“In these unprecedented times” has become a staple phrase since the era of COVID-19 began, and for good reason. The changes we’ve seen have been mundane and grand, influencing everything from the smallest of daily activities to the largest of global economies. With these changes comes a huge wave of distressed debt, and a lasting impact on NPL markets both in the US and worldwide.
While the influx of distressed and criticized debt opens up new opportunities for NPL buyers, traders, and sellers are leveraging technology like debt trading marketplaces to keep up with demand. However, there will be advantages and disadvantages to COVID’s impact on the market.
The zombie effect and lasting impacts
COVID-19 has led to broad economic contraction, which has also been seen in NPL markets. Because NPLs are such a slow-moving market, many of the sales in the US and Europe prior to COVID were still due to the 2008 financial crisis, and COVID has slowed down that offloading process.
While banks have seen an increase in criticized and non-performing loans, in 2020, forecasts indicate that things won’t be as dire as originally expected.
Global credit loss forecasts, S&P Global.
Much of this is due to the zombie effect; firms are being kept alive by government support (like the ($1.9 trillion stimulus package just passed in the US) that will eventually phased out, and long grace periods make loans slow to turn bad. As more and more of these firms fail to bounce back, the credit losses will increase, leading to a slower, steady supply of NPLs.
An upcoming NPL boom in the US and Europe
Despite the slow reaction time, things have been set into motion, and the inertia is strong. In a recent report, PwC estimated that around $180 billion USD in NPLs will trade in 2021 and 2022, with most coming after 2021. Most of the 2021 trades are expected to be legacy debt, with more recent coming into the fore in 2022 and beyond. In fact, the ECB estimated that in an adverse scenario, we could see as much as $450 billion in NPLs hit banks’ balance sheets before 2022, which means sales could skyrocket in future years.
In the US, it seems commercial real estate NPLs will dominate. CRE is one of the hardest-hit sectors, and one least to be resilient post-pandemic—already, offices are planning on staying virtual or semi-virtual even after it becomes safe to return, leading to a collapse of the traditional office-space economy. As unfortunate as it may be for companies, it presents a huge opportunity for CRE debt markets, as the United States CRE sector alone is expected to reach $320 billion in distressed debt in the next five years.
Source: “Troubled Property Sales to Escalate Next Year,” CoStar Group
The big picture
Though these changes may happen on a semi-unpredictable timeline, the pandemic will likely continue to create significant growth in NPL sales. As much as vaccines and public action may bring the era of COVID-19 to a much-anticipated end, the effects on NPL markets will carry forward for years as banks attempt to recover from the pandemic.
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