Distressed Debt
After a boom in 2006,the distressed debt business in certain European markets is dramatically decreasing. While the situation looks to improve slightly in 2008, the situation remains worrisome.
A Roland Berger Strategy Consultants trend study shows that banks in German-speaking countries expect the volume of bad debt transactions to decrease from about EUR 21 billion to roughly 7.5 billion this year. A slight recovery is expected in 2008, with a rise to EUR 10 billion. The greatest obstacles are the international financial crisis and the fact that buyers and sellers have completely different ideas about price, according to survey participants. Over half of the managers surveyed said that they wanted a stock exchange for bad loans, which would make trading simpler and more transparent. Other factors toward helping achieve a turnaround include improving the legal framework and further professionalizing the market.
The turbulence the recent US real estate market triggered in international financial markets has noticeably reduced banks' appetite for non-performing loans. But it in certain markets, like Germany, interest in them remains high. There, the total volume of distressed debt there is estimated to be about EUR 150 billion. In other European countries, such as Austria, for example, the market for these loans is hardly existent.
A Roland Berger Strategy Consultants trend study shows that banks in German-speaking countries expect the volume of bad debt transactions to decrease from about EUR 21 billion to roughly 7.5 billion this year. A slight recovery is expected in 2008, with a rise to EUR 10 billion. The greatest obstacles are the international financial crisis and the fact that buyers and sellers have completely different ideas about price, according to survey participants. Over half of the managers surveyed said that they wanted a stock exchange for bad loans, which would make trading simpler and more transparent. Other factors toward helping achieve a turnaround include improving the legal framework and further professionalizing the market.
The turbulence the recent US real estate market triggered in international financial markets has noticeably reduced banks' appetite for non-performing loans. But it in certain markets, like Germany, interest in them remains high. There, the total volume of distressed debt there is estimated to be about EUR 150 billion. In other European countries, such as Austria, for example, the market for these loans is hardly existent.
Many potential sellers, but hardly any buyers
Alexander Kainer, Project Manager in Roland Berger's Vienna office, explains: "It's immediately apparent that more than three-quarters of the banks active in distressed debt only sell such debt. Of the banks that we surveyed, none act solely as buyers." In 2006, only a fifth of credit institutions also acted as traders. Banks sell non-performing loans primarily to relieve their loan books or because they can sell at an attractive price. A desire to improve their own equity backing or credit rating was also mentioned as an important factor for a sale.
No viable market
In Kainer's opinion, "The fact that there is no functioning distressed debt market in Central Europe can't be due to a lack of volume." In Germany alone, the market is estimated to be about EUR 150 billion. A look at the US shows that this amount is more than sufficient: there, the bottom limit for funds that invest in distressed debt is as low as USD 500 million. Experts point to the fact that different price expectations (according to 88.9% of those surveyed) and a poor legal framework (72.2%) are at the root of Europe's overall reluctance to play a larger role in market. Thus 58% of the survey's participants would like to see an organized stock market for distressed debt. They feel that this would increase market transparency and make trading easier. But that would necessitate a strategic rethink, Kainer says. "Banks still don't have a clear idea about the details of organizing such a stock market, or who should bear the costs for making the necessary infrastructure available," according to Kainer.
Alexander Kainer, Project Manager in Roland Berger's Vienna office, explains: "It's immediately apparent that more than three-quarters of the banks active in distressed debt only sell such debt. Of the banks that we surveyed, none act solely as buyers." In 2006, only a fifth of credit institutions also acted as traders. Banks sell non-performing loans primarily to relieve their loan books or because they can sell at an attractive price. A desire to improve their own equity backing or credit rating was also mentioned as an important factor for a sale.
No viable market
In Kainer's opinion, "The fact that there is no functioning distressed debt market in Central Europe can't be due to a lack of volume." In Germany alone, the market is estimated to be about EUR 150 billion. A look at the US shows that this amount is more than sufficient: there, the bottom limit for funds that invest in distressed debt is as low as USD 500 million. Experts point to the fact that different price expectations (according to 88.9% of those surveyed) and a poor legal framework (72.2%) are at the root of Europe's overall reluctance to play a larger role in market. Thus 58% of the survey's participants would like to see an organized stock market for distressed debt. They feel that this would increase market transparency and make trading easier. But that would necessitate a strategic rethink, Kainer says. "Banks still don't have a clear idea about the details of organizing such a stock market, or who should bear the costs for making the necessary infrastructure available," according to Kainer.
Buyer's reputation critical for distressed debt deals
"Due to the legal uncertainty, the buyer's reputation plays a key role in trading distressed debt, aside from the price. Close personal contacts and trust are essential in this business," says Kainer. This is linked to the fact that the resale of loans not yet due is possible only with the agreement of the borrower. For banks, it is also important that their own reputation not suffer as a result of the sale and that the buyer is very experienced in the process. Specialized institutions are particularly cautious actors in this area, as they cannot afford to put their reputation on the line. They look for buyers with a high degree of restructuring competence to avoid negative effects on their business.
Almost all banks that participated in the Roland Berger study sell senior loans or have done so in the past. 63.2% of credit institutions emphasize guarantees, while 52.6% sell junior loans/mezzanine finance.
SMEs have more non-performing loans on their books
Dealing with bad loans can be far more difficult for SMEs than large companies. In 2006, companies with less than EUR 10 million in annual sales accounted for a quarter of the distressed debt in the banks surveyed. Companies with sales between EUR 10 and 100 million and those with sales between EUR 100 and 500 million accounted for 30% each. Only 15.9% of problem loans affected large corporations with sales of more than EUR 500 million.
Banks rely on internal early warning systems
To recognize distressed debt as early as possible and to assess the corresponding danger, most institutions rely on an internal early warning system. Furthermore, banks use default and non-payment criteria laid out in Revised International Capital Framework, known as Basel II, and the borrower's financial position to classify loans.
If you have questions or comments on this, or any other story, please do not hesitate to contact us:
"Due to the legal uncertainty, the buyer's reputation plays a key role in trading distressed debt, aside from the price. Close personal contacts and trust are essential in this business," says Kainer. This is linked to the fact that the resale of loans not yet due is possible only with the agreement of the borrower. For banks, it is also important that their own reputation not suffer as a result of the sale and that the buyer is very experienced in the process. Specialized institutions are particularly cautious actors in this area, as they cannot afford to put their reputation on the line. They look for buyers with a high degree of restructuring competence to avoid negative effects on their business.
Almost all banks that participated in the Roland Berger study sell senior loans or have done so in the past. 63.2% of credit institutions emphasize guarantees, while 52.6% sell junior loans/mezzanine finance.
SMEs have more non-performing loans on their books
Dealing with bad loans can be far more difficult for SMEs than large companies. In 2006, companies with less than EUR 10 million in annual sales accounted for a quarter of the distressed debt in the banks surveyed. Companies with sales between EUR 10 and 100 million and those with sales between EUR 100 and 500 million accounted for 30% each. Only 15.9% of problem loans affected large corporations with sales of more than EUR 500 million.
Banks rely on internal early warning systems
To recognize distressed debt as early as possible and to assess the corresponding danger, most institutions rely on an internal early warning system. Furthermore, banks use default and non-payment criteria laid out in Revised International Capital Framework, known as Basel II, and the borrower's financial position to classify loans.
If you have questions or comments on this, or any other story, please do not hesitate to contact us:
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