Question and Answer with Richard Thompson, Partner Portfolio Advisory Group at PwC

Richard is the partner in charge of the Portfolio Advisory group at PwC, a global team of over 80 loan portfolio experts providing strategic and transactional advice to both the buyers and sellers of loan portfolios. We caught up with Richard to get his thoughts on the trends in the current asset trading marketplace.

What‘s the current position in the European asset trading marketplace?

European banks are holding about €1.9 trillion of unwanted loan portfolios – loans they don’t want to hold on their balance sheets. To put that figure into context that’s around 4% of all European banking assets. In addition to that €1.9 trillion, there will be some additional loans that the banks have yet to identify as unwanted, so the number could well be nearer to the €2.5 trillion mark. One of the key reasons for this potential increase is that the results of the latest asset quality reviews (i.e. stress tests) may not have yet fed their way through into their balance sheet strategies.

How is that €1.9 trillion split?

If you take a look at the €1.9 trillion, it is broadly split between €850bn of non-performing and €1,150bn of performing assets but as a general rule, to date we have seen more non-performing assets trading. This is likely the result of a more liquid market with a number of large investors on the demand side who are well geared up and understand the principles of buying non-performing assets. Additionally, on the supply side, the non-performing assets are being provisioned at closer to what might be realisable in the market compared to what performing assets are. In effect, the prices the larger investors are prepared to pay for non-performing assets are closer to the value that the banks are holding the assets at on their balance sheets. Of the €1.9 trillion, our view is that around €500 billion will trade over the next few years and the remaining €1.4 trillion will move off through natural attrition.

What about the demand side?

If you look at the demand side, we think that there is around €100 billion (equity and debt) available in funds to buy assets. Taking into account discounts to par, we see that as providing a large part of the funding that will be required for the potential trading volume referred to above.

From a pricing perspective, we survey around 80% of the market and we’ve observed prices going up in the liquid markets of UK, Ireland and Spain and so you would expect returns to come down.  Our hypothesis is that people are being more positive on modelled cash flows so more upside is being built into deal models, as opposed to reducing targeted return hurdles. As competition has increased more people are optimistic that borrowers are returning to the habit of paying in a more upbeat economy and investors are more confident on returns based on this.

What are the trends in the UK Market?

If you look at the UK market, last year around €21.5 billion was traded, which is nearly 25% of the total EU marketplace.  The UK has definitely been a secured market from what we have seen in terms of trading in the public domain (excluding the debt purchasers and charge offs). We’re also seeing a strong trend in trading of performing loans (or close to performing), particularly in  secured retail assets (2nd charges). This is an interesting trend because if you look at pricing, what we’re seeing is that the banks are now able to sell assets at closer to where they may be provisioned reducing any adverse impact on capital.  We think we’ll see this trend continue. We think the challenger banks are also seeing this as a good opportunity to acquire mortgage assets and customers at a price that’s competitive to originating new mortgages through the usual channels. Our house view on the total UK market is around the £15-20 billion mark with the potential to go above £20 billion with an increase in average portfolio deals which has been the trend with a number of very large portfolios coming to the market.

Summary

Overall, in the market, over €90 billion was traded last year and, so far with around €40bn of transactions already in progress across Europe, 2015 is shaping up to be another strong year for portfolio sales. We expect overall transaction levels to be up on 2014.