital inflows, which TRY billionhave traditionally been a primary driver of economic growth 600over the past few years. Secondly, in addition to the decrease in 234.1demand for banking products, the supply of capital in the banking 500sector decreased and, coupled with low domestic consumptiondue to high interest rates, further dampened growth. 400 185.0 170.1Total banking assets 300 131.6TRY billion 200 90.2 88.9 180.11,200 91.2% 100% 87.5% 100 122.5 139.3 90%1,000 77.1% 80% 0 65.9% 69.0% 62.7% 70% 2008 2009 2010800 60% ■ Retail ■ SME ■ Corporate/commerical600 50% Figure 35 | Source: BRSA Turkish Banking Sector Interactive Monthly Bulletin 40%400 30% The well-capitalized Turkish banking sector is in a good 20% position to cope with Basel III legislation and it is expected to200 1,008 10% expand customer credit further, and force private consumption 407 500 582 733 8340 0% and capital investments significantly over the short term. 2005 2006 2007 2008 2009 2010 ■ Assets ▬ Assets/GDPFigure 34 | Source: Turkstat; Turkish Banking Association66 Ernst & Young European Non-Performing Loan Report 2011
    • Regulatory aspectsPrior to the changes in Banks Act No. 4389, which came into On 7 January 2011, required reserve ratio on Turkish Liraforce on 23 June 1999, the Treasury Under Secretary and denominated deposits started to be calculated by usingthe CBRT had been the two main regulatory and supervisory variable ratios depending on different time deposits. Valid frompillars in the banking sector. With this act, the Banking 21 April 2011, required reserve ratios on TRY-denominatedRegulation and Supervision Authority (BRSA), with financial deposits are 16% for demand deposits, 16% for time deposits up toand administrative autonomy, was formed and became one month, 13% for time deposits up to three months, 9% for timeoperational as from 31 August 2000. deposits up to six months, 6% for time deposits up to one year, 5% for time deposits for more than one year. Also, according toThe BRSA is the sole authority in charge of the supervision, the CBRT announcement in September 2010, the remunerationsurveillance and regulation of 174 institutions, comprising of required reserves for both TRYand foreign currency has beenTurkey’s 49 banks, 47 financial leasing companies, 78 factoring terminated. These changes will directly impact the cost of fundingcompanies as well as 9 consumer-financing companies. In order for banks, and coupled with the strong competition in loan andto enhance competition within the financial industry, minimize deposit market shares, net interest margins are expected torisk, reduce the costs of operation and intermediation, harmonize contract as the reflection of such reserving costs may not be fullywith other financial market regulations and practices, and to recovered from customers.foster a more active and transparent financial system throughmore active markets, a new Banking Act (5411) was issuedon 1 November 2005. BRSA’s mission is defined as being “tosafeguard the rights and benefits of depositors and create theproper environment in which banks and financial institutions canoperate with market discipline, in a healthy, efficient and globallycompetitive manner, thus contributing to the achievement ofthe country’s long-term economic growth and stability.” Withthe establishment of BRSA, the Savings Deposits InsuranceFund (SDIF), previously under the authority of the CBRT, startedto operate under the administration of BRSA. Later on, withthe enactment of Act No. 5020 on 26 December 2003, themanagement of the SDIF was separated from the management ofBRSA. Banks in Turkey are subject to general controls under theprovisions of the Turkish Commercial Code and of various tax lawsand are also subject to special oversight by BRSA. BRSA exercisesits supervisory authority on a direct and ongoing basis in terms oflegal considerations and financial soundness. Additionally, banksare required to submit quarterly internal audit reports to BRSA.Associated with governmental measures to control the currentaccount deficit, the CBRT has started to introduce severalmeasures to moderate lending growth. One of the most importantdevelopments is the CBRT‘s decision to change required reserveratio on deposits and cut interest rates further on such deposits.In August 2011, required reserve ratio on foreign currencydenominated deposits are determined as follows: 11.5% fordemand deposits up to one year, 9.5% for time deposits up tothree years and 8.5% for time deposits over three years. Ernst & Young European Non-Performing Loan Report 2011 67
    • TurkeyLoan marketThe top five banks comprise 55.3% of the all banking sector gross has decreased to 3.7% as of December 2010 dueloans. Isbank and Garanti are the leading banks in terms of total to recovering financial markets and the sale or write-loans with over TRY64b (€31b) loans provided by each bank as of offs of elements of NPL portfolios. Due to strictDecember 2010. Retail banking activities in the Turkish banking BRSA regulations, Turkish banks have a conservativesector is quite new and accordingly retail loans comprise a limited provisioning policy on NPLs, with coverage ratioportion of the total loan portfolio. of specific provisions of approximately 84.1% as of December 2010. Nineteen percent of banks’ NPLDuring the last couple of years, with the introduction of new portfolios stem from non-performing credit card loans,regulations regarding capital adequacy requirements and which amount to TRY3.8b (€1.8) as of December 2010.potentially upcoming Basel III requirements, banks in Turkey Consumer loans, excluding credit cards but includingwere urged to limit their credit exposure in line with their equity. housing, automobile and other retail loans, constituteThe total NPL portfolio of banks in Turkey is reported as TRY20b 18.0% of the total NPL portfolio of banks as of(€9.7b) as of December 2010. Together with the portfolio held December 2010.by SDIF,23 the total NPL market is estimated to be more thanTRY28b (€13.5b). The NPL ratio has increased from 3.1% in The ratio of loans to deposits of 88.5% is below theSeptember 2008 to 3.6% as of December 2008, and further European average, with only Slovakia and Belgium havingincreased to 5.3% as of December 2009. Since then, the NPL ratio slightly lower ratios. The low loan-to-deposit ratio shows that there is room for the Turkish loan market.NPL dynamics% of total loans8%7%6%5%4%3%2%1% 3.1% 4.8% 3.7% 3.6% 7.6% 6.0% 2.8% 4.5% 4.1%0 2008 2009 2010 ■ Corporate/commercial banking loans ■ SME loans ■ Retail loansFigure 36 | Source: BRSA Turkish Banking Sector Interactive Monthly Bulletin23 The SDIF holds TRY8.8b of NPL in its balance sheet, as of December 2010.68 Ernst & Young European Non-Performing Loan Report 2011
    • NPL ratios of major banks in Turkey as of December 2010TRY million80 8% 7.1% 2,407 1,93970 7% 855 1,280 1,86160 6% 1,758 4.8%50 5% 2,266 4.8%40 3.6% 4% 3.4% 3.8% 1,758 2.9%30 3% 2.4% 3.1% 92220 1.5% 2% 12,036 39010 1% 64,232 64,476 57,161 52,896 52,189 44,836 44,003 24,627 18,2030 0% sı sı sı nk di sı sı nk k nk an ka ka ka ka ka re ba Ba Ba zb K an an an an an Ak ns G pı ni B i B B r B B IN Ya De na İş at lk nt fla Ha Fi ira ra kı Z Ga Va TC ■ Total loans ■ NPL volume ▬ NPL ratioFigure 37 | Source: Ernst & Young research Ernst & Young European Non-Performing Loan Report 2011 69
    • TurkeyDuring the last two years, we have witnessed that almost all In 2010, a total of 19 NPL transactions were disclosed in theforeign investors engaged globally in NPL business have shown market. The NPL portfolio amount subject to sale in theseinterest to the Turkish market. These include Bank of America transactions was ca. TRY2.6b (€1.2b). Details of main NPLMerrill Lynch, Deutsche Bank, LBT (former Lehman Brothers) transactions are shown below:and Standard Bank. Additionally, the local asset managementcompany Girişim Varlık is active in the sector.Recent transactions in the Turkish NPL marketBid date Vendor NPL amount Portfolio Offer Purchaser on saleJun 11 Isbank TRY88.4m Not disclosed TRY13.9m Standard Varlık Yönetim A.S.Apr 11 Denizbank TRY111.3m Credit cards, retail and commercial loans TRY10.6m Girişim Varlık Yönetim A.S. (FIBA Group) Mar 11 Sekerbank TRY143.2m Not disclosed TRY12m Girişim Varlık Yönetim A.S. (FIBA Group) Mar 11 TEB TRY39.9m Not disclosed TRY4.1m Standard Varlık Yönetim A.S.Jan 11 TEB TRY55.5m Not disclosed TRY4.3m LBT Varlik Yönetimi A.S.Dec 10 Alternatifbank TRY34.5m Not disclosed TRY1.3m Anadolu Varlık Yönetim Şirketi A.S. Dec 10 Isbank TRY300.4m Not disclosed TRY50.8m Girişim Varlık Yönetim A.S. (FIBA Group) Dec 10 Isbank TRY41.9m Credit cards, retail and commercial loans TRY6.5m LBT Varlik Yönetimi A.S. Dec 10 Fortis Bank TRY33.9m Commercial loans LBT Varlik Yönetimi A.S. Nov 10 Yapı ve Kredi Bankası TRY427.8m Credit cards, retail and SME loans TRY56m LBT Varlik Yönetimi A.S. (TRY256.9m credit cards) Girişim Varlık Yönetim A.S. (FIBA Group) ( TRY170.9m retail and SME loans)Nov 10 Alternatifbank TRY59.6m Not disclosed TRY11.5m Girişim Varlık Yönetim A.S. (FIBA Group) Oct 10 Turkland Bank TRY17.8m Not disclosed Girişim Varlık Yönetim A.S. (FIBA Group) Sep 10 Denizbank TRY81.6m Credit cards and retail loans TRY7.4m LBT Varlik Yönetimi A.S. ( TRY49.4m credit cards) Standard Varlık Yönetim A.S. (TRY32.2m retail loans)Sep 10 Eurobank Tekfen TRY46m Corporate loans Not disclosed LBT Varlik Yönetimi A.S. May 10 Yapı ve Kredi Bankası TRY298.7m Corporate and commercial loans TRY7.5m LBT Varlik Yönetimi A.S. May 10 Fortis Bank TRY54.5m Corporate and commercial loans TRY2.6m LBT Varlik Yönetimi A.S. May 10 Citibank TRY89.2m Credit cards and retail loans Girişim Varlık Yönetim A.S. (FIBA Group) Mar 10 Yapı ve Kredi Bankası TRY381.9m Credit cards TRY32.4m Girişim Varlık Yönetim A.S. (FIBA Group) Mar 10 Fortis Bank TRY30.4m SME loans TRY1.7m Girişim Varlık Yönetim A.S. (FIBA Group) Mar 10 Yapı ve Kredi Bankası TRY224.4m SME loans TRY31.2m LBT Varlik Yönetimi A.S. Mar 10 Yapı ve Kredi Bankası TRY74.6m Retail loans TRY6.5m Standard Varlık Yönetim A.S. Feb 10 Denizbank TRY50.2m Credit cards and retail loans TRY4.9m Standard Varlık Yönetim A.S. Jan 10 Akbank TRY326m Not disclosed TRY38.5m Girişim Varlık Yönetim A.S. (FIBA Group) Nov 09 Fortis Bank TRY115.9m Retail loans TRY6.5m LBT Varlik Yönetimi A.S. TRY8.5m cash and 40%Nov 09 Isbank TRY186.1m Corporate loans Standard Varlık Yönetim A.S. of the collection (gross) Nov 09 Isbank TRY37.8m Not disclosed TRY9.5m LBT Varlik Yönetimi A.S. Apr 09 Yapı ve Kredi Bankası TRY393.9m Consumer loans and credit cards TRY26.5m Girişim Varlık Yönetim A.S. (FIBA Group) Figure 38 | Source: SDIF announcements; ISE; public information70 Ernst & Young European Non-Performing Loan Report 2011
    • OutlookNPL investors are not required to establish an asset management company (AMC)to invest in an NPL portfolio. However, AMCs enjoy certain tax benefits compared withordinary companies, therefore, the NPL market is dominated by AMCs. LBT VarlıkYönetim A.Ş., incorporated by Lehman Brothers and acquired by Vector HoldingsS.A.R.L. after the collapse of Lehman Brothers Holding in the USA; FinansVarlik,established by FIBA Holding and named as Girisim Varlik; Standard Varlık Yönetim A.Ş.,established by Standard Bank Plc., are the most active AMCs in the market and expectedto be the potential buyers in future transactions. The number of AMCs increased fromfour in 2005 to eight as of 2011. Yapi Kredi Bank, İsbank and Fortis, that have realizedmore than half of the NPL portfolio sales in the market during the last two years, areexpected to be the potential sellers, together with other major players and small-scalebanks who were not active in the sector in the historical period. Since 2008, €2.2b ofNPL portfolios were sold to AMCs in Turkey, and in the coming years, we expect thatthe market activity will continue. In the long run, considering new regulations regardingcapital adequacy requirements and upcoming Basel III requirements, the NPL market inTurkey is expected to grow significantly.Ernst & Young  European Non-Performing Loan Report 2011 71
    • Greece Following a period of high GDP growth, cheap credit and low unemployment, Greece entered into a severe recession in 2009, driven by the global credit crunch and the structural inefficiencies embedded in the local economy that led to a fiscal as well as a sovereign debt crisis. Greece’s general government deficit is among the highest in the Eurozone, after peaking at 15.4% of GDP in 2009, reducing to 10.5% of GDP in 2010. Given the large size of the fiscal deficit, fiscal policy is expected to remain tight in 2011, which is expected to lead to new contractions in total consumption and investment. Accordingly, GDP is expected to further contract by 3.5% in 2011 and 0% in 2012, following a contraction of 4.4% in 2010. Fiscal policy aimed to reduce fiscal deficit further to 7.5% of GDP in 2011. However, in September the budget plan was revised to 8.5% after Greece announced it would miss the 7.6% target. Greek public debt is also at unprecedented levels and stood at 142.8% of GDP in 2010, increasing from 127.1% in 2009. The debt position looks especially challenging for Greece that, on the basis of IMF projections, is expected to see its national debt rise to 170% of GDP by 2013. The debt ratio is then projected to edge down slowly, but this is based on relatively optimistic assumptions of Greece fully implementing a fiscal adjustment of over 11% of GDP (on a cyclically adjusted basis) from 2010 to 2015, returning to growth, and regaining access to market financing at reasonable rates. In 2010, the Eurozone countries and the IMF approved a €110b financial package to support the Hellenic Government over a period of three years with a commitment to implement structural reforms to reduce its deficit. The Hellenic Government has been progressing slowly in the implementation of structural reforms and required further financial support within only one year. Real GDP and real GDP growth rates US$ billion 300 5.2% 6% 4.4% 4.3% 5% 250 3.3% 4% 2.3% 3% 1.6% 200 1.0% 2% 0.7% 0.0% 1% 150 0% −1% −2.3% 100 −2% −3% −4.4% −3.5% 50 −4% 236.6 242.0 254.5 265.4 268.2 261.9 250.5 241.7 241.8 243.4 247.3 255.6 −5% 0 −6% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 39 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 73
    • Greece Overview of the banking sectorIn July 2011, the Eurozone countries agreed on a second bailout The Greek banking sector comprises around 60 credit institutionsprogram with a €109b loan from the EFSF and IMF. This program and total banking assets were at €502b in July 2011. Thirty-four ofalso includes a substantial voluntary participation of the private the credit institutions are incorporated in Greece, of which 18 aresector, aimed to reach an additional support of €37b until 2014. commercial banks and 16 are cooperative banks.Banks and insurance companies have four different options toexchange existing bonds for new bonds with different maturities The banking sector is dominated by six major banks, with theand coupons, together implying a 21% loss in NPV terms for the top four Greek banks representing two-thirds of the market inbond holders. An additional debt buy-back program of around both lending and deposits.€13b will bring the total support package to €50b. In the mediumterm, the total contribution of the private sector participation is According to ECB statistics, loans to households make up for aboutestimated at around €106b until 2019. a quarter of total banking assets and ca. 40% of total lending.As part of the financial stability packages, the Government Total lending 2010has committed to execute an ambitious privatization programthat is expected to generate from €30b to €50b between2011 and 2015. ■ NBG 17.9% 23.7% ■ EFG Eurobank 2.6% ■ Alpha Bank ■ Bank of Piraeus 6.1% ■ Emporiki 6.7% ■ ATE Bank 15.9% ■ TT Hellenic Postbank 11.8% ■ Others 15.4% Figure 40 | Source: Bank of Greece; Ernst & Young research While consumer spending had been a key driver for growth and had fueled consumer lending prior to the financial crisis, the deterioration of Greece’s economy and the successive credit rating downgrades of the Greek Government as well as domestic banks have resulted in a sharp decline in credit to households. Significant systemic risks remain in the financial system, with annualized growth in housing loans having decreased significantly from a peak at 33.5% in December 2005 to negative levels in 2010 and 2011.74 Ernst & Young European Non-Performing Loan Report 2011
    • Total banking assets€ billion 33.6%600 35% 26.3% 27.3% 30% 25.9%500 21.5% 25%400 20% 11.2% 15%300 10% 3.7%200 5% −0.3% −1.4% 0%100 229.1 246.0 286.0 321.4 391.5 464.8 492.6 515.3 498.6 −5%0 −10% 2003 2004 2005 2006 2007 2008 2009 2010 2011 ■ Total banking assets ▬ Housing loansFigure 41 | Source: Bank of GreeceThe total credit growth remained positive NPLsin 2010, largely driven by credit growth % of total loansin the public sector, while credit in theprivate sector had been contracting for 30%much of 2010 as well. Within private sector 25%credit, corporate credit growth has beencontracting since the beginning of 2010 20%while the credit growth in the household 15%sector started to contract in the thirdquarter of 2010. The lending growth in 10%the economy remains weak, driven by a 5%secular contraction across sectors in 11.6 26.0 13.2 5.5 3.9 9.3 2.7 9.2 3.3 9.2 3.6 8.6 0.9 1.6the Greek economy. 0% Bank of TT Hellenic Emporiki ATE Bank Alpha Bank EFG Eurobank NBG Piraeus PostbankAsset quality continues to deteriorate, ■ 2008 ■ 1Q2011with the NPL ratio having increased from10.4% in December 2010 to 11.5% in March Figure 42 | Source: Bank of Greece; Ernst & Young research2011. Provisioning for bad loans increased18% during Q1 2011 and the stock of funding pressure the banks have been facing given the nearrestructured loans also increased significantly closure of the wholesale markets for the banks.to 3.7% of total loans. Profitability in the Greek banking sector is under strong pressure.The domestic deposit base of the Greek banks has been Revenues have declined 6% between 2008 and 2010 and the threecontracting since March 2010. Given the weak economic largest Greek banks reported sharply lower net income for 2010.environment and the lack of confidence in the domestic banking At the same time, loan loss provisions have increased 95% betweensector, Greek banks are facing large-scale drawdown on their 2008 and 2010 while credit costs are up 116 basis points in thedeposit base. This continued outflow of funds is adding to the period, causing the profitability of the sector to drop sharply. Ernst & Young European Non-Performing Loan Report 2011 75
    • GreeceIn 2008, the Greek state approved a €28b government liquidity In conjunction with the €110b emergency loan package by thepackage to stabilize the banking sector and to enhance liquidity Eurozone countries and IMF, in June 2010 the ECB approved theof the Greek economy. The package comprised three pillars: €15b establishment of a €10b Hellenic Financial Stability Fund (HFSF)of state guarantees for new medium- to long-term bank loans to stabilize the Greek banking system by strengthening the capitalissued until the end of 2009; €5b for capital injections through adequacy of credit institutions when capital is not availablethe purchase of preferred shares by the Government, and €8b through normal, generally private, options. It provides equityfor the issuance of special bonds by the state to be able to inject capital to credit institutions by acquiring preference shares and,liquidity into banks. The three pillars were made available in two under certain conditions, common shares in respective banks.installments of €11b in 2009 and €17b in 2010. In June 2010,this liquidity package was further extended through additional As part of a wider banking consolidation initiative that isguarantees of €15b, which can be pledged to ECB for provision encouraged by the Greek Government, a number of proposalsof liquidity, with the top four Greek banks receiving the largest have been put on the table. In early 2011, NBG approached Alphasupport distributions. Bank in order to proceed with a merger, which was rejected by the management of Alpha Bank. Later in 2011, state-ownedSplit of the received support Hellenic Postbank absorbed T-Bank. However, as part of the Greek privatization program, it is expected that the Greek Government€ billion will sell its stakes in both Hellenic Postbank and ATE Bank in4.5 the short term. In August 2011, Alpha Bank and Eurobank, the second and the third largest lenders, announced their intention to4.0 merge. The merger is still pending approvals and is expected to be completed by end of 2011. The new group will be among the top3.5 25 largest Eurozone banking groups with pro forma total assets of €146b. As part of the transaction, the new group will proceed3.0 immediately with the implementation of a comprehensive €4b capital strengthening plan to improve the Core Tier 1 ratio of2.5 the combined entity. 4.2 3.8 2.2 2.2 2.60 NBG EFG Eurobank Alpha Bank Bank of Piraeus OthersFigure 43 | Source: Ernst & Young research76 Ernst & Young European Non-Performing Loan Report 2011
    • Ernst & Young  European Non-Performing Loan Report 2011 77
    • GreeceLoan marketThe deterioration of the financial situation of both consumers NPL ratioand corporate due to the overall economic crisis in Greece has ledto a steep increase in NPLs on banks’ balance sheets. % of total loans 14%The NPL ratio has surged to above 10%, with that for consumerloans being significantly higher at around 17%, compared with 12%around 9% for mortgage loans and around 7.5% for corporateloans. Translated into euros, the total NPL volume in Greece 10%has risen to approximately €22b, of which around €6b relatesto mortgage loans. 8%The macroeconomic environment negatively affected the 6%financial condition of households and businesses, making itincreasingly difficult for them to service their debt. This adverse 4%trend is expected to continue in the near future as a resultof the continuous austerity measures imposed by the Greek 2%Government. At the same time, demand for new loans declined 10.4 11.5 5.0 6.8 7.7 9.0and banks have been reluctant to extend new credit. 0% Dec 08 Jun 09 Dec 09 Jun 10 Dec 10 Mar 11We expect the level of NPLs to continue to increase in 2011and stabilize during 2012. The Greek Government has introduced Figure 44 | Source: Bank of Greece; IMFcertain temporary measures to regulate the collection of NPLsin Greece creating uncertainties around the recovery and hencethe pricing of NPL portfolios. Such measures include extensivedocumentation obligations, a strict time frame at which debtcollectors can contact the delinquent borrower, allowing aone-month break between contacts, and a list of “dishonestpractices,” such as contacting employers or relatives, with finesof up to €500,000 if debt collectors or banks are in breach ofthe law.No activity has been observed in the Greek market regardingthe sale of NPL portfolios of the Greek banks over the last twoyears and it remains to be seen if the sale of NPL portfoliosto international investors will be a way for Greek banks totackle their NPL problem.78 Ernst & Young European Non-Performing Loan Report 2011
    • Outlook Asset quality deterioration to continue. Driven by the weak economic environment in Greece, NPL formation is expected to remain at levels similar to 2010 at least in 2011. Profitability to remain under pressure. As a result of deteriorating asset quality, loan loss provisions are expected to show only a modest decline in 2011. On the other hand, revenue growth will continue to remain under pressure driven by a weak economy, a shrinking loan book and negative liability spreads. Thus, Greek banks are expected to have a low return on equity in 2011 and 2012. Reduction of ECB reliance is difficult. Reducing reliance on ECB would be difficult for Greek banks. These banks funded 22% of their total assets through the ECB as of 1Q 2011, which was the highest in Europe. Though these banks are making efforts in this direction by undertaking measures such as deleveraging and asset disposals, the deposit reductions that have been overtaking loan run-offs and are expected to continue to do so in the near future, are likely to make the process difficult. Liquidity position expected to remain weak. With no catalyst in sight for liquidity improvement, Greek banks are expected to face a strained liquidity position in the near future. Besides, the cost of funding for these banks may increase due to continued sovereign debt risks. Although the Greek Government has been able to secure a bailout, the market does not seem to be totally unconvinced that European sovereign debt problems are solved. Sector consolidation expected. Given the lack of drivers to improve profitability, the banks in the sector may look at consolidation as a possible source of growth. Consolidation will also be attractive for increasing scale, and improving efficiency, while the regulators may also push weaker players, from a capital perspective, to find a possible suitor. The Greek Government is also looking to sell its stake in ATE Bank and TT Hellenic Postbank to reduce its own debt burden.Ernst&YoungErnst & Young European Non-Performing Loan Report 2011 79
    • Portugal The Portuguese economy experienced a significant boost when joining the European Union in 1986 and the EMU in 1999. However, in recent years, it has suffered from sluggish and negative growth and uncompetitive industries. The country is now facing one of the worst economic crises in its 868-year-old history. Due to poor economic growth, the Portuguese economy has consistently under performed its respective EU members. However, in 2007, the Portuguese economy grew by 2.4% due to a wider EU recovery but suffered contractions of 0% and 2.5% in 2008 and 2009, respectively. The onset of the Eurozone debt crisis has led to government debt exceeding 90% of GDP, record-high spreads on sovereign debt and downgrades in credit ratings. In April 2011, the acting prime minister was forced to seek assistance from the European Union and IMF, and agreed a financial bailout package of approximately €78b. The strict conditions stipulated in the bailout package and associated austerity measures present a real possibility that Portugal may slide further into recession in the short term. To this extent, real GDP is expected to decline by 1.8% in 2011 and 1.5% in 2012. Real GDP and real GDP growth rates US$ billion 300 2.6% 3% 2.4% 1.7% 250 1.6% 1.4% 2% 1.3% 0.9% 0.8% 200 1% 0.0% 150 0% −1.8% −1.5% 100 −2.5% −1% 50 −2% 189.6 191.0 193.8 198.4 198.4 193.4 196.0 192.4 189.5 191.3 194.5 199.6 0 −3% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 45 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 81
    • PortugalOverview of Regulatory aspectsthe banking sectorThe Portuguese banking industry did not suffer significantly as The banking industry of Portugal is supervised by threea direct result of the global financial crisis due to low exposure supervisory authorities and complies with the Basel Coreto Lehman Brothers and US subprime products. However, as the Principles for Effective Banking Supervision and with thecrisis unwound, the banking industry began increasingly to suffer International Organization of Securities Commission’s (IOSCO)from the wider global economic downturn, facing significant Objectives and Principles of Securities Regulation.funding issues. This led to the nationalization of two Portuguesebanks. To maintain confidence in the sector, the Government was In the context of the Portuguese financial assistance programforced to nationalize Banco Português de Negócios in November negotiated with the European Commission, the ECB and the IMF,2008 and Banco Privado Português, a small financial institution it was established that the solvency levels of the national bankingthat provided private banking, which became insolvent in 2010. system should be strengthened. As such, Banco de Portugal has approved a new regulation, requiring all banking groups to meet aMore recently, despite the Portuguese Government implementing minimum Core Tier 1 ratio of 9% in 2011 and 10% from the endheavy austerity measures, relentless pressure from global of 2012 onward.markets has resulted in a downgrade of Portuguese debt to junkstatus and prompted Portugal’s banks to threaten to cease buying Based on the specific risk profile of each banking group and takinggovernment debt. This in turn led to Portugal seeking a €78b into consideration the results of the solvency and deleveragingbailout package from the ECB and IMF to increase liquidity and assessment framework, conducted under the program, theease capital outflows in the banking sector. As a condition of the regulation also envisages the possibility of Banco de Portugalbailout, Portugal will be expected to implement further austerity being more demanding on a case-by-case basis regarding themeasures and conduct an ambitious privatization program. minimum Core Tier 1 requirement for some banks. Moreover, theFurther reforms to the tax system, labor market laws and Portuguese banks must reduce the transformation ratio (ratio ofprotected sectors of the economy are also expected. medium- and long-term loans to time deposits) to 120% until the end of 2014.Total loans by customer type as of December 2010 In the wake of the financial crisis, Banco de Portugal increased its 1% supervision activity in the banking system, keeping supervisory ■ €141.3b Private individuals teams permanently in banks. According to the financial assistance 14% ■ €138.5b program, Banco de Portugal will boost its supervisory activities Real estate workout by increasing resources for the recruitment of specialist banking ■ €47.2b supervisors and intensifying on-site inspections and data accuracy Other financial 43% verification. Systemically important institutions will be required to intermediates ■ €2.9b prepare contingency resolution plans reviewed on a regular basis. Insurance corporations 42% and pension fundsFigure 46 | Source: Banco de Portugal82 Ernst & Young European Non-Performing Loan Report 2011
    • Loan marketThe Portuguese banking system experienced a large increase inloan originations until 2008. Since then, total credit granted hasremained stable at around €330b, as banks started to encounterdifficulties in securing funding, and consequently lending criteriawere tightened. Meanwhile, default rates started to increasesignificantly since 2007, due to increases in the unemploymentrate, inflation, taxes and, more recently,interest rates.The level of NPLs as a percentage of total loans in the Portuguesebanking sector has seen a steep increase during the globalfinancial crisis. The ratio surged from 1.7% in 2007 to 4.1% in2010. With additional austerity measures due to come into effectas a condition of the bailout, Portugal’s current recession andtrend of increasing NPL levels looks set to continue over the shortto medium term.NPL dynamics€ billion16 4.5% 4.1%14 4.0% 3.3% 3.5%12 3.0%10 2.2% 2.5%8 1.7% 2.0%6 1.5%4 1.0%2 0.5% 10.9 13.5 5.0 7.10 0.0% 2007 2008 2009 2010 ■ NPLs ▬ Gross NPLs/total loansFigure 47 | Source: Banco de PortugalIn 2010, the total loans and advances to customers of selectedbanks amounted to €284b, of which more than €7.5b were NPLs.The NPL ratio for these institutions increased from 2.3% in 2009to 2.7% in 2010. Ernst & Young European Non-Performing Loan Report 2011 83
    • PortugalEstimate of NPLs in selected banks During 2006 and 2007, NPL transactions occurred with some regularity, attracting€ billion the attention of international investors.3 NPL transactions were expected to continue over the following years. However, following Lehman Brothers’2.5 bankruptcy, Portuguese banks stopped selling their NPLs as prices dropped to2 uneconomic levels. Consequently, the Portuguese NPL market dried up.1.5 However, banks started outsourcing NPLs management, giving rise to a new1 opportunity for servicing providers. While there are servicing providers that only0.5 manage external NPL portfolios (Intrum Justitia is probably the most active player 2.3 2.5 0.9 1.1 2.0 2.5 0.6 0.6 0.4 0.5 0.2 0.40 in this segment and recovered NPLs Caixa Geral de BES Millenium bcp BPI Santander Totta Banif of €600m in 2010), there are others Depósitos that manage external assets, as well as ■ 2009 ■ 2010 investing (Whitestar and Servdebt are the major servicing providers here asFigure 48 | Source: Banks‘ annual reports; Ernst & Young research they are managing a portfolio of more than €1b each). According to APERC (the Portuguese servicing companies association) there are now about 50–60NPL ratios in selected industries companies in this business. Based on the latest data from APERC, the association% of total loans has 27 affiliates which, during 2010,8% recovered €539m, while managing a portfolio of almost €3b and employing7% almost 1,500 employees.6% During 2010, the NPL market started to show signs of life, mainly in response to5% the new regulatory framework that forces4% banks to sell NPLs to reach the capital requirements. Moreover, the prices have3% been increasing, particularly in the case of unsecured portfolios, although they2% are still behind those offered in 2005 and 2006.1% 2.5 1.8 1.1 2.9 3.3 1.6 5.3 5.5 3.1 5.0 7.0 3.0 5.5 8.1 3.40% The most active buyers in Portugal are 2007 2008 2009 2010 2011 foreign investors, such as private equity ■ Transforming industries ■ Construction ■ Other corporate services firms and hedge funds, for example, Bank of America, Citibank, Credit Suisse, UBSFigure 49 | Source: Banco de Portugal and Apollo.84 Ernst & Young European Non-Performing Loan Report 2011
    • OutlookIn the short run, NPL transactions are expected to increase interms of number and volume, according to NPL market players.Even though the Portuguese economy is not expected to grow inthe next two years; the increase of unemployment, interest ratesand a tightened regulatory framework will force banks to sellNPLs, even at discount.According to some key players, there are high hopes for thePortuguese NPL market. These expectations are specificallybased on international investors that have achieved higher returnsthan expected on previous investments in Portuguese assets.Historically, servicing companies have been working mainlywith banks. However, there are new market opportunities inother businesses, such as utilities and telecommunications thatare interesting for servicing providers, as well as governmentalNPLs. This could be an interesting option, not only for servicingcompanies that would increase their portfolio, but also in helpingthe Portuguese Government recover some of its NPLs, whichin turn would help to achieve its deficit targets.
    • Poland Poland is the only country in the European Union to have recorded positive GDP growth during the global financial crisis, with 1.6% in 2009, which was then followed by a further increase of 3.8% in 2010. The strong GDP growth of the past three years was mostly driven by consumption and positive trade balances. On accession to the EU, Poland recorded a strong improvement in the labor market but, more recently, unemployment rates have increased, peaking in double-digit levels in 2009 as a result of the global financial crisis. The Polish economy is also beginning to experience inflationary pressure with the CPI inflation rate reaching 4.5% in April 2011, resulting in the National Bank of Poland increasing interest rates to 4.5% in June 2011. According to, World Bank, in 2011, Poland’s GDP per capita is projected to reach around 56% of the EU-15 level of income, increasing from only 33% in 1991. However, concerns still remain on sovereign debt. Although the key ratio is still below the safety threshold of 55% of GDP, the Polish Government has implemented a number of measures (including changing the pension funds regulatory with respect to the mandatory premium transfers) to keep the fiscal deficit under control. Prospects for the Polish economy are improving and economic growth is expected to accelerate from 3.8% in 2010 to above 4% in 2011. However, some doubt remains as to whether Poland will be able to return to the higher growth rates of above 5% recorded prior to the global financial crisis. Real GDP and real GDP growth rates US$ billion 600 15% 500 10% 6.3% 6.8% 5.3% 5.1% 3.8% 4.0% 3.8% 4.2% 4.5% 4.3% 400 3.6% 5% 1.6% 300 0% 200 −5% 100 −10% 293.3 303.9 322.9 344.9 362.5 368.4 382.4 397.7 413.0 430.3 449.5 468.9 0 −15% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 50 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 87
    • PolandOverview of the banking sectorThe Polish banking sector, despite strong connections to the The concentration of the top five banks, as at December 2010,more established European banking markets, was one of the was almost 43.9% and was very close to the EU average (44.3%).most resilient models in the wake of the global financial crisis. The PKO BP (State Treasury) and PEKAO (UniCredit) are the mostPolish Government was not forced to support the banking market dominant banks on the market in terms of assets and profits. Overin respect of capital injections or similar liquidity measures, in 25% of total assets and 45% of the Polish banking sector‘s profit ispart due to a low level of exposure of Polish banks to US subprime attributable to these two players.instruments. In general, Polish banks are well capitalized with anaverage capital adequacy ratio of 13.8% as at 31 December 2010, Over the past two years, the Polish M&A market has beenwell above that recorded by other more established European principally shaped by a slowdown in activity or the withdrawalbanking markets. of foreign investors, as they seek to respond to adverse market conditions in their home or other overseas territories, coupledThe majority of banks remained fairly profitable throughout with increased consolidation in the local market. The mostthe crisis, with the Polish banking sector recording an average prominent transaction was the acquisition of Bank Zachodni WBK,41% increase in net profit to PLN11.7b (€2.9b) in 2010. Based on a Poland’s fifth largest universal bank, by Spain’s Banco Santandersurvey made by the Polish Financial Supervision Authority (KNF), for around €4.1b. Other recent transactions include the €490mthe Polish banking sector is expected to grow further purchase of Polbank (a Polish branch of Greek EFG) by Austria’sby 25.6% in 2011. Raiffeisen, and Getin Holding‘s €35m acquisition of Allianz Bank Polska.As at December 2010, there were 646 banks in the Polishfinancial system, and total banking sector assets of PLN1,159b(€290b) accounted for 70% of total financial institution assets(excluding the National Bank of Poland). Commercial banks (49)accounted for 89.2% of total banking assets, while cooperativebanks, which are very dispersed due to historical reasons,accounted for the remainder of banking assets. Internationalshareholders controlled 66.2% of banking assets as at December2010, while the rest were owned by local investors.Total banking assets NPL dynamicsPLN billion PLN billion120 29.2% 30% 100 20%100 25% 15.6% 80 15%80 20% 11.0% 16.1% 60 17.7%60 15% 8.8% 10% 7.4% 7.9% 8.9% 40 9.5%40 10% 5.2% 4.9% 5% 20 1,035.4 1,057.4 1,158.020 5% 538.5 586.4 681.1 801.7 34.8 29.0 24.2 22.7 29.8 50.7 61.4 2.1%0 0% 0 0% 2004 2005 2006 2007 2008 2009 2010 2004 2005 2006 2007 2008 2009 2010 ■ Total banking assets (PLNb) ▬ Growth rate ■ NPL volume ▬ NPL as % of portfolio for non-financial institutionsFigure 51 | Source: Polish Financial Supervision Authority Figure 52 | Source: Polish Financial Supervision Authority88 Ernst & Young European Non-Performing Loan Report 2011
    • Regulatory aspectsThe fast growth of mortgages, consumer loans and foreign- Secondly, in accordance with the newly issued KNFcurrency risks-taking by Polish households triggered the Polish S-recommendation, from 2012, loan repayment instalmentsFinancial Supervision Authority to tighten regulations. At the will be restricted to less than 42% of the borrower’s monthlyend of April 2011, Swiss-franc-denominated mortgage loans income. Currently, the limit applicable for clients with a monthlyamounted to 53% of the total mortgages, down from 61% at income less or equal to the national average salary is 50% ofDecember 2009. The stricter criteria applied to foreign-currency their monthly income. For clients earning above the averageloans are producing results. income, the proportion may amount to not more than 65%. The new regulations are also likely to reduce the credit capacityLiquidity. Based on the last Financial Stability Report, published in of clients willing to draw loans in foreign currencies, as theJuly 2011 by the National Bank of Poland, the funding position of maximum crediting period to be assumed for the purpose ofPolish banks remained stable. Their funding structure, including calculation of repayment instalments will be 25 years. Currently,the share of foreign funding, did not change significantly. The the credit ability of clients contracting foreign currency loans isshort-term liquidity position of the banking sector has improved; 20% lower than in the case of loans denominated in Polish zloty.however, it remains considerably diversified among individual The implementation of the new regulations will also oblige banksbanks. In the longer term, the situation of banks will be influenced to take into account the possibility of income decreases amongby new European liquidity risk regulations. In line with the decision clients who may retire during the loan repayment period.of the Basel Committee, observation periods for the LiquidityCoverage Requirement (LCR) and for the Net Stable Funding Ratio Provisioning. In 2010, there was a significant increase in the(NSFR) were to begin in 2011 and 2012, respectively. profits of the banking sector; however, banks’ results still came under pressure from write-offs as credit risks materialized.Capital. According to the National Bank of Poland, the regulatory Provisions and write-offs were on a similar level in 2009 and 2010capital of the domestic banking sector has increased slightly over (PLN11.7b (€2.9b) and PLN11.3b (€2.8b), respectively) and muchthe last few years. Based on the last available data (April 2011), higher than in 2008 (PLN4.1b (€1.0b)).the structure of regulatory capital was favorable in terms of thecapacity to absorb potential losses, as it was largely composed The negative balance of write-offs is primarily a consequence ofof core capital. the materialization of risks associated with the retail segment, which accounted for 80% of total write-offs made by banks inOperating regulations. The growth of regulatory capital in 2010 2010 (75% in 2009). The total scale of write-offs made in 2010was due to the issue of new shares by five commercial banks and and resulting from the impairment of financial assets related toretention of 2010 profits. The analysis of the dividend pay-out households amounted to PLN9b (€2.2b) and was 2.3% higherplans in banks provides reasons to expect a further growth in than in 2009. The negative balance of write-offs and provisionsregulation of capital in the Polish banking sector. related to consumer loans amounted to PLN7b (€1.7b), a decrease from the previous year of 1.0%, with write-offs madeFirstly, in 2010, KNF issued new rules, the “T-recommendation,” in the second half of last year significantly lower than in the firstwhich could limit the access of lower-income households to half. According to the Polish Financial Supervision Authority,credit. Under the new regulations, it will be obligatory for foreign the gradual decline in the level of write-offs (especially in thecurrency borrowing that the loan-to-value (LTV) ratio does not fourth quarter of 2010) may be a signal that the second half ofexceed 90% for five-year loans and 80% for longer tenor loans. 2010 saw a break in the growth of adverse trends and a gradualMoreover, banks will have to ensure a segregation of duties for abating of negative pressure.loan sales and underwriting. Banks should also consider internaland external sources of information while assessing creditcapacity. At the same time, information given to the clients shouldbe comprehensive and unambiguous. Finally, banks must allowclients to take and pay credits off directly in a given currency.According to KNF, the introduction of T-recommendation willimprove the quality of credit risk management for banks inPoland. Ernst & Young European Non-Performing Loan Report 2011 89
    • PolandLoan marketWhile annual growth rates in some segments of the credit and SME clients who were affected by the financial unrest.market exceeded 50% during 2004 to 2008, the rate of It should be noted that, despite the currency fluctuations,expansion subsequently slowed considerably to moderate, foreign currency-denominated mortgages have demonstratedsingle-digit levels, with domestic bank borrowings reaching a better payments history than PLNdenominated loans.almost PLN700b (€176b) at the end of 2010. The rapid growthin loan portfolios was mainly driven by: (i) increased private Top five banks: total loans and NPL ratio (as of Q1 2011)consumption, particularly in 2009; (ii) further demand for realestate; and (iii) heightened competition between banks. PLN billion 160 8%However, increasing funding costs, PLNcurrency fluctuations and 7.1% 7.0% 7.0% 7.0%macroeconomic uncertainty have resulted in deleveraging among 140 7%corporate borrowers and stagnation in the SME sector.At the start of 2011, there were early signs of recovery in demand 120 6% 4.8%for investment loans and in banks’ willingness to lend. The loans-to-deposits ratios of the banking sector in general, is around 100 5%120%. This is a factor to consider when projecting furtherloans’ growth. 80 4%The NPL portfolio of Polish banks amounted to PLN61.4b 60 3%(€15.4b) in April 2011. Of this, retail NPLs amounted toPLN34.9b (€8.8b), mainly consisting of consumer loans, (66% 40 2%of the portfolio) while the corporate loans balance amounted toPLN26.4b (€6.6b) and mainly relates to SME loans (69%). The 20 1% 134.0volume of loans originated by the top five banks represents 88.3 61.9 33.7 34.550% of the total of bank loans in Poland. 0 0% PKO BP PEKAO BRE ING BZ WBKThe NPL ratio of the banks in Poland increased to 8.8% as of ■ Total loans ▬ NPL ratioDecember 2010, compared with 4.9% in December 2008. Thisgrowing trend was mainly caused by rising indebtedness among Figure 54 | Source: Ernst & Young researchconsumers (a significant share is attributed to consumer financebanks that accepted higher-risk clients during the credit boom) The fundamental change to the first wave of NPL transaction in Poland (2005–2008) is the stronger position of local purchasers.NPL ratio in retail and coporate banking Companies such as Kruk SA (the current market leader), EGB and BEST are present in the recent transactions both as a servicer20% and an investor. The possibility of issuing bonds or raising capital on the stock exchange allowed those entities to become active15% players in all phases of NPL transactions.10%5%0% 2008 2009 1Q 2010 2Q 2010 3Q 2010 4Q 2010 ▬ Customer loans ▬ SME ▬ Large corporates ▬ PLNmortages ▬ FX mortagesFigure 53 | Source: Polish Financial Supervision Authority90 Ernst & Young European Non-Performing Loan Report 2011
    • Outlook In both 2009 and 2010, banks in Poland recorded provisions exceeding PLN11b (€2.7b). Recent development indicates that NPL sales activity seems to be picking up again since 2010. According to the debt collection companies, the total market value of Polish outstanding debt is estimated to as much as PLN180–280b (€45– 70b) and 25% of this amount is linked to the banking system. The NPL market in Poland continues to develop with several collection companies growing in size and being able to attract capital. This creates additional demand for NPL portfolios. The tendency toward higher sale prices from 2010 is evident and continues throughout 2011. Prospects for the NPL market are very promising. Forecasts based on independent scientific research, the National Bank of Poland and major NPL market players in Poland confirm expectations of a 2011–2012 peak in NPL transactions. Moreover, certain forecasts for 2011 expect annual growth of two digits for both retail and corporate NPL transactions in terms of their face value. Nevertheless uncertainty at international financial markets may cause significant slowdown in the transaction activities.Ernst & Young  European Non-Performing Loan Report 2011 91
    • Russia Russia is the largest country in the world by territory and still is the world’s largest exporter of natural gas, the second-largest exporter of oil and the third-largest exporter of steel and primary aluminium. Mindful of this over-reliance on commodity exports, over the last several years, the Russian Government embarked on a program to decrease dependency on exports and develop high technology sectors. Despite the oil price drop, Russia, like other emerging markets hit hard by the crisis, was fast to recover and come back from the dip phase to normal development. The Russian economy achieved high rates between 2000 and 2008 but experienced a severe recession in 2009 when real GDP decreased by 7.8%. In response to the crisis, the Central Bank of Russia spent one-third of its US$600b international reserves to slow the devaluation of the rouble, and injected a further US$200b into the financial system to increase liquidity and aid Russian firms with large foreign debts. In 2010, the economy began to recover and GDP grew by 4%, driven largely by investment demand, stock building and private consumption. However, more recently, the economy has struggled due to reduced growth in energy output, a weak banking sector (relatively to developed economies) and high dependence on natural resources. Despite these concerns, the economy is expected to grow by 4.3% on average between 2011 and 2015, increasingly driven by domestic demand, rising oil prices and acceleration of global economic growth. Annual average inflation is forecast to rise to around 9% in 2011 as a consequence of rising food prices and risks underpinned by high oil prices. Real GDP and real GDP growth rates US$ billion 2,000 20% 15% 1,500 8.5% 8.2% 10% 7.2% 6.4% 5.2% 5.2% 4.0% 4.2% 4.1% 4.0% 3.9% 5% 1,000 0% −7.8% −5% 500 1,022.0 1,062.3 1,105.0 −10% 718.2 764.0 826.3 896.8 943.9 870.1 905.2 943.5 982.4 0 −15% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 55 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 93
    • RussiaOverview of the banking sectorDue to the massive liquidity support by the Government, Russian Total banking assetsbanks have emerged fairly unscathed from the recent globalfinancial crisis and have actively competed for good quality RUB billioncorporate and retail loans despite the downturn in economic 40,000 50% 44%growth over the last several years. 38% 40% 30,000At the beginning of the crisis, in order to sustain liquidity inthe banking system, the Russian Central Bank introduced direct 30%lending to pre-qualified banks (those having international or 20,000national credit ratings). The auctions have been organized 15% 20%between those banks for unsecured loans. At the end of 2010, 5% 10,000the bulk of such loans have been repaid. 10% 20,241 28,022 12,941 29,430 14,093 33,805 16,139However, while the interest rate has fallen from 13% to 8% during 0 8,560 0%the last few years, a lack of liquidity and the absence of long-term 2008 2009 2010 2011funding still remains and represents an issue for the economy. ■ Banking sector assets ■ Top five largest banks’ assetsFurther, lending policies have become more conservative over the ▬ Banking assets‘ annual growth raterecent past, resulting in reduced profitability and growth in thebanking sector. Figure 57 | Source: Russian Central BankSince the crisis in 2008, the Russian Government and regulators Between 2007 and 2010, the total number of banks and otherhave exerted growing influence over the banking sector. In credit organizations decreased from 1,135 to 1,012. The rolereturn for government support for state-owned banks during of the liquidator of insolvent banks is played by the Statethe financial crisis, more conservative capital requirements and Deposit Insurance Agency. The largest five banks by assetsreporting procedures have been introduced. are almost fully directly or indirectly state owned and account for approximately 48% of total banking assets.Corporate and retail loansRUB billion16,000 40% 37% 36%14,000 35% 31%12,000 28% 28% 28% 28% 30%10,000 25% 19%8,000 20%6,000 13% 15%4,000 10% 5% 12,844 12,879 14,530 14,6722,000 2,300 3,189 4,188 1,179 5,803 2,065 8,731 3,242 4,017 3,574 4,085 4,103 300 6190 0% Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Mar 11 ■ Banking sector assets ■ Top five largest banks’ assets ▬ Ratio of corporate to retail loansFigure 56 | Source: Russian Central Bank94 Ernst & Young European Non-Performing Loan Report 2011
    • Regulatory aspectsThere are only 2 foreign banks among the largest 10 banks Since 2007, the Russian Government and regulators have exertedin Russia by assets, namely, UniCredit and Raiffeisen. International significant influence on the banking sector. The Governmentbanks, including HSBC, BNP Paribas, Barclays, Santander, offered support to state-owned banks during the financial crisis,Rabobank, Swedbank AB and KBC Group N.V., are either exiting leading to their strengthened position in the market. The Centralthe market or partly ceasing operations (mostly in the retail Bank has also introduced more conservative capital requirements,sector) due to low profitability and an inability to compete with required more stringent reporting procedures and generallystate-owned banks. increased monitoring of all players.The Government has various plans to develop the banking sector On 28 February 2009, amendments were made to Russianincluding development of the Moscow financial center and a Federal Law No 395–1 (1990) “On Banks and Banking Activity”national payment system. There are also plans to develop the (the Banking Act). These set minimum charter capital levels atretail network of the largest banks on the basis of the Russian RUB180m (€4.3m) for newly registered banks, RUB90m (€2.2m)Post and there is further discussions that the control of state- for newly registered non-banking credit institutions applying for aowned banks should be reduced to less than 50% by 2015. license to make settlements between legal entities and RUB18m (€0.4m) for all other recently established non-banking credit institutions. The amendments also lay down stricter requirements for credit institutions applying for a general banking license (one that entitles credit institutions to enter into transactions in roubles and foreign currency and to take roubles and foreign currency deposits from legal entities and individuals). Such a license may only be issued to institutions with capital of at least RUB900m (€21.6m). Subject to certain other conditions set out in the Banking Act, a bank may only take deposits from individuals if its own funds (capital) or charter capital is at least RUB3.6m (€0.1m). The Central Bank of Russia also has increased the extent of disclosure requirements, especially for non-performing debt and non-core assets (e.g., real estate assets held on the balance of the banks). Ernst & Young European Non-Performing Loan Report 2011 95
    • RussiaLoan marketTotal NPLs in the Russian banking system are estimated at Recent NPL sales from banks under rehabilitation proceduresRUB1,815b (€43.7b) face value, accounting for 8.2% of loans Seller Volume (RUB billion) Acquirergranted as at 1 January 2011. As a consequence of the crisis,the level NPL ratio sharply increased from 2.5% in 2008 to 3.8% Svyaz-Bank 80.0 VEBand 9.5% in 2009 and 2010, respectively. The value of bad debt Petrovskiy Bank 56.0 DIAreserves also significantly increased. KIT Finance 50.3 DIA Soyuz Bank 30.9 DIANPL dynamics Otkritie Bank 9.0 DIA NPSB 4.5 DIAUS$ billion 10%25,000 10% Figure 59 | Source: Russian Central Bank; Ernst & Young research 8%20,000 8% Recent NPL transactions15,000 6% Seller Volume (RUB billion) Acquirer 4% GE Money Bank 9.0 Collector agencies10,000 3% 4% MDM Bank 8.0 EOS Group5,000 2% Alfa-Bank 1.1 Collector agencies 13,417 19,885 19,847 22,140 1,885 1,815 VTB 24 6.7 Rusdolg 335 7560 0% Tinkoff Credit Systems 0.76 Collector agencies 2008 2009 2010 2011 OTP Bank 5.4 Morgan & Stout ■ Total lending ■ NPLs ▬ NPL ratio Figure 60 | Source: Russian Central Bank; Ernst & Young researchFigure 58 | Source: Russian Central Bank A number of factors point to a future upsurge in the levelHistorically, in Russia, NPLs correlate with net job numbers. of activity in the NPL market, with high volumes of NPLsNet job numbers have stabilized, indicating underlying overdue among banks’ assets (estimates vary from 10% to 30%) andpayments are also stabilizing at levels similar to last year (in the foreseeable reclassification of restructured debt as NPLsabsolute terms). In 2010, total lending increased by 15%, which (estimates vary between 30% to 70% of restructured debtcontributed to a fall of the percentage of NPLs at the beginning becoming non-performing in the near future). Banks areof 2011. reluctant to continue to increase bad debt reserves and sacrifice capital for that purpose in order to maintain profitability levels.The market for trading NPLs in Russia is similar to the marketin other European countries, with most trades being for retail Corporate bad loans have been estimated at 80% of total NPLs atportfolios. There is very little trade in corporate NPL portfolios, the end of 2010. The rest is attributable to retail loans. However,mainly due to a wide gap between buyers and sellers over price as noted above, the market for corporate debt currently remainsand the unwillingness of many banks to make public the poor stymied by the gap between buyer and seller estimations on NPLquality of their portfolios. There are transactions when banks sell valuation, due to the lack of a widely accepted methodology to(transfer) NPLs to their related parties in order to remove them value these portfolios.from their balance sheets and to deal with collaterals (specificallyreal estate) in a tax-efficient way. At present, the potential NPL market is dominated by sellers unwilling to dispose of their bad debt at currently proposedTrading in corporate NPL portfolios is very likely to increase prices; however, a number of banks are currently developingin Russia if liquidity dries up because NPL volumes are high, legal specialized departments or creating vehicles for managementobstacles appear manageable and the market is developing. of their non-performing and non-core assets. These include Sberbank-Capital, VTB Debt Center and Alfabank’s “A2.”96 Ernst & Young European Non-Performing Loan Report 2011
    • Outlook Despite the before-mentioned factors, overall activity in the NPL market is rising (for instance, IFC launched a €450m fund for bad debt buyouts). Significant portfolios have passed through specialized state agencies, such as Deposit Insurance Agency (DIA) and VEB. The most significant NPL purchases were made by the state agencies from sanitized banks that entered the insolvency process. We expect the market activity to increase significantly in the coming years.Ernst & Young  European Non-Performing Loan Report 2011 97
    • Ukraine Ukraine is the second-largest country in Europe after Russia by territory and is seen as a key element in economic and political stability in the region. Prior to the global financial crisis, Ukraine had one of the highest global GDP growth rates, foreign direct investment (FDI) and consumer spending levels. However, it has been one of the worst-affected economies by the global financial crisis, recording a 15.1% contraction in GDP to US$114b over 2008 to 2009. Prior to the global financial crisis, GDP growth was driven by commodity exports, such as steel and external financing. However, with the onset of the crisis, export volumes declined significantly owing to a decrease in real wages, rising unemployment and reduced credit availability. Ukraine has one of the lowest average incomes in the Central and Eastern Europe (CEE) region, US$225 per month, and is experiencing significant inflation, which is expected to reach 10.5% in 2011. Since the global financial crisis, the Ukrainian Hryvnia has depreciated against the US dollar by over 70%, leading to significant increase in debt servicing costs of Ukrainian companies on foreign currency loans. Regular interventions by the National Bank of Ukraine to stabilize the Hryvnia have resulted in Ukraine becoming the second largest IMF borrower with a current IMF debt of more than US$14b. This has led to national debt reaching US$56.4b as of 31 March 2011. In 2010, the economy began recovering from recession and recorded a real GDP growth rate of 4.2%. Growth rates are forecast to increase over the next few years, driven primarily by a competitive depreciation of the Hryvnia and anticipated export growth resulting from the recent award of WTO membership. Furthermore, a Free Trade Agreement is under negotiation with the EU that would further encourage exports and FDI. With world demand for steel (a key Ukrainian export) recovering, steel prices rising and an inexpensive, abundant and educated labor force, the prospects for Ukraine over the next several years appear encouraging. Real GDP and real GDP growth rates US$ billion 120 15% 12,1% 100 7,4% 7,6% 10% 5,4% 5,7% 5,4% 3,0% 4,2% 4,8% 4,7% 5% 80 2,3% 0% 60 −5% −14,8% 40 −10% 20 −15% 101,9 100,0 105,7 111,4 116,7 83,6 86,1 92,6 99,6 86,8 90,5 94,9 0 −20% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 61 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 99
    • UkraineOverview of the banking sectorThe Ukrainian banking sector was among the hardest hit In 2010 the total assets of the Ukrainian banking system (beforein the entire CEE region in 2008 and 2009 due to the global deduction of provisions on active operations) increased by US$8bfinancial crisis. According to the results of the second stress test and keep growing in 2011. The adequacy of regulatory capital forcommunicated by the National Bank of Ukraine (NBU), the capital the whole banking system remains high (20.8%, according to theshortfall in the banking sector was estimated at US$5b, of which NBU estimates as of 1 January 2011). However, certain bankingUS$1.9b related to ailing banks Nadra and Rodovid. institutions have issues with equity levels due to significant losses attributable to additional provisions booked on loan portfolios.The financial crisis has adversely impacted the profitabilityratios of Ukrainian banks. In 2009 and 2010, the banks recorded Total banking assetsnegative returns on both assets and equity. Despite this, thebanking sector was able to maintain a net interest margin of US$ millionover 5%. In response to the IMF granting a US$14.9b loan to the 76.2% 140 80% 67.2%Ukraine in July 2010, Standard & Poor’s improved the long-term 59.1%debt credit rating of Ukraine in foreign currency from CCC+ to B+ 120 60%along with upgrading the credit rating of obligations in its national 100currency from B− to BB−. 40% 80As at 1 January 2011, 194 banks in the Ukrainian financial system, 20% 7.3%including 55 banks with foreign equity, has been recorded. Of 60 1.3%these 176 banks have an NBU license for banking activity with the −8.3% 0%remaining 18 banks currently in the process of liquidation. The 40share of foreign capital within the total registered authorized capital 118,692 120,271 110,244 118,327 −20% 42,352 67,362 20of banks in Ukraine amounted to 40.6%. These banks benefitedfrom foreign ownership during the financial crisis and are regarded 0 −40%as an attractive home for domestic deposits due to a perceived 2005 2006 2007 2008 2009 2010lower risk, enhanced stability and increased transparency. ■ Total banking assets ▬ Growth rate Figure 63 | Source: National Bank of UkraineCorporate and retail loans As at 1 January 2011, the top 10US$ million banks accounted for 54% of total70 banking assets, with Privatbank being the largest. Nadra, the ninth largest60 bank in terms of assets, is currently in50 financial difficulties, having received an emergency US$1b restructuring loan40 and it is estimated that an additional capital of US$1b may be required.3020 Corporate lending exceeds retail lending by more than 100% and both sectors 21,588 33,200 15,397 54,690 30,422 61,375 34,916 59,485 27,870 63,842 23,43010 6,566 experienced strong growth prior to0 the financial crisis. After the onset of 2005 2006 2007 2008 2009 2010 the financial crisis, lending effectively ■ Corporate loans ■ Retail loans froze until the end of 2009. In 2010, corporate loans increased by 7% whileFigure 62 | Source: National Bank of Ukraine retail loans continued to decrease by a further 16% during the same period.100 Ernst & Young European Non-Performing Loan Report 2011
    • Regulatory aspectsThe National Bank of Ukraine is the country’s central bank; a Between 2008 and 2010, the NBU adopted a number ofspecific central body of the state administration that acts as its regulations to stabilize the activity of the banking system.currency issuer and that pursues common state policy in moneycirculation, credit and supporting the value of the monetary unit. Liquidity. The NBU continues to support banking sector liquidityIt oversees the functioning of the banking system in general and through refinancing loans. During Q4 2008, when Ukraine faced aalso determines the exchange rate of the monetary unit against liquidity crisis, it provided UAH105.4b (€9.6b) of refinancing loansforeign currencies. to support a number of banks. The loans were mainly issued with 12-month maturities but the term of those issued for distressedThe NBU is responsible for determining and enacting revisions banks were subsequently extended for several years.to the discount rate and other interest rates. It grants permissionfor commercial banks’ registration and licenses banking business, Capital. The minimum level of bank’s regulatory capital hasas well as determining the obligatory reserve fund for commercial increased to UAH120b (€11.0b). At the same time, the level ofbanks and other financial and credit institutions. regulatory capital should not be less than share capital. According to Associations of Ukrainian Banks data, at 1 January 2011,According to the constitution of Ukraine, the main function of the 34 banks or 19% of all banks operating in Ukraine had equity ofNBU is to ensure the stability of the national monetary unit — the less than UAH120m (including subordinated debt and excludingHryvnia (UAH). To carry out its main function, the NBU fosters the unformed provision). According to resolutions of the NBUstability of the banking system and, to the best of its ability, seeks from November 2010, banks are no longer permitted to taketo ensure price stability. subordinated debt into account when calculating regulatory assets. Operating activity. Financial institutions are prohibited from unilaterally increasing interest rates or other costs under facility agreements or changing the debt repayment schedules. Financial institutions are also prohibited from requiring early repayment of outstanding debt and from unilaterally terminating the facility if the borrower does not agree to the increased interest rates or other costs. Provisioning. Resolutions of the NBU from November 2010 superseded a number of anti-recessionary decrees. According to the new resolutions, when calculating provisions for their statutory books, banks can take into account additional collateral for loans to producers, real estate firms and agricultural producers. Such provisions should stimulate lending to key industries and facilitate debt restructuring. The legislative changes that allow the banks to sell NPL to venture funds for investment certificates, and not to create 100% provision against the certificates, have now been discussed by the Government and the NBU. This would speed up the transactions and stimulate the banks to get rid of their bad debts. Ernst & Young European Non-Performing Loan Report 2011 101
    • UkraineLoan marketAlthough, in general, the financial sector conditions are slowly During 2009 and 2010, Ukrainian banks were looking for ways toimproving, banks remain under stress. High NPL levels represent manage their NPL portfolios. Different options were considered,a major challenge to banks’ balance sheets and the resumption ranging from establishing their own collection units to outsourcingof lending, with weaknesses in the legal, tax and judicial systems and disposal of NPLs. Many of the NPL portfolio transactions thatpreventing more aggressive resolutions of bad loans. As a result, took place in 2009–2010 were between related parties or SPVsand notwithstanding that the banking system as a whole is highly created by the banks to clean up their balance sheets.liquid, anaemic credit growth conditions have continued in 2011.Lending to households remains stalled due to perceived high Also, debt collection businesses started to grow and attracted acredit risks, though credit to enterprises has shown some signs few foreign investors (Horizon Capital and Abris Fund). Currently,of revival recently. the sector is considered to be very attractive and large investment funds are looking to enter the market through the establishmentWith the start of the financial crisis, the level of NPLs has of a collections business or investment in an existing one. Due toincreased dramatically. In 2009, loan loss provisions increased legal obstacles related to registration of collateral and assignmentby 152% compared with 2008, while gross loans fell by 2% year of rights to the loan, the NPLs that were sold in the last two yearson year. In 2010, loan loss provisions continued to increase as were mostly Hryvnia-denominated unsecured consumer loans.Ukrainian banks recognized further loan impairment. Among thetop 20 Ukrainian banks, Rodovidbank, Swedbank and Ukrgasbank Industry experts assess the total NPL market capacity atwere most hit by NPLs. UAH300b (€27.5b) with almost equal split between corporate and retail loans. More than 80% of NPLs relate to non-performingStandard & Poor’s experts attributed Ukraine’s banking system banking loans. The remaining 20% of NPLs refer to debts toto a group of the weakest because of the high level of country telecommunication companies, insurance companies andrisk. The share of problem loans (including restructured loans) companies that provide housing and utility services.stands at almost 50% in 2010. Fitch and Moody’s credit agenciesassessed the proportion of NPLs at the level of 56.5% and 40% Prices for the NPL purchase of debt vary from 0.1% to 20% ofrespectively. their nominal value. Increased competition among debt collectors has driven an increase in prices.NPL dynamics Two major debt collection schemes include “collect and get commission”UAH billion and “buy and collect.” Following the800 18.6% 20% resumption of retail lending, it is expected that, in 2011, the volume700 of the collect and get commission 14.8% market will increase to around UAH6b600 15% (€0.6b), and to around UAH8b (€0.7b)500 in 2012.400 10% The size of the buy and collect market300 is forecast to increase in 2011 up to 5.5% 5.7% 4.7% UAH4.0–4.5b (€0.4b) as Ukrainian200 4.0% 5% banks will continue selling loans impaired as a result of the economic100 downturn in 2008–2009. However, 142 246 430 742 726 107 751 140 11 17 42 from 2012, the market is expected to 80 0% 2005 2006 2007 2008 2009 2010 shrink to UAH3.0–3.5b (€0.3b) unless ■ Total loans ■ Loan loss provisions ▬ Aggregate loan loss provision rate a new economic downturn arises.Figure 64 | Source: National Bank of Ukraine102 Ernst & Young European Non-Performing Loan Report 2011
    • Outlook The recent troubles in the global financial markets and a potential onset of a double-dip recession may have a negative impact on the growth of the Ukrainian economy. However, deleveraging of the Ukrainian banking sector from the highs of 2008, as well as consolidation of the government monetary and fiscal policies, make the repeat of the dramatic fall in 2008 (when real GDP slumped almost 15%) unlikely. Despite positive signs, the recovery of Ukrainian banks is still fragile as they continue to clear their balance sheets of bad debt. In the first half of 2011, Ukrainian banks recorded a collective loss of US$133m — a significant improvement from the first half of 2010, when the losses were US$1b. Under the pressure from IMF, Ukraine has been implementing structural reforms including a new tax and pension legislation. However, in view of the upcoming parliamentary elections, some of the critical but unpopular measures (such as an increase in gas retail prices) are likely to be delayed until 2012. The majority of experts expect the Ukrainian economy to maintain a positive momentum with real GDP growth rates of around 5% within the next few years. The overall sentiment among market players is that the market for NPLs will develop over the coming years as Ukrainian banks learn the benefits of outsourced collection as well as continue to clear their books through true sale of NPLs.Ernst & Young  European Non-Performing Loan Report 2011 103
    • Kazakhstan The Kazakh economy grew significantly between 2003 and 2007, mostly driven by foreign direct investment (FDI) inflows into geological exploration works, crude oil and gas extraction, and rising energy prices. The global financial crisis, as well as a significant decline in commodity prices, had an adverse effect on GDP growth. Prior to the global financial crisis, the Kazakh economy experienced accelerated growth followed by a gradual economic deceleration in 2008 and 2009. In order to sustain and enhance the economic competitiveness of domestic producers, and to maintain the country’s gold reserves, the local currency experienced a significant devaluation in 2009. The Kazakh economy regained momentum in 2010 due to the influence of liquidity injections (11% of GDP), as part of the implemented economic stabilization measures, and positive market conditions supported by a solid performance in industrial production, oil and gas, mining and agriculture. In 2010, the country’s exports — predominantly mineral resources including hydrocarbons and base metals — grew by 37.1% on the prior year. Despite the recent positive trends, there still remains uncertainty with respect to medium term prospects for capital markets and commodity prices, upon which the Kazakh economy is so dependent. Furthermore, liquidity restrictions in global capital markets have negatively impacted on Kazakhstan’s sovereign credit rating. Kazakhstan’s GDP is forecast to grow at an average of 5.1% p.a. over 2011 to 2015; however, this forecast is heavily dependent on projected commodity prices. Real GDP and real GDP growth rates US$ billion 120 15% 10.7% 9.6% 9.7% 8.9% 100 10% 7.0% 6.0% 5.0% 4.4% 4.8% 5.2% 80 3.2% 5% 1.2% 60 0% 40 −5% 20 −10% 52.1 57.1 63.2 68.9 71.1 71.9 77.0 81.6 85.7 89.4 93.7 98.6 0 −15% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 ■ Real GDP (US$) ▬ Real GDP growth rate, year-on-year Figure 65 | Source: Global Insight Ernst & Young European Non-Performing Loan Report 2011 105
    • KazakhstanOverview of the banking sectorThe Kazakhstan banking sector is headed by the National Bank Financial indicators of Kazakh second-tier banks in 2010of Kazakhstan, which is charged with maintaining financial KZT billion Income- Loan Provisions for loansector stability through primarily developing and implementing earning assets portfolio portfoliomonetary policy and exercising exchange rate controls. Kazkommertsbank JSC 2,029 2,344 724The rest of the banking system consists of 39 banks, with the Halyk Bank JSC 1,798 1,224 2866 largest banks by assets (Kazkommertsbank JSC, BTA Bank BTA Bank JSC 1,500 1,645 922JSC, Halyk Bank JSC, Bank CenterCredit JSC, ATF Bank JSC and Bank CenterCredit JSC 1,121 720 110Alliance Bank JSC) accounting for almost 76% of total bankingassets in the Kazakh banking sector. ATF Bank JSC 927 849 128 Alliance Bank JSC 333 546 319The banking sector developed rapidly during the period 2000 to2007, driven by growing GDP and an influx of foreign financial Other 2,403 1,738 317investments. However, the global financial crisis led to a Total 10,111 9,066 2,806significant decline of the banking sector, primarily due to the lowquality of banking assets and significant levels of external debts Figure 67 | Source: AFN; in accordance with KASheld by commercial banks. This in turn led to the default of anumber of large financial institutions, leading to a lack of liquidity In 2010, total assets of the Kazakh banking system grew by 4%and sharp rises in interest rates offered to borrowers. to KZT12.03b (€60m) on the prior year, against a recorded 2.8% decrease in 2009. Loan portfolios have traditionally constitutedIn response, the Kazakh Government founded the Sovereign the largest portion of commercial banking assets, accounting forWealth Fund Samruk-Kazyna (SWF SK) in order to ensure stability 75% of total banking assets in 2010. Moderate growth of loanand enhance competitiveness of the Kazakh economy. The portfolios was recorded in 2009 due to the economic incentivesstabilization program, put forward by SWK SK during 2009 and provided by the financial stabilization program conducted by SWF2010, allocated additional funding capital provided by the Kazakh SK. However, the tightening of banking lending criteria led to agovernment on the following basis: financial sector stabilization subsequent decline in 2010.of KZT486b (€2.4b); residential property sector development ofKZT360b (€1.7b); small and medium business support of KZT120b(€0.6b); and innovative, industrial and infrastructure projects ofKZT120b (€0.6b).Total banking assetsKZT trillion20 5% 4% ■ Other assets 4% ■ Direct investments 1.7 1.715 1.1 0.3 0.4 3% ■ Loan portfolio 0.3 ■ Securities10 2% 2% 9.6 9.1 ■ Interbank deposits 9.2 1% ■ Cash, affinated precious metals and5 0% 0.9 1.8 2.2 correspondent accounts 0.6 1.1 1.0 0.8 1.0 0.9 −1% ■ Provisions0 −1.1 −4.0 −3.2 −2% −2.6% ▬ Total assets growth rate (right scale)−5 −3% 2008 2009 2010Figure 66 | Source: AFN106 Ernst & Young European Non-Performing Loan Report 2011
    • Regulatory aspects Loan marketIn April 2011, the previous regulator — the Agency of Financial The total banking system’s loan portfolio experienced a declineRegulation (AFN) — was abolished and regulatory functions in quality during the financial crisis. On average, during 2008–covering commercial banks were passed over to the National 2010 69% of total loans were granted to legal entities, 56% of theBank of Kazakhstan. loan portfolio was denominated in national currency, 82% of the portfolio consisted of long and medium-term loans and half of totalAmendments to the regulatory requirement for commercial loans consisted of NPLs. During the same period, the NPL ratiobanks during 2008–2010 included the establishment of business increased from 4% to 20%.continuity plans to strengthen risk management, lower called-upshare capital requirements, lower minimum reserve requirements Loan portfolio qualityand revisions to the corporate income tax code with respect torestructuring revenues. 2010 26% 54% 20%At the end of 2010, the Kazakh Government put forward an 2009 25% 44% 31%initiative to implement an economic program to maintain and 2008 43% 53% 4%further develop the financial sector in the post-crisis environment.The concept includes the utilization of public-private partnership 0% 20% 40% 60% 80% 100%schemes as the main financing mechanism for the economy, ■ Standard loans ■ Problem loans ■ Bad loansregulation of the monitoring system applied to the financialsector, development of a mechanism for early detection and Figure 68 | Source: AFNprevention of financial sector imbalances, and the revisionof legislation. The measures implemented in 2009 and 2010 to reduce the bad debt of commercial banks’ portfolios had limited success. BanksIn addition, the Government is planning an amendment to the tax enthusiasm for writing off bad loans from their balance sheetssystem, which would allow banks to effectively write off NPLs on remained low due to the possible negative consequences from antheir balance sheets. However, according to Standard & Poor’s, income tax perspective, due to recovering provisions and a lack ofasset quality indicators will not reach the pre-crisis levels in the appropriate instruments.medium term. In March 2011, the financial regulatory authority proposed aCapital. The financial authorities approved a harmonization new conceptual plan to improve the quality of commercial bank’spolicy, effective from 2013, between domestic and international assets, which includes (i) the establishment of a new distressedbanking capitalization requirements based on the Basel III accord, assets fund specialized in the acquisition of distressed assets ofin order to overcome the shortcomings of the country’s banking commercial banks, and (ii) set up or acquisition of assetactivities exposed by the global financial crisis. In line with Basel III management companies by the commercial banks with theguidelines, the harmonization introduces the concept of common purpose to acquire and resolve problematic assets ofequity as paid-up ordinary shares and reserves for bank risk, and commercial banks.it excludes perpetual financial instruments and preferred sharesfrom Tier 1 capital. During 2008–2010 the principal funding channel for Kazakh banks was in the form of deposits. In 2010, deposits from corporate clients were twice as large as those of individuals. Due to the strengthening of the local currency last year, deposits denominated in local currency increased from 58% of total deposits in 2008 to 62% in 2010. In addition, borrowings from international financial institutions decreased by 21% in 2010 as a by-product of the restructuring process of the commercial banks. As a result of governmental actions to stabilize the country’s financial sector, public sector borrowing increased by 83% over 2008–2010. Ernst & Young European Non-Performing Loan Report 2011 107
    • KazakhstanM&A activitySale of RBS’ retail loan portfolio to HSBC (2010) Acquisition of Metrocombank (2009)In June 2010, HSBC Holdings plc acquired the retail banking Former shareholders of ATF Bank acquired a 100% stake inassets of RBS Kazakhstan for up to US$52m. Assets subject to Metrocombank, a small privately owned commercial bank inthe deal included a retail loan portfolio (comprising primarily of Kazakhstan for an undisclosed amount. Again, the proceedspersonal loans and credit cards), 80 ATMs and 2 support offices. from the transaction were to be used to invest in the bank’sThe deal was completed in September 2010. equity in order to satisfy the Government’s new minimum capital requirements.Acquisition of ProstoCredit by Eurasian Bank (2011)On 21 February 2011, Eurasian Bank, one of the top 10 Sale of Alliance Bank of its retail NPL portfolio (2011)commercial banks in Kazakhstan, completed the acquisition of In August 2011, Kazakhstan-based Alliance Bank has foundProstoCredit LLP, a non-banking lending institution and former a buyer for its problem retail loans. The deal to sell thesubsidiary of Société Générale in Kazakhstan, for an undisclosed non-operating loans is nearing its completion. As a result, thesum. According to the terms of the agreement, the non-defaulted bank will receive KZT14b (€70m) worth of equity capital undercredit portfolio was immediately absorbed into the balance sheet IFRS. As reported, in April 2011, the bank announced its intentionof Eurasian Bank. The full integration of the newly acquired to get rid of bad retail loans worth KZT182b (€0.9b).ProstoCredit business into the bank’s structure (including theorganizational model, sales system and information platform) willbe completed over time. ProstoKredit is currently designated asa retail business of Eurasian Bank and operates as a separate andindependent legal entity.Acquisition of Dana Bank by Punjab National Bank (2010)In March 2010, Punjab National Bank completed the purchase of a64% stake in Dana Bank, a privately owned small-cap commercialbank in Kazakhstan, for US$23.8m from BATT Corporation. Theproceeds from the transaction were to be used to invest in thebank’s equity in order to meet the minimum capital requirementsintroduced by the Government in 2009.Recent M&A transactionsTarget Seller Buyer Deal type Deal value, US$ million Completion dateProstoKredit Société Générale Eurasian Bank Corporate Not disclosed Feb 11Dana Bank (64%) BATT Corp PNB Corporate 23.8 Dec 10Retail business of RBS RBS Kazakhstan HSBC Asset >52 Sep 10Metrocombank Private investor Private investor Corporate Not disclosed Dec 09Alliance Bank retail Alliance bank Not disclosed Asset Not disclosed n/aNPL portfolioFigure 69 | Source: Ernst & Young research108 Ernst & Young European Non-Performing Loan Report 2011
    • Outlook According to projections published by the Regional Financial Centre of Almaty, the profitability of Kazakh commercial banks is not expected to increase in the short term due to low interest income growth. The structure of the loan portfolio is projected to respond to the anticipated changes in the overall economy. Specifically, the percentage share of the overall loan portfolio for telecommunications, agriculture, logistics, gas generation or distribution and utility sectors is expected to grow.Ernst & Young  European Non-Performing Loan Report 2011 109
    • Ernst & Young’s leading value propositionServices Our Strategic Portfolio Solutions team is a multi-disciplinary team of experienced transaction managers and professionals, who closely work together in an integrated approach to increase transaction value for our clients. We are committed to bringing all required knowledge and skills right to your doorstep, advising you on your most complex loan portfolio transactions. This is how Ernst & Young makes a difference. NPL market offerings to date have concentrated on disposal and very rarely provide a holistic way of looking at the problem from the point of view of maximizing value. Yet, this is the way the shareholders and management of banks perceive the NPL issues. We believe the time is right for a broader approach driven by value improvement across a range of options — managed to produce higher, faster, lower-risk recoveries. The Strategic Portfolio Solutions team takes responsibility for all stages of delivery, right through to completion, and provides a dedicated senior delivery leader with highly relevant skills and experience, pooling knowledge from different professional teams within Ernst & Young, such as real estate, advisory and tax. Restructuring • Review of the operating model and loan origination process to identify quality and risk issues and evaluate against leading practice • Credit risk analysis and its impact on performance indicators ing Tran • Support, challenge and advise management tur sa ct during decision-making process uc r io st nA Transactions Advisory Services Re • M&A lead advisory dvis Process • Financial due diligence ory management • Portfolio valuation • Transaction database Leg ccou ory A al, n Real Estate Advisory vis x • Ta Real estate due diligence Ad tin and e g at • Drive-by and desktop valuations Real Est • Strategic real estate advisory Legal, Tax and Accounting • Legal due diligence • Transaction documentation (NDA, SPA, annexes) • Audit and tax compliance • Regulatory implications 110 Ernst & Young European Non-Performing Loan Report 2011
    • Our approach to addressing non-core loan portfoliosWe have the capability and resource to support from the early We provide the required services through an integrated, cross-stages of the decision-making process right through to the boarder advisory team with one senior delivery leader.execution of the chosen strategy. Decision support Execution support Data collection Structured and verification solution Impairment loss and cash Sale flow modeling Stratification Options and performance analysis analysis Capital impact Hold and analysis restructure Hold for Loan file reviews future exit• The process of taking strategic decisions regarding non-core • The decision-making process may conclude that a portfolio portfolios requires a robust analysis to be undertaken based on is non-core but that it is not possible, or it is not economically high-quality input data. A significant challenge lies in balancing favorable, to pursue an exit in the short to medium term. In the need for taking immediate action with the time required to this case, holding the portfolio while maintaining flexibility to analyze portfolios adequately. facilitate a future exit, is the most appropriate course of action.• Portfolio sales can be complex, with buyers typically expecting • The decision-making process may show that an immediate to obtain significant amounts of detailed portfolio information. exit of the portfolio is not optimal and that it should be worked Therefore, a thorough preparation and execution phase is out with a view to maximizing and/or accelerating individual required to meet investors’ expectations. loan recoveries.• Structured solutions are only achievable if they are implemented on a bespoke basis, giving consideration to the assets together with the desired accounting, regulatory and tax treatment. Ernst & Young European Non-Performing Loan Report 2011 111
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