• Max Hagelstein

Could 2021 see the NPL market spring back to life?

Many of Europe’s banks have spent the last decade winding-down their GFC era non-performing loans (NPLs) from their balance sheets. But is the pandemic about to reverse the progress made in that area such that we see real estate NPLs rise again in 2021 and beyond?

ING economist Teunis Brosens pointed out in a recent article that ‘defaults and NPLs’ have been ‘deceptively quiet’ across the board in 2020 despite the economic turmoil. But concluded that a sharp increase in NPLs is a question of ‘when, not if’, with some countries and markets being hit more than others.

A multitude of factors have NPL volumes muted in spite of the pandemic. Massive support from governments in the form of tax deferrals, furlough schemes and grants have helped prevent corporate distress and artificially protected asset valuations. These have yet to fully adjust to new post-Covid levels. Other factors have delayed asset prices from resetting: low levels of transaction volumes/comparables, daily traded property funds gating investor redemptions hence preventing forced sales. Lenders have also played their part with a general attitude of leniency and willingness to work with borrowers.

But this will not last forever. As the availability of vaccines moves ever closer, government support schemes will wind down and likely be gradually replaced with tax rises and austerity. Lenders’ willingness to collaborate with borrowers will also fade away as default interest accrues and there is less social pressure to support real estate borrowers. Asset values of non-prime real estate will likely adjust downwards in 2021, leading to higher LTV ratios, covenant breaches and enforcements.

Much of what happens will be different depending on the type of finance, the real estate sector, quality and geography. We expect the highest levels of distress in economies where real estate is most exposed to hospitality, tourism, leisure and retail.

We also expect a lot of distress to come from loans that have reached maturity and are difficult or impossible to refinance - maturity defaults, which are not technically NPLs but are similar. This will be acute in the more sensitive assets such as hospitality and retail. Refinancing will be especially tricky because valuations will be volatile and lenders will react accordingly.In practice we believe that this environment will trigger a wave of secondary loan trades, some at discount to book value.

Overall however, institutional lenders will have less desire to lend into real estate, putting pressure on borrowers and pushing them towards pricier bridging, mezzanine or preferred equity to finance or refinance their positions. With major lenders pausing, non-bank lenders will be well positioned to provide liquidity, offering flexibility around leverage and structure, and facilitating workable solutions to the sponsor.

Rivercrown is positioned to finance credible business plans in need of time for stabilization. Structures will range from negotiating a new deal, debt for equity, or a wholesale restructuring across the capital stack. We will also look to acquire secondary positions – for example from banks selling parts of their loan books, something we expect to see much more of in 2021. We will leverage the combination of our real estate and capital markets experience to invest across both public and private markets.

Even with vaccines now on the horizon, economic activity is unlikely to normalize in the near-term. As the real impact of the pandemic on real estate reveals itself, asset valuations and LTVs are likely to shift in a way that will inevitably create distress. The good news is workable options are available for both lenders and credible borrowers.

Max Hagelstein is Head of Equity at Rivercrown