NPL Strategy

From Open Risk Manual

Definition

An NPL strategy encapsulates the overall objectives and approach for any entity managing material Non-Performing Loan portfolios.

NPL strategies differ significantly depending on whether the management of NPL assets are considered part of the business model (e.g. specialized distressed asset investors) or not (e.g. typical banks), the nature of credit assets (retail versus wholesale) etc.

Strategy Elements Overview

An NPL strategy should encompass, at a minimum, time-bound quantitative NPL targets, supported by a corresponding comprehensive operational plan. It should be based on a self-assessment and an analysis of NPL strategy implementation options. The following high level points are recommended as core NPL strategy elements[1]

  1. Assesment of the operating environment, including
    1. internal NPL capabilities to effectively manage, i.e. maximise recoveries, and reduce NPLs over a defined time horizon
    2. external factors impacting NPL workout and
    3. capital implications
  2. Development of detailed NPL operational plan, including
    1. targets in terms of development of operational capabilities (qualitative) and
    2. projected NPL reductions (quantitative) over the short, medium and long-term time horizons
  3. Implementing the operational plan, including any necessary changes in the organisational structure
  4. Fully embedding NPL strategy into the management processes, also including a regular review and independent monitoring

Self-assessment of internal capabilities

  • Scale and drivers of the NPL profile:
    • the size and evolution of its NPL portfolios on an appropriate level of granularity, which requires appropriate portfolio segmentation
    • the drivers of NPL in-flows and out-flows, by portfolio where relevant
    • other potential correlations and causations.
  • Outcomes of NPL actions taken in the past:
    • types and nature of actions implemented, including forbearance measures;
    • the success of the implementation of those activities and related drivers, including the effectiveness of forbearance treatments.
  • Operational capacities (processes, tools, Data Quality, IT/automation,staff/expertise, decision making, internal policies, and any other relevant area for the implementation of the strategy) for the different process steps involved, including but not limited to:

Management Options

Examples of NPL management options, not being mutually exclusive, are:

  • Hold/forbearance strategy: A hold strategy option is strongly linked to operating model, forbearance and borrower assessment expertise, operational NPL management capabilities.
  • outsourcing of servicing and write-off policies.
  • Active portfolio reductions: These can be achieved either through sales and/or writing off provisioned NPL exposures that are deemed unrecoverable. This option is strongly linked to provision adequacy, collateral valuations, quality exposure data and NPL investor demand.
  • Change of exposure type: This includes foreclosure, debt to equity swapping, debt to asset swapping, or collateral substitution.
  • Legal options: This includes insolvency proceedings or out-of-court solutions.

References

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