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A different kind of NPL wave is on the way

Bank Sign Above Door

The UK Government and Bank of England’s (BoE) extraordinary monetary and fiscal support averted a full-blown UK corporate insolvency crisis last year. But a new wave of non-performing loans (NPLs) is merely delayed.

For many corporates, the cost of survival has been to load on more debt voluntarily. At the latest count, the Government’s flagship coronavirus loan schemes have extended £71.5bn to more than 2.1 million SMEs. Further, the BoE currently has an outstanding direct investment of £12.1bn in 50 large UK companies’ corporate debt, as at late January. Without these measures, an estimated 12% of UK firms would have failed due to the lost revenues causing a cash flow crisis. According to credit risk specialist Euler Hermes, this would have increased unemployment by five million, equal to an 18.8% headline unemployment rate, which would have been the highest level since before the Second World War.

All this extraordinary state intervention has created an artificial protective bubble. It has also provided safe harbour for underperforming SMEs. The number of annual UK company insolvencies fell to a 31-year low in 2020, at 12,557, according to The Insolvency Service. Several influences explain this attenuated market attrition of uncompetitive corporates. These include the government loan schemes, reduced HMRC enforcement, a creditor enforcement moratorium, and regulatory pressure on lenders to exercise forbearance. But, when government support tapers, three likely consequences will emerge: corporate insolvencies (UK insolvency rate is forecast to increase by 43% in 2021); a new generation of non-performing loans (NPLs); and possibly more ‘zombie companies’, where cash flows are only sufficient to cover debt interest payments, stifling investment and productivity. In the remainder of this article, we will focus on the expected profile of the coming NPL wave, the environment for banks and investors, and the role of technology.

New NPLs unlike previous cycle

To begin with a simple observation: this time will be different. Unlike the previous real estate-driven cycle, a greater diversity of sectors, industries and behavioural changes will drive this NPL wave. For example, real estate landlords will suffer from rising tenant insolvencies and footprint shrinkage from retail to office as tenants seek to reduce operating costs and adapt to expected shifts in working from home trends. Elsewhere, the aviation, transportation, tourism, leisure and hospitality sectors continue to face headwinds as severe lockdowns persist, while long-term demand assumptions are no longer reliable. Within these sectors, vulnerable companies will include those late to undertake necessary restructuring, those where demand reduction is permanent, and those with pre-existing structural challenges (whether sector headwinds or corporate-specific).

Banks will need to loosen capital requirements  

Banks’ loan books will obscure the full impact of Covid-19 until late 2021. NPLs will fall into two buckets: pre-Covid-19 secured loans already in distress; and Covid-19 unsecured loans, specifically those issued under the government’s Bounce Back Loan Scheme (BBLS). By late January, more than 1.4 million loans were extended, worth £44.7bn. In addition, more than 83,000 loans have been approved for top-ups, valued at £0.74bn. Bank capitalisation is much better – and regulators have increased the financial system’s resilience since the global financial crisis – but they are still constrained. First, clearing banks are all focused on maximising loan recoveries from existing loan book exposures and commitments under the government’s coronavirus loan schemes. Second, regulatory capital against lending constrains banks. There is a clear trade-off between financial stability and banks’ ability to lend. The transfer of banks’ Covid loans to a third-party bad bank has been mooted. If this were to happen, it would further free up banks’ regulatory capital which could be recycled into new lending to provide corporates with a lifeline. Third, bank NPL departments are constrained. Banks are scaling-up debt collection capacity via automation (BBLS via Debt Collection Agencies)to prepare for NPLs to come, aligned to the unwinding government loan schemes and other protections.

NPL investors will need specialist expertise

Many of these NPLs, without the luxury of enforceable collateral, will require restructuring and turnaround expertise – from forensic due diligence to discounted cash flow analysis and debt collection to corporate restructuring. For example, for NPLs against hospitality and leisure, debt buyers will need to develop a turnaround strategy to revive the business. Rather than the workout of a specific defaulted loan (as was customary in the last cycle), a broader corporate restructuring may be more suitable to the current cycle and circumstances. For cross-border NPL transactions, the complexity multiplies. Depending on where the NPL businesses are located, different legal and regulatory frameworks will apply. Also, mobility restrictions, state loan schemes and other moratoriums will all unwind at a different pace; all of these issues feed back into the pricing consideration.

Digitalisation has matured NPL sector

Digitalisation has helped the broader European NPL sector mature, further accelerated by the rapid adoption of technology through the pandemic. A digitalised NPL process will help create larger and more standardised datasets, with improved analytics and due diligence tools powered by artificial intelligence, and compliance with GDPR data protection regulations. All of which has helped to reduce the bid-ask spread, increase the universe of potential NPL investors, and speed up the end-to-end process for deal assembly, sale process, execution, to post-sale workout and management.

We expect the NPL market to be slow to pick up pace, but could last for three years with a consistent flow of deals that balance banks’ competing priorities, financial stability, and lenders’ risk appetite.  BTG Advisory can assist and is well placed with an experienced team, and a track record of NPL portfolio delivery, to help with these issues when the market opens.  Loan portfolio management (

If you would like to talk about any of the themes discussed above, please get in touch.

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