NPL Risk Factors

From Open Risk Manual

Definition

NPL Risk Factors denotes, in broad terms, the risk factors affecting the eventual performance of Non-Performing Loan portfolios, i.e. the degree to which the creditor will recover the scheduled cash flows of a loan or credit product

Some NPL risk factors may be common with those affecting the Credit Risk of performing exposures, whereas other might be specific to credit obligations that are already non-performing

The relevance and importance of NPL risk factors depend on

  • the type of NPL portfolio: retail/corporate, secured/unsecured, etc.
  • the entity managing the NPL portfolio (bank, investor) and the context / objective

Indicative List

A general indicative list applicable to banks is implicit here[1]

The Macroeconomic Conditions

Macroeconomic conditions play a key role in the performance of NPL. Such conditions are essentially dynamic in nature. They include both the general economic conditions and more specifically

  • the dynamics of the real estate market (or other assets where those are used as collateral) and its specific relevant sub-segments
  • relevant sector concentrations (e.g. shipping or agriculture)

The Regulatory, legal and judicial framework

National as well as international regulatory, legal and judicial frameworks influence the banks’ NPL strategy and their ability to reduce NPLs.

For example:

  • legal or judicial impediments to collateral enforcement influence a bank’s ability to commence legal proceedings against borrowers or to receive assets in payment of debt and will also affect collateral execution costs in loan loss provisioning estimations. Therefore, banks should have a good understanding of the particularities of legal proceedings linked to the NPL workout for different classes of assets and also in the different jurisdictions in which they operate where high levels of NPLs are present.
  • the average length of such proceedings
  • the average financial outcomes
  • the rank of different types of exposures and related implications for the outcome (for instance regarding secured and unsecured exposures)
  • the influence of the types and ranks of collateral and guarantees on the outcomes (for instance related to second or third liens and personal guarantees)
  • the impact of consumer protection issues on legal decisions (especially for retail mortgage exposures), and the average total costs associated with legal proceedings.


Furthermore, the consumer protection legal environment should also be borne in mind as it also plays a role in client communication and interaction.

Market Expectations

Expectations of external stakeholders (including but not limited to rating agencies, market analysts, research, and clients) with regard to acceptable NPL levels and coverage determine how far and how fast high NPL portfolios should be reduced. These stakeholders will often use national or international benchmarks and peer analysis.

NPL Investor Demand

Trends and dynamics of the domestic and international NPL market for portfolio sales will help banks make informed strategic decisions regarding projections on the likelihood and possible pricing of portfolio sales. However, investors ultimately price on a case-by-case basis and one of the determinants of pricing is the quality of documentation and exposure data that banks can provide on their NPL portfolios.

NPL Servicing

Another factor that might influence NPL performance is the maturity of the NPL servicing industry. Specialised servicers can significantly reduce NPL maintenance and workout costs. However, such servicing agreements need to be well steered and well managed by the bank.

The Tax Regime

National tax implications of provisioning and NPL write-offs may also be an influencial NPL factor

Issues and Challenges

  • NPL risk is not normal part of the business model of banks and there is significantly less developed framework for understanding and managing NPL portfolios versus performing credit assets

References

  1. ECB: Guidance to banks on non-performing loans, March 2017