Creating Value From bad Loans
Bad loans – or legally speaking, non-performing loans (NPLs) – may have a negative sounding name, but they are assets that can create significant profits for investors.
The NPL industry worldwide is massive, and made up of institutional investors (funds) and professional investors (debt management companies). In the hands of an experienced investor, a loss-making loan can be turned into an asset producing double-digit profits.
Banks sell bad loans because it is expensive to keep them on their books. Investors buy bad loans because they are not subject to the same regulatory regime as banks, and because they are usually willing to take more risks than banks.
Until recently, the NPL industry in Hungary was small. No portfolios were sold, only a few single assets existed, and sales prices for NPLs were not attractive. Then, in 2014, foreign investors appeared in Hungary and pioneered the first NPL deals. Since then, the Hungarian market has become home to all the international players: Bank of America, CarVal, Balbec, APS, Deutsche Bank and many more. Sellers include CIB/intesa, Raiffeisen, Unicredit and Erste Bank.
The portfolios to be sold are either corporate or retail/consumer loans. Retail portfolios are more complicated to acquire because both seller and buyer must pay special attention to consumer protection laws. Corporate loans (or “connections”) usually number in the hundreds, while retail loans number in the thousands.
The loans in the portfolio are either “terminated” or “live” (live means the debtor is in default but the contract has not been terminated.) Of the two, terminated loans are easier to sell because only outstanding receivables must be transferred once a loan agreement is terminated.
Under the advice (usually) of Deloitte, PwC or ZolfoCooper, sellers issue competitive tenders for the sale of their NPL portfolios, and those bidders offering the best price and contractual terms will win. Each transaction takes roughly four months, and the documentation is often complex. Furthermore, buyers in Hungary need a financial license, which may add more complexity and delays.
But how do you buy or sell an NPL asset? There are several options, and the legal solutions depend on a variety of questions. Is it a portfolio or a single asset being sold? If a portfolio, is it retail or corporate?
Legal solutions are evolving with each new transaction, and Hungary’s Parliament has helped players by enacting new NPL legislation that allows for both terminated and live portfolios exceeding HUF 10 billion in value (or consisting of at least 20 contracts) to be transferred from seller to buyer with the approval of the National Bank of Hungary (MNB). This law solves two legal problems: firstly, without it, live contracts could not be transferred without the debtor’s consent, which would be impossible in the case of portfolios of thousands of loans. Secondly, the law now makes it possible for unconventional security interests such as security assignments, options and prompt collection rights to be transferred with the loans.
But this law has one unattractive feature. A transaction may only be closed when approved by the MNB, and the approval time can take up to five months.
Therefore, buyer and seller often chose a simpler solution: the assignment of receivables, which is a simple contract requiring no MNB approval.
A third legal solution is transfer of contract, which is a three-party agreement regulated in the new Civil Code between buyer, seller (or creditor) and debtor. This solution does not require MNB approval, but it does need the consent of the debtor, so this solution cannot be used in cases involving numerous debtors or when there is only debtor but he/she is not willing to sign the transfer contract.
Hungarian lawyers are on the steep-end of the learning curve with NPL transactions, working to simplify and speed up deals. One of our United Kingdom clients, an experienced investor who does billions of euros’ worth of NPL deals each year in the London market, says that a NPL deal need not take longer than a couple of weeks to conclude. We, in Hungary, are working towards that level of experience, and hopefully we will get there soon.
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