PWC on NPE: Brand New Day?
December issue of the “The Italian NPE Market”.
PWC released an update of its recurrent Report “The Italian NPE Market”.
The global outlook has deteriorated markedly throughout 2022 amid high inflation, aggressive monetary tightening, and uncertainties from both the war in Ukraine and the lingering pandemic.
The stock of non-performing exposures on Italian banks' books has reached its lowest value in the last 15 years with €68bn in June 2022.
We need to go back to 2008 to find similar values. In recent years, banks have continued the deleveraging process and deterioration rates have remained extremely low in the period 2020-2021 (1% in 2020 and 0.9% in 2021) thanks to effective Government measures.
French and Spanish banks now register the largest total amounts of NPEs in Europe, accounting respectively for €110bn and €79bn.
The French NPE market was not very active compared to EU southern countries in the last years and major banks are now implementing a more comprehensive NPE strategy, which is expected to include more significant sales.
Warning signs emerged in 2022: for the first time since 2019, an increase in default rates was observed in the first semester in Italy: for corporates, +15% compared to December 2021while still decreasing for families.
The rise in cost base (raw materials, energy, funding) is likely to negatively impact companies’ 2022 financial statements leading to worse results than in 2021. In addition, all loans with a public guarantee granted under 2020-2021 temporary framework (over €250bn) will end the pre-amortization period. Possible contractions in demand could create defaults very quickly.
PWC expects Government to maintain supporting measures. However, this intervention may be limited given the 145% debt/GDP ratio reached after the pandemic.
In line with market consensus, we estimate around €60bn of new defaulted loans in the next 24-36 months (around 2x, +€30bn compared to the actual volumes of the previous two years). Loans with public guarantees are expected to represent a relevant portion of total defaults. In any case, the new NPE inflows would be far from the levels reached in the period 2012-2013 with approximately €140bn of new flows in the two-year period.
The strengthening of companies' liquidity and capitalization will smooth the impact compared to the past.
Any increase in non-performing flows is expected to be offset by the continuation of de-risking, also in line with the plans of the largest banks (“Zero-NPL bank” strategy by Intesa Sanpaolo; 3.5% Gross NPE ratio target in 2024 for UniCredit), and will allow to keep at current levels banking NPE ratios.
Given this scenario, Europe's largest banks are likely to set more provisions for possible loan losses in the fourth quarter, having already bolstered provisions in the third. Of the 25 largest banks in the continent, 19 reported either higher loan loss provisions or in line compared to a year ago. In Italy, the cost of risk of Top5 banks remained almost stable in September 2022 YoY (at 49 bps) still at a very limited level.
The Italian banking system appears more solid than in the 2013-2014 crisis.
Banks hold solid capital levels (CET1 ratio +3 p.p. between 2014 and 2021) that could help them manage a downturn.
NPE coverage ratio increased (+ 7 p.p. significantly between 2015 and 2021) showing the ability to absorb future losses.
Above €300bn of primary market NPE transactions in the period 2015-2022 of which €110bn assisted by GACS allowed to reach minimum levels in terms of stock of nonperforming loans on banking books.
A real debt servicing "industry" has been created with €300+bn under management and 15,000 resources employed.
However, now, the main priority is shifting: from “gone concern” to “going concern” credits.
The amount of loans in Stage 2 has soared, reaching over €250bn in June 2022, equal to 14% of total loans (vs. €141bn at the end of 2019, equal to 9% of total loans). This is not only an Italian phenomenon: the amount of stage 2 credits in Europe reached around €1.4tn in June 2022, representing around 10% of total credits.
UtPs still on bank balance sheets (€36.5bn), the loans backed by state guarantees disbursed in the last 2 years more than €250bn, and the expected new NPE flows (up to €60bn) bring the total amount of credits “under the spotlight” to over €500bn. These loans should be the real focus of all players involved in the NPE space in the next years. These are "live" credits to be managed proactively with the aim of bringing them "back to performing". That's hundreds of thousands of small and medium-sized businesses that need to be supported.
To date, there is no proven model for the large-scale management of sub-performing/UtP loans. Changing the perspective of credit management to the "going-concern", business models will have to be (further) rethought. The use of data, the automation of the decision-making process, and the use of new technologies such as Artificial Intelligence and Machine Learning will be crucial. Players will need to develop new competencies (e.g. capacity to attract new finance, proactive management of public guarantees, RE asset valorization).
The "going concern" nature of these credits in the coming years poses a major problem of the potential impact on the real economy. Only an alliance among all the actors involved will be able to guarantee the right support for the real economy. Banks and servicers will have to develop a structured approach aimed at encouraging the relaunch of struggling companies. The Government will have to ensure the launch of recapitalization and revitalization initiatives for the country that are also capable of involving investors who bring "patient" capital to provide new finance.
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Link to the Report
https://www.pwc.com/it/it/publications/npl/doc/pwc-the-italian-npe-market-dec2022.pdf