Debt markets continue to feel the calming — even sedative — effects of the battery of support measures rolled out to counteract the decline in business activity due to the effects of COVID-19. Jumbo deals involving non-performing loans (NPLs) are expected to resume in the last quarter of 2021. Until then, we will witness two very interesting developments until then: single name sales and the appearance of new players in the debt market.
Jumbo NPL portfolio deals
There is a certain consensus among NPL portfolio sellers and purchasers that jumbo deals will only return to the scene at the end of 2021. There are three reasons behind the current standstill:
The sedative effects caused by State support measures, such as payment holidays, extraordinary capital injections, secured loans, participating loans, the underwriting of bonds and occasional acquisitions of shares, are keeping companies from defaulting on a massive scale. Defaults are expected to impact the balance sheets of financial institutions primarily in 2022, when all of these mechanisms expire or when it becomes harder to qualify for them.
During 2021, a large number of hard-hit companies will make use of restructuring measures that will be more or less intense based on the objectives they wish to attain (a new debt structure, a new capital structure, the divestment of non-strategic lines of business or concentration through classic M&A transactions, such as mergers or acquisitions). Portfolio sellers are carefully analyzing how such restructuring efforts could impact the recovery ratio for NPLs in their portfolios and assessing the ideal moment to package them into portfolios and sell them to investors. The aim would be to avoid the transaction and reputation costs associated with restructuring and to obtain a price for the NPLs that allows the accounting provisions to be recovered.
Finally, regulators have received a clear message from financial institutions: “we need to make capital requirements for NPLs more flexible”. It is highly likely that regulators will allow financial institutions to record lower accounting provisions for the loans affected by restructuring measures enacted in response to COVID-19. This flexibility in capital requirements will allow financial institutions to drain their balance sheets of NPLs in a more structured manner, gradually and over a longer period, with the benefit of lower internal consumption of capital. This will help bring about more uniform portfolios, perhaps even sector-based ones (hotels and tourism, travel agencies, passenger transportation, leisure and restaurants, etc.), because the intensity of the crisis caused by COVID-19 varies for different sectors.
Single name sales
Until jumbo deals reappear, the trend seems to be for one-off NPL transactions with very specific and rather well-known counterparties (borrower and guarantors), referred to as single name deals. Financial institutions may initiate these types of deals without having to lay out the preparation costs required for jumbo portfolio sales. Furthermore, and due to the characteristics of the borrower or its guarantors, there are fewer purchasers of single names, which avoids lengthy bidding processes that generally have cumbersome purchase agreement and loan documentation requirements.
In the current scenario, the objective is for a single name deal between the originating financial institution and an investor to take place without the transferred loans losing institutional guarantees or State support measures.
Appearance of new players in the debt market
The parties we advise in the debt market also seem to agree that 2021 is a transitional year, the calm before the storm. The storm might not be quick and ravaging (i.e., large NPL portfolios concentrated in a few deals within a short time frame), but instead be more of a steady drizzle over several years.
While we wait to know what the NPL deal weather forecast will look like for sure, we are witnessing the appearance of new players in the debt market. New platforms are appearing for managing non-performing assets (NPLs and foreclosed property or REOs), driven by the financial institutions themselves in their effort to reduce the cost of managing their assets and to provide services to external parties located beyond their usual jurisdictions (Brazil, Mexico). The debt servicing industry is starting to carefully analyze the changes that the forthcoming European Directive on credit purchasers and credit servicers, which is in an advanced legislative state, may trigger.
What trends may already be observed in the main markets in Latin America, Spain and Portugal? What investments will be made in those jurisdictions and who will be behind them?
Garrigues is pleased to share our view of the main trends in these debt markets, drawing from our on-the-ground network of offices in Brazil, Chile, Colombia, Spain, Peru and Portugal.