Non-Performing Loans: Basics and Recent Developments

What is a Non-performing Loan?

Both companies and individuals may, for various reasons, default on their bank loans. If this continues for a more extended period (in other words, it is not an occasional delay in the monthly repayment), banks may be forced to classify it as a non-performing loan or an NPL.

Banks are subject to strict rules about when and how a loan can be put into an NPL category. Essentially, under European regulations, a loan becomes non-performing when there are indications that the borrower is unlikely to repay the loan or if more than 90 days have passed without the borrower paying the agreed installments. This may happen when an individual loses their job and therefore cannot repay their mortgage as agreed or when a company experiences financial difficulties.

Why are NPLs bad?

If a bank has too many NPLs on its books, this will reduce its profitability because they generate losses. In addition, to prepare for these losses, banks need to create provisions in their books; that is, they need to put aside money to cover the losses they expect to incur. These funds are, therefore, no longer available to provide new loans or to absorb other losses. This further reduces banks’ earnings and weakens their condition.

What Steps Might Banks Take?

Banks follow pre-determined lending criteria to properly assess the creditworthiness of borrowers to ensure that loans are only granted to customers who are likely to repay them. Despite these steps, banks tend to accumulate a sizeable portion of NPLs. As of December 2021, the level is 3% of all loans in Hungary and 4.2% among mortgage loans.

Once the amount of NPLs within a particular bank’s portfolio becomes very high, the tendency is to sell off the non-performing loans at a significant discount either one by one (this is typically only the case for loans to companies) or in a larger package (this happens both for corporate loans and loans to individuals).

Depending on how the sale is structured, borrowers are typically notified of the sale and do not have a say in the transaction; once informed, they automatically owe their debt to the entity that has bought their loan. The buyer is usually a non-bank entity that is subject to less strict prudential rules than banks and is, therefore, able to hold the NPLs on its books. After acquiring an NPL, the buyer will typically either try to come to an agreement with the borrower or, if that is not successful, it will enforce the security behind the loan (for private individuals, this is typically a mortgage over their property), acquire the mortgaged asset and then sell it off.

Hungary’s Current Picture

While the overall NPL rate of Hungarian banks was above 10% in 2015, by the third quarter of 2021, it has dropped to 3%. Between 2016 and 2019, several banks sold off large NPL chunks, thereby reducing the overall NPL rate. After the coronavirus epidemic started in early 2020, the National Bank of Hungary introduced a debt moratorium for companies and consumers. Between March 2020 and October 2021, all borrowers were automatically relieved from their obligation to pay their loan installments unless they expressly indicated that they wanted to continue paying. This also meant that non-payment did not result in a default under the loan agreements and these loans did not count towards the NPL rate of a bank (or the overall NPL rate).

From November 2021, the automatic general moratorium no longer applies. That said, pensioners, families expecting or raising children, those on public work schemes, and people whose incomes have fallen compared with the previous year are still eligible for continued participation in the moratorium until June 2022. Companies could also request a continuation of their moratorium if their turnover had fallen by at least 25% in the previous 18 months.

In practice, this means that significant numbers of Hungary’s borrowers have not had to pay back installments on their loans for two years. This has kept the NPL rate artificially low. It is widely expected that, after the moratorium ends (this is currently foreseen to happen in June 2022), hundreds of thousands will face difficulties in restarting their repayment regime, with an increased rate of inflation not helping the process. This will likely result in a gradual increase in the NPL rate from Summer 2022. From 2023 to 2024, it is expected that the Hungarian NPL market will be reactivated, with banks once again starting the process of selling off NPL packages to debt collection companies and other investors.

This article was first published in the Budapest Business Journal print issue of March 11, 2022.