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February 1, 2021updated 29 Jan 2021 6:29pm

‘European bank mergers and NPL sales on the rise in 2021’

By Alejandro Gonzalez

Investors expect European banking sector consolidation and an acceleration of non-performing loan (NPL) sales in 2021, Fitch Ratings says.

In a poll of the audience (mostly investors) at Fitch’s Credit Outlook conference on 13 January, 91% expected more mergers and acquisitions, with 52% citing domestic mergers to strengthen banks’ market positions as the main driver.

Nearly 70% of the audience expected NPL sales to pick up, with banks’ capital management the main driver, followed by increased expertise among non-bank financial institutions (NBFIs) in handling NPLs.

The rating agency said: “We also expect banks to continue to develop fee-income sources, while we expect NPL sales to stay subdued at least in 1H 2021.

“Mergers to strengthen domestic market positions would make sense for many banks given that European banking sectors are still fragmented, with a large number of small banks that lack economies of scale to compete effectively while maintaining profitability and making the necessary investments in technology.

“We believe banks face three key challenges that will spur consolidation, with implications for their business profiles, profitability, earnings stability and ratings.

Fitch Ratings: 3 key challenges

“First, banks face lower interest rates for even longer as a consequence of the coronavirus pandemic. We expect some banks to pursue mergers to increase their operational efficiency and investment capacity. Operational efficiency can mitigate the pressure on profitability from low rates; investment capacity is important for developing digital capabilities. Other banks may seek bolt-on acquisitions to increase their fee-earning activities and reduce their reliance on interest income. In most cases, fee-earning activities are also relatively capital-efficient.

“Second, banks need increased investment in technology and IT infrastructure, including customer-facing portals, to stay competitive. We expect more banks to seek bolt-on acquisitions of – or cooperation with – fintech companies to bolster their digital capabilities.

“Retail banks that have relied on branch networks or that operate in markets with high cash usage may have fallen behind in developing digital capabilities. Small banks could be particularly vulnerable to accelerating digitalisation as they may lack the scale to afford the necessary investments to keep up with advancing technology.

“Third, many European banks are faced with a combination of weak profitability but significant excess liquidity. Some banks may therefore chase higher-yielding business, including through cross-border or regional expansion. While many banks have shifted to simpler and more risk-averse business models focused on their domestic markets since the global financial crisis, a few have looked to expand into emerging markets to boost their earnings.

“We typically consider this credit-negative, with execution risk and increased risk to asset quality generally outweighing the higher profitability, and we agree with the audience at the conference that cross-border or regional expansion is not very likely for European banks in 2021.

“While conference attendees mostly expected NPL sales to pick up, with banks’ capital management and increased NBFI expertise the main drivers, we expect NPL sales to remain subdued, at least until the economic effects of the pandemic become clearer.

Government support

“We expect increasing inflows of NPLs as support measures for borrowers are gradually withdrawn, which could mean a strong supply of NPLs for banks to sell to debt purchasers.

“However, both NPL inflows and the outlook for existing NPLs are highly uncertain given the unpredictable course of the pandemic, with fresh lockdowns across Europe and the possibility of borrower support measures being extended for several more months.

“We believe timely NPL sales will be difficult against this backdrop, with intense scrutiny from regulators and ESG-minded investors of banks’ behaviour and fair treatment of customers.

“NPLs linked to structurally non-viable or cyclically challenged businesses, and non-performing consumer loans, however, may be more straightforward to sell.”

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