After more than a year of low transaction levels, wary buyers and reluctant sellers, the global market in institutional debt portfolios is set for a revival in 2011, according to a new market review from KPMG’s Portfolio Solutions Group.
The report shows that banks across the world have been slow to put their poorly-performing or non-performing loans on the market, preferring instead to develop longer term strategies for servicing and disposing of these assets.
But, driven in many cases by pressure from regulators to remove non-performing loans from their balance sheets and improve capital ratios, banks are preparing loan books for sale and are increasing the lines of finance they are prepared to provide to prospective buyers.
Pricing has been a major barrier to loan sales in the 12-18 months, with buyers adopting more rigid investment and servicing criteria even for performing loan portfolios, and banks reluctant to accept the consequent prices on offer.
This mismatch in expectations has been worsened by the impact of the sovereign debt crises in Europe. Widening bond yield spreads between the more stable EU countries and those in serious economic difficulty, have allowed speculators to trade these assets as if they were distressed investments, often achieving returns of 15 percent or more.
The effect has been to push up the expected rate of return on non-government assets, perceived to be less secure. In some cases, buyers have dropped out of the loan portfolio market altogether, citing reluctance to spend the resources necessary to price illiquid assets.
“The lack of buyers has been a problem,” says Stuart King, a member of the Portfolio Solutions Group and a partner in KPMG in Spain. “But the signs are that the improving economic outlook has brought about stabilization in default rates among both corporate and consumer clients, and that non-performing corporate loans are being provisioned and losses updated.
“Consequently we are seeing a reduction in book values and bid/ask spreads for defaulting loans. With more finance on offer from sellers, the market is beginning to free-up, with traditional financial investors able once more to focus on lower quality and difficult-to-manage assets.”
This slow economic improvement is being complemented by widespread action from regulators aimed at restoring bank balance sheets to health.
Throughout the EU, banks that have received state aid are being required to undertake some form of restructuring which can involve a reduction in their holdings of risk-weighted assets, while also conforming to the tougher capital requirements of the forthcoming Basel III regulations.
In the US, the Federal Reserve Board, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation have all imposed new capital adequacy and asset quality ratios. Nevertheless, it may not be easy for banks to meet these requirements in the current market, where the low prices achievable for loan portfolios may make it difficult to achieve the necessary improvements in levels of capital.
Financial authorities in Korea have adopted a similar approach, while in Thailand the Thai Asset Management Company (TAMCO), a state-owned agency created in 2001 to manage the growing issue of non-performing loans, is the subject of intense market scrutiny to see what will happen to its portfolio.
“All the signs are there for an increasingly active loan market in 2011,” says KPMG. “Elsewhere, we are seeing a slow increase in the number, and sometimes the quality, of assets on offer. For those with capital to spare and an appetite for risk, this could prove to be a very profitable year.”
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