Norwegian debt collector B2 Impact has shone a positive light on the battered European debt collection sector. On Sept. 4, the company successfully priced €200 million of notes that it will use to redeem debt maturing in 2026.
B2 Impact, with a double-B rating and leverage of 1.7x at the end of the second quarter, according to the firm, is not the name that first comes to mind when talking about debt collectors. Those names that have made the headlines in the past few months — such as Intrum, iQera and Lowell — have moved to sub-single-B territory. Lowell reported net leverage was 3.0x at the end of the second quarter, while Intrum had a leverage ratio of 3.9x, and iQera’s pro-forma leverage stood at 4.2x (as reported by the companies).
Under pressure
Debt collectors have been hit by a range of challenges, notably higher interest rates, which pushed their funding costs much higher. And in its first-quarter presentation, single-B rated Axactor listed four more sources of pressure on the industry’s profitability, namely: “fierce" competition, reduced collections (due to inflationary pressures in the past few years, and changes in legislation), failing M&A transactions, and opaque securitization/SPVs.
Some debt purchasers have emerged relatively unscathed, while others look shaky. The companies that are more talked about are those that built up high leverage in the era of low interest rates, as they tend to have a tangible equity deficit, and in some cases had excessive growth plans, says Anna Stark, assistant vice president, Financial Institutions Group at Moody’s Ratings. Stark adds that these problems are compounded by the current low supply of new non-performing loan (NPL) portfolios in Europe, which are the driver of future collections and of the internal rate of return achieved by debt collectors.
Collection of debt in itself is a necessary function and revenues have held up well, says Wolfgang Felix, senior analyst and founder of independent credit research firm Sarria. Rather, the problems stem from the acquisition of non-performing debt portfolios — or more precisely, when and how they were acquired. “Debt collectors buy debt from banks and corporates, this is a multi-year bet. When these purchases are funded exclusively through debt, and then interest rates rise, the valuation of these receivables suffer and you end up with an over-leveraged balance sheet,” explains Felix, adding that books bought at the top of the market now need to be recapitalised.
Shifting model
The servicing part of these collectors' businesses does not require much capital to be committed, notes high-yield credit analyst Brian O’ Brien. In contrast, purchasing portfolios is capital-intensive and puts these companies in competition with large private-equity firms which have a lower cost of funding. In his view, purchasing portfolios “makes little sense for a debt collector in the current rate environment.” Intrum’s shift to a “capital-light” business model via an investment agreement with Cerberus reflects this new reality.
The European market has proved to be challenging as banks stopped lending to weaker consumers, thereby reducing the supply of NPL portfolios in the post-Covid period. But the business model of debt collectors is certainly not broken, notes Anna Sherbakova, vice president in the Ratings FIG Group at Moody’s. Sherbakova points to the cases of Encore Capital Group, which operates in the US and Europe, and B2 Impact.
The gradual easing of monetary policies in Europe will make it easier for debt purchasing companies to achieve a return in excess of their cost of capital. “Interest rate cuts would be a significant credit positive,” adds Sherbakova.
Meanwhile, benefits from lower base rates will take time to feed through. Axactor CEO Johnny Tsolis said during a conference call on Aug. 15 that just a one percentage point fall in interest rates would improve Axactor’s cash flow and net financial results “rather substantially,” but warned that any rate impact “will take time and the effect in 2024 will be limited.”
Intrum blueprint
Intrum and iQera have taken the first steps in the restructuring of their debt. Intrum at the end of August achieved the required noteholder support for its proposed recapitalisation plan, while in July iQera opened a conciliation procedure under French law. Lowell provided no details on its refinancing plans during the earnings call on Aug. 29, only stating that discussions here “remain ongoing with key stakeholders.”
Intrum opted to repay the bonds that were coming due in July 2024, but has proposed to amend and/or exchange its existing senior unsecured notes maturing between 2025 and 2028. S&P said it would consider the potential exchange as distressed because of the proposed 10% equity conversion on the notes. The rating agency also thinks the proposed step-up on the coupons of nearly 300 bps on a blended basis, accompanied by a two-year extension, would not offset the increase in Intrum's credit risk. Intrum’s 2028 notes traded in early September at a yield of more than 22%.
“For Intrum, it was clear from the start that bondholders did not want to be equitized and shareholders didn’t want that either,” O’ Brien recalls. “Management has followed the path of least resistance and this ‘amend and extend, buy time’ strategy will probably be the blueprint for other debt collectors’ restructurings.”
Intrum’s proposed restructuring is interesting as it shows what happens when the debt credit curve is spread over time and holders of the shortest-dated bonds end up being in a much stronger position than holders of the longest-dated notes, despite the pari passu provisions, points out Sarria's Felix.
“Debt collectors are in a funny situation where they have plenty of liquidity, no insolvency triggers but also no equity perspective,” Felix explains. “Debt collectors are supposed to work out NPL portfolios and selling them is part of that mandate, which means they can sell them at any time to raise cash. That steepens the recovery curve. If you can strike a deal that gives the company time, recoveries will improve overall and in particular for the back-end and shareholders. So the game is to strike the right balance that crams down the front-end with at least a 2/3 majority. This is why early consenters will consist of holders of long- and middle-dated bonds, and shareholders. Then there are the sellers of CDS.”
Holders of the short-dated bonds, those maturing in 2024, had no incentive to wait and ended up being repaid at par in July as the company’s deal was not far enough progressed, he adds. However, their departure left only a proportion of the 2025 notes to hold out. So as time went by and accounts remained locked up, the deal grew into the money.
However, Spread Research points out that Intrum's liquidity was considerably reduced after the repayment of the senior unsecured notes due 2024 and the secured term loans due 2025. "While the contemplated debt restructuring is obviously a relief on a short-term basis, the new unsecured notes will be costly and prevent any improvement in credit ratios," says Benjamin Sabahi, head of credit research at Spread Research.
Portfolio availability
The difficulty in collecting the expected amounts on the portfolios is probably the biggest risk factor for debt collectors. But there are also risks regarding the availability of portfolios to acquire.
Comments on the forward pipeline during recent company earnings calls have been quite positive, and sometimes upbeat. B2 Impact said on Aug. 22 that “following a period of high interest rates, we see the NPL volumes are trending up, both NPLs as well as Stage 2 loans [Stage 2 loans are those where there has been an increase in credit risk since the initial recognition].” One debt collector, meanwhile, pointed to a year-on-year increase in NPL volumes in the eurozone in the first quarter of 2024.
“Market prices for NPL portfolios have been adjusting down towards what Axactor considers fair levels given the increased funding cost for the industry. Recent deals have been signed on significantly higher gross IRR levels compared to Axactor’s early years,” the company said in its Aug. 15 earnings release.
Lowell, in its Q2 2024 presentation, mentioned a “healthy pipeline visibility” with more than £400 million of forward flow purchases committed through to the end of 2026, and highlighted that potential returns across the UK and Nordics were attractive.
Furthermore, a survey by the European Commission’s NPL advisory panel published in April indicated that market participants expected an increase in NPL levels in 2024 and in “2025 and beyond” — mostly in corporate/SME lending, commercial real estate, and unsecured consumer loans. As shown in the chart below, 71% of survey respondents expected their country’s stock of non-performing/Stage 3 loans (credit-impaired) to be “slightly more than current level” over the next two years. Only 8% expected a decline relative to current levels.
On the other hand, high NPL ratios at lenders look like a thing of the past, reducing the need to offload large portfolios. “While some countries show relatively high percentage increases from the low levels observed at year end 2023, no European country is projected to come near the old highs after the global financial crisis,” notes Burkhard Heppe, chief technology officer at NPL Markets in the firm’s “Projections of Global NPL Ratios 2024H1” report, dated Aug. 5.
In the report, Heppe compiled the forecasts that the IMF included in its April World Economic Outlook (WEO) and estimated a maximum projected NPL ratio over the next three years based on NPL Markets’ own projection (in the table below, this is the “WEO24 Maximum NPL Ratio” column). The report stresses, however, that the maximum NPL ratio of 7.7% until 2028 for Italy does not look plausible.
Healthy collections
Meanwhile, debt collectors have tended to be quite good at extracting the revenues they had anticipated from acquired portfolios. Indeed, one thing that companies such as Intrum and Lowell have a history of doing well is collecting and pricing NPLs, says Brian O’ Brien.
Morningstar DBRS — which has rated many securitisations of non-performing portfolios over the years — found that collections from borrowers were satisfactory in most jurisdictions. “In this asset class, recoveries are measured in relation to the business plan submitted by the servicer; each portfolio has its own story, and in some cases recoveries can be ahead of plan, in some cases behind, and it’s quite difficult to be exactly on track,” says Alberto Cruces de la Rosa, vice president, European NPL Ratings, at Morningstar DBRS.
During the Covid period, recoveries underperformed business plans mainly because judicial recoveries were halted and people were probably less keen to repay, but this situation has now normalised, he notes. Irish, UK and Portuguese transactions have typically showed resilience, while recovery ratios in Italy and other southern European jurisdictions have been mixed — generally weak for the securitisations issued before 2019, and strong for the later transactions.
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