Shining a Spotlight on Looming Credit Risks - One Year of the Credit Secondary Market Act
Authored by Jürgen Sonder and Ludwig J. Weber
Growing Secondary Market for Defaulted Loans Boosts Financial Resilience
Cracking the Whip on Financial Instability
Insomuch as geopolitical strife and economic woes hang heavy, one man stands tall: Michael Theurer, a board member of the German Federal Bank, deems it crucial to fortify our financial system. "Our top priority must be a strong financial system," he declared at the 2024 Financial Stability Report launch on November 21st.
But what of the real economy, the beating heart of our society? In times of uncertainty, a robust financial market aids in weathering crises. Sadly, the insolvency count has risen to pre-pandemic levels, foreshadowing a grim economic future in 2025.
Spotlight on Property Investments
The findings from the current edition of the NPL Barometer by the Federal Association of Credit Acquisition and Servicing (BKS) and the Frankfurt School of Finance & Management offer a grim portrait: Non-performing loans (NPLs) are poised to spiral upwards, plaguing all asset classes, particularly consumer credit, small and medium-sized enterprises, and commercial real estate—an area gaining the focus of the Bundesbank, and a segment in which forced administration presents advantageous options for banks.
Prevention: The Champion Against Peril
Each year, the BKS estimates that German banks could grapple with a staggering 40 billion euros worth of NPLs across industries. Credit risks, thus, become a mounting concern for financial institutions. Prevention, as always, is the best weapons against potential financial peril. A fully operational and professional secondary market for NPLs can provide valuable support to the financial sector, preventing a disastrous self-propagating downward spiral.
One Year of the Credit Secondary Market Act
The EU directive on credit services and credit purchasers also plays its part, marking a significant step towards devising a harmonious legal framework for the secondary market across Europe. Originally drafted in 2021, it was birthed as the Credit Secondary Market Act (KrZwMG) in Germany, going into effect on December 30th, 2023. The KrZwMG introduces new obligations for credit institutions and NPL purchasers, demands for credit service providers, and their supervision by the BaFin.
The Spotlight on Credit Service Providers
Under the KrZwMG, credit service providers now need a permit from the BaFin to conduct their activities within the secondary market. Licensed providers are then enabled to function as credit service providers within the EU. The BKS, representing the largest portion of the German secondary market for NPLs in terms of transaction volume, has already ensured full compliance with the KrZwMG by the summer of 2024.
The secondary market aids banks, savings banks, and state banks in pruning their balance sheets by offloading NPLs, leading to strengthened risk structures, improved liquidity, and expanded lending opportunities. Investors find allure in NPL portfolios due to the potential discounts on distressed claims, sought after as a risk-adjusted return. The chance to join the debtor company, either via a debt-equity swap or an insolvency plan, is an additional enticement for investors. Recovery prospects for the respective portfolios serve as the cornerstone of successful NPL transactions for both buyers and sellers. Professional due diligence evaluations help determine the yield potential and establish the price for NPL portfolios, ensuring accurate assessment of the claims themselves and the legal and financial risks attached. Acute crisis expertise proves instrumental in this regard.
Balancing Scales
This area is critical for banks in assessing their default risk, especially in cases involving corporate and real estate financing. When debtors experience financial difficulties, institutions must decide whether they can support the company's restructuring. Assessing the risk and selecting the appropriate restructuring approach must always be done on a case-by-case basis.
A Symphony of Experts
Just as in the handing of NPLs, expertise teams up with success to engineer the restructuring of struggling companies. This partnership has allowed the NPL balances of European and German credit institutions to diminish gradually, contributing significantly to financial market stability during the past few years—proof that the financial system has successfully weathered the aftermath of exceptionally high interest rates following the pandemic.
*) Jürgen Sonder is President of the Federal Association for Credit Acquisition and Servicing, a Senior Advisory Board member at the Intrum Group in Germany, and a member of the Supervisory Board at the Frankfurt Institute for Risk Management and Regulation. Dr. Ludwig J. Weber is a corporate financing and restructuring expert at the law firm Schultze & Braun. He counsels financiers and investors on assessing credit portfolios and NPL transactions.
Insights:
The Credit Secondary Market Act (KrZwMG) aims to facilitate the transfer of non-performing loans (NPLs) in Germany, functioning as part of broader European Union efforts to minimize NPLs across member states, especially since the financial crisis and the COVID-19 pandemic.
The KrZwMG:1. Simplifies the sale of NPLs for banks, supporting healthier balance sheets and reducing the risk associated with large NPL volumes.2. Enhances liquidity by allowing banks to use resources once tied up in NPLs for lending and other financial activities.3. Boosts investor confidence, contributing to increased investments in distressed assets and stabilizing the financial system.
In the NPL market, the KrZwMG:1. Increases transaction volume due to clearer and more favorable conditions for buyers and sellers, potentially leading to a wider range of investors, such as specialized debt funds and private equity firms.2. May lead to price stabilization as better liquidity and transparency can help in more accurate valuation of NPLs and smoother transactions.
- The rising insolvency count is a worrying trend, indicating a potential economic downturn in 2025, necessitating prevention measures to mitigate credit risks.
- The Credit Secondary Market Act, effective from 2024, is a key legislation aimed at reducing non-performing loans across industries in Germany, thereby strengthening the financial system.
- Finance institutions stand to benefit from the KrZwMG as it facilitates the sale of non-performing loans, fortifying balance sheets and reducing risk.
- Investing in non-performing loan portfolios in 2025 could provide attractive risk-adjusted returns, with recovery prospects serving as the basis for successful transactions.
