investing in the french non-performing loan market...in comparison to its european neighbors who...

Untapped potentialInvesting in the French non-performing loan market

Minds made for shaping financial services

May 2019

Contents

Foreword 1

Economic backdrop 2

French retail credit market 4

Focus on NPL exposures 5

NPL market evolution 6

French NPL transactions 8

French debt servicers 9

Team 12

Team credentials 14

Foreword

Ajay Rawal Partner, EY Global Head of Bank Restructuring Ernst & Young LLP

Julien Denis Associate Partner,Valuations, Modelling & EconomicsErnst & Young Advisory

2018 saw a record-breaking year for European non-performing loan (NPL) transactions as deal volumes surpassed €220b.1 The Italian and Spanish markets recorded over €150b of portfolio sales. However in France, despite a total stock of over €130b in Q3 2018, sales volumes struggled to reach €5b in 2018.2,3 We believe the untapped potential of the French market will be realized over the coming months and years, as financial and regulatory pressures accelerate divestment.

The current state of NPL stocks on French banks’ balance sheets is in part due to the robustness of the economy during the global financial crisis and the European debt crisis that followed. France only suffered a relatively modest contraction of 2.9% in 2009 and returned to growth the following year. Consequentially, NPL formation was far lower than other European economies, such as Greece and Ireland, where NPL ratios increased to levels requiring large structural solutions.

Secondly, despite now having a material volume of NPLs, French banks have faced challenges with NPL divestment. The market is dominated by multiple decentralized mutual and co-operative banking unions, complicating the creation of transformative transaction strategies. Additionally, banks remain wary of the negative impact on their domestic reputation which may result from vast NPL transactions.

Neverthelesss, pressure for these Banks to divest is only likely to increase. Even France’s relatively low NPL ratio of just 2.9%, is weighing on capital and profitability amid a period of weak economic performance.4 Moreover, with the

implementation of IFRS9 and ECB/EBA directives on the horizon, French banks institutions will be under increasing pressure to derecognize their stocks of NPLs.

In anticipation of growing transaction volumes, an ongoing period of consolidation has emerged among the domestic NPL investors. Additionally, international debt purchasers have made acquisitions to develop and bolster their servicing capacities in France.

This document sets out the opportunities and challenges of investing in the French NPL market. In particular, we provide an overview of the economic context, the debt servicer and purchaser landscape and an overview of the regulatory and legal hurdles.

1 EY Research2 EBA Risk Dashboard3 EY Research4 EBA Risk Dashboard

1Untapped potential Investing in the French non-performing loan market |

Economic backdrop

The French economy fared better than all its Eurozone counterparts during the global financial crisis. GDP contracted by 2.9% in 2009, and had recovered to pre-crisis levels by the first quarter of 2011.5 This was a significantly faster recovery than other Eurozone economies, such as Italy, who are yet to achieve the GDP levels from over 10 years ago. The result was far lower immediate levels of NPL formation in France than were witnessed across the remainder of the Eurozone.

Growth from 2011 has been sluggish however, due to excessive imbalances caused by the increasing level of public debt and weak competitiveness.6 Policy measures taken in recent years have improved such imbalances and the French economy has been enjoying a period of improving growth rates, which are forecast to continue. The unemployment rate, one of the structural weaknesses of the French economy, is expected to decrease for a fourth year and reach 8.8% by the end of 2018.7

Benefitting from the low level of interest rates and enhanced consumer protection measures, the number of over-indebtedness filings continued to decrease significantly and reached 162,900, a 29% decrease compared to the levels of 2014.8

The consequence is that while French banks have a total NPL stock in excess of €130b, the second largest Europe, the economic backdrop has not created the same impetus for structural solutions as seen in other markets.

218.1 232.5 220.8 223.0 230.9 217.3194.2 181.1

162.9

0

50

100

150

200

250

2010 2011 2012 2013 2014 2015 2016 2017 2018

Number of Overindebtedness filings (000)

0%2%4%6%8%

10%12%14%

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

E

2019

F

2020

F

2021

F

2022

F

2023

F

Unemployment rate

France Euro Area

–6

–4

–2

0

2

4

6

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

E

2019

F

2020

F

2021

F

2022

F

2023

F

GDP Growth

France Euro Area

Source: IMF DataMapper

Source: IMF DataMapper

Source: Banque de France

5 EBA Risk Dashboard6 European Semester Country Report France (2017) — European Commission7 IMF DataMapper8 Banque de France

2 | Untapped potential Investing in the French non-performing loan market

Residential property marketWhile the French house prices have underperformed the Euro Area for the period 2007–2017, the negative deviations from the global financial crisis and the European debt crisis were somewhat limited and have resulted in the house prices in 2017 exceeding the pre-crisis levels.9 This trend has continued into 2018 with house prices in Metropolitan France growing by 3.2% year-on-year. Indeed the volume of second-hand dwellings sold in France has reached the highest level since 2000 with 960,000 dwellings transacted in the 12 months to Q4 2018.10

This contrasts sharply with those European economies with the highest NPL ratios. House price indexes for countries such

as Greece languish at levels significantly lower than pre-crisis levels while significant economic hurdles present a challenge in restarting growth.

These characteristics should make for encouraging reading for potential buyers and selling in the French NPL market. A liquid market with an upward growth trend presents an environment where assets will be easier to sell and amicable solutions with customers be more readily achieved — decreasing investors’ time to cash and increasing valuations.

0

20

40

60

80

100

120

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

European House Price Index (2007-2017)

Greece Ireland Italy Portugal Spain Euro AreaFrance

Source: OECD

9 OECD (2019), Housing prices (indicator). doi: 10.1787/63008438-en10 INSEE data, publication Number 48, published 28 February 2019


The French retail credit market is relatively concentrated when compared with other European markets. As of 2017, the largest six banking institutions have a total market share of over 89% of the Net Loans outstanding.11

Credit Agricole and Groupe BPCE dominate the domestic retail banking market, each with customer bases close to 30 million. While La Banque Postale and BNP Paribas have lower market penetration, they still command strong brand awareness.

While this level of scale appears to be favourable for effective NPL management, three of the largest institutions;

Crédit Agricole, Group BPCE and Crédit Mutuel are decentralized co-operative banking unions who delegate debt servicing strategy to their regional network. This results in multiple transactions of regional stock with low volumes and minimal competition. Many portfolios are sold through bilateral processes.

While the international banks have greater control over their overall strategy, many have only initiated the development of their domestic deleveraging plans more recently.

French retail credit market

16.8

13.4

8.5 8.16.4

5.35.4

3.4 2.91.5 1.4 0.7

CréditAgricole, LCL

Groupe BPCE CréditMutuel, CIC

Société Générale,Crédit du Nord

BNP Paribas La BanquePostale

Net Banking Income (NBI) and Operating Results of French Retail Banking (€bn, 2017)

NBI Opera�ng Result

Number of French customers (m, 2017)

2729.4

12 11.5

7.3

10.5

BNP ParibasCrédit Agricole, LCL Groupe BPCE Crédit Mutuel, CIC Société Générale,Crédit du Nord

La Banque Postale

11 SNL data, Net Loans defined as Gross Loans less Reserves on Loans


In comparison to its European neighbors who have been more heavily impacted by the recent financial crisis, France has managed to maintain a relatively low and decreasing NPL ratio (3.7% as of Q4 2016 and 2.9% as of Q3 18).12 While this improvement is encouraging — a sizeable proportion of this can be attributable to divestment strategies of French banks in other European markets, mostly notably in Italy. Significant

credit market growth in France has also contributed to the NPLratio decrease.

Despite these trends, the total NPL stock in France remainshighly significant at €130.2b as of Q3 2018 — the secondlargest in Europe.

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

120.0

125.0

130.0

135.0

140.0

145.0

150.0

Q416 Q117 Q217 Q317 Q417 Q118 Q218 Q318

France — NPL evolution (€b)

NPL NPL Ratio

Focus on NPL exposures

0%

5%

10%

15%

20%

25%

0

50

100

NPL ratio NPL stock

150

200

250

300

Q4

16

Q3

18

Q4

16

Q3

18

Q4

16

Q3

18

Q4

16

Q3

18

Q4

16

Q3

18

Q4

16

Q3

18

NPL stock and NPL ratio by country

Italy France Spain UK Germany Netherlands

12 EBA Risk Dashboard


NPL market evolution

Relative economic prosperity and structural challenges have translated into a nascent, but growing, French NPL market. This market has been characterized by limited competition and large volumes of restricted tenders. Adding to this — the

earliest NPL portfolios transacted were low quality and vendors seldom communicated coherent strategies on transaction size and timing to the market. This has led to an NPL disposal ratio of just 5%–6% of domestic NPL stock.13

Nascent market

Limited competition (restricted tenders)

Low activity volume

Low quality NPLs

Low intermediation

Growing market

Increased competition

Growing transaction volume

Improved NPL debt quality

Large participants.

Mature market

Active M&A market, high intermediation

Stable transaction volume

Assignment of better quality debt

Strong involvement of international banks

Step 1

Step 2

Goal

Despite this slow start, some encouraging trends have begun to emerge:

• Multiple French banks have formalized their sales processes, increasingly favoring auctions over bilateral transactions to enhance the level of competition and portfolio pricing. This, coupled with declaration of strategic transaction targets and timelines, has allowed for greater market investment.

• The domestic investors have undergone a period of consolidation to bolster their ability to capitalize on more sizeable portfolios. International debt purchasers

have also been active in acquiring domestic servicers to accelerate capability development ahead of anticipated portfolio transactions.

• Recently, vendors have extended the quality of assets disposed to higher quality secured portfolios. This has led to an increase in purchase price as a ratio of the Gross Book Value (GBV).

These trends have been pronounced and we expect these trends to continue.

13 EY Research


• Banks will have to face several new regulations that will considerably impact the level of provisions and capital requirements.

• The adoption of IFRS9 is likely to require banks to provide more heavily on non-performing loans.

• The EBA’s guidelines on management of non-performing and forborne exposures may also provide a further impetus for sales by increasing provisioning on newly emerged NPLs.

• In order to meet the new capital requirements, French banks will need to sell a greater share of their NPLs.

Regulatory pressure

• In the current low rate environment, banks are searching for new sources of value creation.

• Untreated NPL stocks have been weighing on the capital and profitability of the banks.

• NPL sales represent a potential opportunity as banks can realize immediate profits on non-profitable loans.

Search for value

• NPL stocks are expected to remain largely stable while internal collection and servicing teams at Banks are shrinking.

• Banks have demonstrated their plan to allocate resources to other areas in their core business and will not prioritize investment in human capital to replace diminishing collections and servicing teams.

Servicing capacity

Key drivers

• Historically, banks have been reluctant to outsource debt collection to third parties due to risks to their reputation and public image.

• Banks are now more likely to outsource and sell NPL portfolios as ethical agreements set by organizations such as La Fédération Nationale de l’Information d’Entreprise, de la Gestion des Créances et de l’Enquête Civile (FIGEC), can help to mitigate social risks.

Shifting attitudes

Despite a general adoption of the NPL disposal process, the level of maturity regarding transaction execution varies significantly between the French credit institutions.


FY18 assets for sale and sale processes Historically, the French market has been driven by a significant number of small deals with purchase prices between €1m–€5m, with larger deals containing NPLs of a lower quality. In recent years, the size and volume of transactions have been increasing while the quality of the portfolio assets have been improving. This has been driven by sellers’ appetite for value creation, restructuring or completing run-off processes.

French NPL transaction volumes in 2018 were estimated to be c. €4b–€5b GBV, of which a significant portion was originated from the consumer finance sector. Pricing ranged between 1% of GBV for unsecured consumer NPLs, to 70% for higher quality

secured NPLs.14 A significant increase has been observed on unsecured NPLs while secured NPLs also increased in price due to the growth in investor appetite and recourse to auction tender offers.

The transactions in 2018 were predominantly spot sales with a few forward flows agreements in the consumer finance sector. Despite secured NPL sales gaining market share, our analysis highlights that c. 60% of the total transaction value in 2018 are still for unsecured portfolios.

2019 is expected to be another year of growth as a strong pipeline has already been identified.

French NPL transactions

Selected transaction (not comprehensive, indicative amounts)

Year Asset type Acquirer Seller type Indicative GBV

2017 Unsecured Confidential Consumer Finance entity 20

2017 Secured and Unsecured EOS Consumer Finance entity 450


2017 Secured and Unsecured EOS Run-off bank 60

2017 Unsecured Hoist Consumer Finance entity 50

2017 Secured and Unsecured Confidential Retail Bank 70

2017 Secured and Unsecured EOS Retail Bank 60

2017 Mortgage Confidential Run-off bank 100

2017 Secured and Unsecured NACC Consumer Finance entity 100

2017 Secured Confidential Run-off bank 50

2017 Unsecured and SME Confidential Retail Bank 150


2018 Unsecured Confidential Consumer Finance entity 1,500


2018 Secured and Unsecured Confidential Confidential 50


2018 Secured EOS Retail Bank 25



2018 Secured Hoist Run-off bank 100



2018 Secured EOS Run-off bank 125

2018 Unsecured EOS Consumer Finance entity 210

2018 Secured Confidential Run-off bank 20

14 EY Research


Debt servicer landscapeThe French credit management market is characterized by strong barriers to entry; debt servicers rely on long-standing relationships with vendors such as banks and large corporates, and need to be able to demonstrate a significant track record. With the absence of a national credit bureau, each participant is required to develop their own historical statistics and credit data.

In the context of these barriers, the market is composed of c.400 participants, most of whom are domestic operators servicing local regions, but has been dominated by a handful of debt servicers with significant scale and experience in their respective asset classes. These servicers have also extended their role in the market to debt purchasing in recent years.

Over the last two years, many of the debt servicers have undertaken a strategy to diversify their capabilities across different loan types. Growth has been achieved both organically and also through acquisitions. Notable acquisitions include Contentia by EOS in 2016 and DSO by MCS in 2018: both achieved an expansion in capabilities and market footprint.

As yields tighten in other European markets, the incumbent participants are enhancing their capabilities in anticipation of a significant influx of competition from international credit funds and debt purchasers. Portfolio pricing is likely to be driven higher, pressuring returns, and the French debt servicers will need to consider their cost of funding.

French debt servicers


French debt servicers

Credit servicer Shareholder SMEs Secured Unsecured Headcount Comments

MCS Groupe and DSO Group

BC Partners

Montefiore c. 1,300

• Initially specialized in large-size SME loans

• Servicing and purchasing of both PL and NPL assets

• Acquired DSO in FY18

Intrum Justitia Public c. 700

• Initially a specialist for unsecured loans


• Merged with Lindorff in 2017

EOS Contentia Otto Group c. 550


• Acquisition of Contentia in 2016

RecocashVerdoso Individuals

c. 150

• Created in 1971

• Debt collection servicing platform

• Mainly focused on corporate clients

Hoist Finance Public c. 130

• Initially a specialist for unsecured loans

• Have recently diversified its activities to secured loans

• Servicing and Purchasing of both PL and NPL assets

NACC B2Holding c. 100

• Initially specialized in large secured loans and in French overseas

• Servicing and Purchasing of both PL and NPL assets

• Acquired by B2 Holding in 2018

Cabot Credit Management

Encore Capital Group (Nasdaq)

c. 100

• French subsidiary of Cabot Credit Management Group (UK based credit management service provider and NPL debt purchaser)

• Nemo was acquired by Cabot Credit Management Group in 2016.

1640 Finance Individuals <50

• Independent company created in 2010

• Servicing and Purchasing of NPL assets

• Mainly focused on consumer loans

Note: Secured refers to residential loans, unsecured relates to consumer loans.

Significant credit servicers


Deal type

Year Bidder Target Rationale Scale Scope Market entry

2011 EOS Credirec Entry into the French Market

2014 Cerberus MCS GroupeImproving MCS’s liquidity and supporting growth

2015Pragma Capital

NACCSupport ongoing growth and structure project financing

2015 AcofiLa Française IC2

Reinforcing credit management capabilities

2016Cabot Credit Management

Nemo Credit Management

Acquisition to facilitate ability to purchase French NPL portfolios

2016 EOS ContentiaExpansion on range of services to non-banking entities and debt purchase activities

2017 DSO Group EFFICOAcquiring expertize for consumer credit servicing

2017 Intrum Justitia LindorffExtending international footprint to France

2017 BC Partners MCSSupporting ongoing growth and structure project financing

2018 B2 Holding NACCSupport ongoing growth and structure project financing

2018 MCS Groupe DSO GroupConsolidating expertize and generating synergy

2018 MCS Groupe Serfin Geographical diversification

Consolidation of the credit servicing market


Team

| Untapped potential Investing in the French non-performing loan market12

Further informationFor further information, please contact one of the following or your usual EY contact:

Christoph Roessle

Partner

Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft

T: + 49 160 939 17475

E: [email protected]

Nuno Silva

Associate Partner

Ernst & Young, S.A

T: + 351 914 898 793


Portugal Germany

Julen Souto Bengoechea

Director

Ernst & Young, Servicios Corporativos, S. L.

T: + 34 690 68 0873


David Frias

Partner

Ernst & Young, Servicios Corporativos, S. L.

T: + 34 619 52 6610


Spain

Ajay Rawal

Partner

Ernst & Young LLP

T: + 44 7770 887 918


Saleem Malik

Associate Partner

Ernst & Young LLP

T: + 44 7341 079 228


UK

Julien Denis

Associate Partner

Ernst & Young Advisory

T: + 33 1 55 61 02 17


France

Ricardo Pires

Partner

Ernst & Young Advisory

T: +33 1 46 93 81 27



Erberto Viazzo

Partner

EY Advisory S.p.A

T: + 39 3481 911 479


Luca Cosentino

Partner

EY Advisory S.p.A

T: + 39 3356 081 314


Italy

Stelios Demetriou

Partner

Ernst & Young Cyprus Ltd

T: + 35 799 62 9728


Cyprus

Alan O’ Brien

Director

Ernst & Young, Chartered Accountants

T: + 353 122 12 386


Tassos Iossiphides

Partner

Ernst & Young Business Advisory Solutions SA

T: + 306 972 77 7799


IrelandGreece

Credentials


FranceProject IndigoLead sell-side advisor on the sale of a secured portfolio for a leading bank.

ConfidentialEY advised a leading consumer finance institution on the definition of its NPL divestment strategy.

SpainProject ZipLead sell-side advisor on the sale of a secured portfolio for a leading bank.

Project VoyagerProvided valuation services to a bidder on a non-performing portfolio with an unpaid balance of c.€760m.

Italy

Project Fino Lead buy-side advisory in relation to the potential acquisition of a non-performing Corporate/SME portfolio of c.€20b.

Project Sun EY advised Banco BPM on the sale of two unsecured bad-loan portfolios totalling c.€1.8b to J Invest SpA and Hoist Finance AB.

Ireland

Project Glas Lead sell-side advisor on the disposal of a c.€2.2b portfolio of non-performing buy-to-let and principal dwelling home mortgages.

ConfidentialEY teams provided buy-side portfolio diligence and deal co-ordination in relation to the acquisition of a c.€1.1b loan portfolio.

GreeceProject AmoebaEY teams provided sell-side support on data remediation, Real Estate revaluation and transaction structuring.

Project ArctosLead sell-side advisor on the disposal of an unsecured portfolio of c.€2b.

UK

Lloyds Banking GroupAppointed as the ongoing sell-side advisor. Advised LBG on multiple deals with transaction values exceeding £6b.

Project YasminSell-side advisory on the secondary sale of a consumer unsecured debt portfolio.

Other

Multiple CEE TransactionsEY teams provided buy-side due diligence in relation to the acquisition of multiple non-performing secured portfolios totalling over €1b.

Major German LendersProvided sell-side valuations and transaction support advisory services on multiple shipping transactions totalling over €15b.

EY is a proven leader in the European loan sale market. The European Loan Portfolio Solutions Group has led multiple buy-side and sell-side engagements across the continent in addition to strategic and product reviews of various portfolios.

Notes


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