The guidance comes in the form of EU Directive (EU) 2021/2167 on credit servicers and credit purchasers (also known as the NPL Directive). The NPL Directive took effect 28 December 2021 with the deadline for implementation in all member states being 29 December 2023.
The new rules could be a factor in an increased business for specialised credit servicers supporting banks that lack expertise to properly service NPLs or are overloaded with NPLs.
Useful terms
- A non-performing loan is a bank loan that is more than 90 days due or that the bank considers is unlikely to be repaid by the borrower.1
- Credit purchasers buy the NPL from the bank or other credit purchasers as an investment. They often delegate the servicing of the NPLs to credit servicers.
- Credit servicers manage the administration of NPLs on behalf of credit purchasers by recovering payments, renegotiating loan terms, and notifying borrowers of any interest rate changes or charges relating to the loans.
- Credit service providers are third parties to whom credit servicing activities that would normally be undertaken by that credit servicer are outsourced.
Why the NPL Directive is needed
Following the global financial crisis in 2008, the NPL ratio in the EU increased from approximately 3% to a peak of around 8% in 2014.2 Since then, the EU has been working towards reducing the amount of NPLs held by banks for a number of years in order to keep credit flowing. In 2018, European NPL sales hit a peak of €208.2 billion and the NPL ratio across Europe had returned to 3% by June 2019.3 However, in the aftermath of the COVID-19 pandemic, NPL sales fell to a four-year low of €67.7billion4, and households and businesses which encountered financial problems as a result of the pandemic have been less likely to repay their loans. High levels of NPLs held on a balance sheet limit a bank’s capacity to provide further lending and reduces profitability due to NPLs generating lower income than performing loans.
In its proposal for the Directive, the Commission suggested that banks with high volumes of NPLs and/or lacking the expertise to properly service NPLs should either outsource the servicing to specialised credit servicers, or to sell the NPLs to credit purchasers in the secondary market with the requisite expertise and risk appetite to manage and “workout” the NPLs.5 However, the lack of a common framework for credit servicers and credit purchasers has led to variations in business models and insufficient competition among servicers, resulting in high credit-servicer fees and banks receiving low prices for NPLs sales.
The Directive is designed to develop the NPL secondary market by introducing a common set of rules for the key parties: credit servicers and credit purchasers. The rules will increase competition between credit servicers which will drive down credit servicing costs, and subsequently lower the cost of entry for potential credit purchasers. With greater accessibility, the NPL market will be more attractive to credit purchasers and should lead to increased demand and higher NPL sale prices. For credit servicers, the increased activity should result in more business and a more competitive market.
Key elements
The Directive sets out a regulatory framework for credit servicers and credit purchasers.
Credit servicers: The key elements for credit servicers include:
- Obtaining authorisation from the home member state to carry out credit servicing activities. Member states are required to publish a list of authorised credit servicers. Credit servicers authorised in one member state can provide credit servicing activities in other member states provided it notifies the original authorising member state.
- Notifying borrowers of an NPL sale and ahead of the first debt collection, providing specific information, including the date of transfer, identification, contact details and authorisation of the new credit servicer or credit service provider. The credit servicer must also avoid misleading borrowers.
- Keeping records for a period of 10 years of all correspondence with the credit purchaser and the borrower, all instructions received from the credit purchaser, and all instructions provided to credit service providers.
These rules do not apply to servicers of NPLs originating from a non-EU bank, or if the credit servicing activities are carried out by an EU credit institution (such as the bank itself), fund managers, UCITS investment companies or a credit servicer that is supervised by a state authority.
Credit purchasers: For credit purchasers, the key elements include:
- Creditors (i.e., sellers) must provide all necessary information to credit servicers before entering a contract to transfer a credit agreement, including the likelihood of recovery of the value of the NPL prior to the sale, the creditor’s rights under the NPL agreement, and, if applicable, information regarding the collateral.
- Credit purchasers must provide the relevant member state authority with details of the appointed credit servicer.
- Credit purchasers must inform the relevant member state authority if it transfers a credit agreement to another credit purchaser.
- A non-EU credit purchaser acquiring EU originated NPLs must designate a representative that is established in the EU. The representative will be responsible for the credit purchaser obligations.
The Directive does not apply to NPL acquisitions by EU credit institutions (such as banks), or purchases which complete before the Directive is implemented by the relevant member state.
Credit purchasers and credit services will be supervised and sanctioned by a competent authority (to be appointed by the member state on implementation of the Directive). The supervising powers are wide-ranging, including the granting and withdrawing of authorisation, carrying out investigations, requiring credit servicers to modify internal governance, and imposing penalties for failure to comply with the rules.
Practical considerations
While the ECB opinion on the Directive supported it as a means of developing the secondary market for loan assets, it noted that careful consideration would be required as to whether or not it would impede the efficient functioning of the market. Member states have until 29 December 2023 to implement the Directive, which leaves two years for the industry to assess the impact and opportunities it presents, therefore all eyes will be on the practical consequences of the measures required. In our view, it will be key to the successful implementation of the Directive (and the achievement of its aims) that it facilitates the trading of NPLs rather than introduces more red tape, but it is clear that various key issues are still to be worked through during the implementation phase.
In terms of the portfolio sales process itself, all parties will have questions at this stage around how they are to conduct a portfolio trade (and how they are to conduct themselves). For example, from a purchaser’s perspective, licenced credit servicers will need to comply with conduct of business rules towards borrowers. Whilst in the context of consumer debt, the requirements are laudable, it remains to be seen what implications the debtor protections will have in the context of a commercial loan to an astute counterparty looking to frustrate a transfer of its loan, or to hamper enforcement action post-sale. On the other hand, selling banks will be required to provide all necessary information to credit purchasers to enable them to assess the value of the loan assets offered for sale and the likelihood of recovery. It remains to be seen what will be achievable here, as the nature of loan portfolio sales invariably involves extensive efforts by sellers to retrieve information from internal storage media – some of which may not be complete or current. Will sellers be able to get comfortable that they have met this test? What warranty coverage will be sought or offered on these points?
Even the definitions themselves leave room for interpretation: for example, different market participants might reach different conclusions as to the distinction between ‘credit servicers’ and ‘credit service providers’ and whether or not their activities trigger any licensing requirements. Some uncertainty persists as to the categorisation of NPLs (and how sales of combined portfolios comprising NPLs and performing loans are to be dealt with). These are material points. For those jurisdictions that already have NPL or credit servicing laws of their own, it will be necessary to see how their lawmakers accommodate the Directive and what this means for their existing requirements; it may open up a need to navigate two-track systems in some countries, depending on whether loans are within the scope of the Directive. It will be interesting to see whether this has an impact on the composition of portfolios.
Timeline
Member states must adopt measures to implement the Directive by 29 December 2023 and enforce those measures from 30 December 2023.
For entities already carrying on credit servicing activities on 30 December 2023, they must obtain authorisation under the Directive by 29 June 2024.
- https://ec.europa.eu/
- https://www.ecb.europa.eu/
- https://events.debtwire.com/
- https://events.debtwire.com/
- https://eur-lex.europa.eu/
Client Alert 2022-019
