Bad debts are rising in Africa, curtailing banks’ ability to pump fresh credit into economies struggling to recover from Covid-19. Options for offloading toxic loans are limited on the continent but an IFC initiative is working to stimulate a vibrant secondary market for NPLs.
Last year the International Finance Corporation partnered with Nimble Group, a South African distressed debt investor, to buy $90m of unsecured retail nonperforming loan (NPL) portfolios in South Africa, Namibia, Botswana, Lesotho and Eswatini (former Swaziland).
The acquisition is the IFC’s first in Africa under its Distressed Assets Recovery Program (DARP) which over the last decade has supported distressed asset markets across the world.
It marks a significant development for a continent faced with rapidly rising NPLs and a lack of options for resolving them. As Covid-19 relief measures like payment holidays expire, Moody’s says NPLs across the continent will double in 2021, curbing banks’ ability to lend credit vital to economic recovery.
Creating a functioning secondary market for NPLs in Africa is key to ensuring financial stability. It is also important for providing much-needed debt rehabilitation and relief to debtors.
A complex market requiring specialist skills, the secondary NPL market is an important risk management tool which allows banks to sell NPLs to non-banking specialised debt resolution entities. This helps reduce risk, frees up capital on balance sheets and allows banks to focus on providing credit to the local economies.
The total amount of NPLs for banks in Africa is estimated to be around $60bn, according to publicly available data, as opposed to around $600bn in Europe. However, NPL ratios in Africa are above 10% in more than 30 countries.
“These high NPL ratios are a significant challenge for many banks,” says Zuberoa Mainz, Senior Investment Officer, Regional Lead of IFC Distressed Asset Recovery Program, Middle East and Africa. Since it was founded in response to the 2008 financial crisis, DARP has committed $7.4bn globally, including the mobilisation of $4.6bn of capital, which has enabled banks to offload $30bn of NPLs. It has worked across Latin America, Europe and Asia.
In South Africa, where the lending market is dominated by banks which tend to look to resolve any NPL issues in house, credit management companies like Nimble Group and Greenpoint Capital Management, a private credit fund, are emerging as viable alternatives for outsourcing both retail and corporate loans.
Moody’s expects NPLs in South Africa to rise to 7%-8% of gross loans in 2021 from around 5% in 2020.
Nimble Group, which helps banks resolve retail, SME and corporate loans as well as buying distressed debt portfolios, has purchased ZAR30bn ($2bn) of debt across 4.5 million accounts over the last five years in South and Southern Africa.
The firm uses artificial intelligence and machine learning to predict how borrowers will behave and has developed digital self-serving channels on Whatsapp and SMS to help banks track debtors.
With the IFC’s support, Nimble has been able to grow its business while moving into less developed markets like Namibia to purchase retail NPLs.
“The concept of debt sales is still very immature, partly because there hasn’t been a good pool of organised capital to buy NPLs,” says Rowan Gordon, CEO of Nimble. “That is now improving as things like the DARP unit come in.”
Greenpoint Capital’s Specialized Lending Fund provides direct lending and restructuring balance sheet solutions to medium to large corporates in South and Southern Africa and has deployed over ZAR3bn across 62 transactions since its inception in 2011, fully realising 51 of those.
More common in the US and Europe, alternative credit providers like Greenpoint are rare in Africa. The firm is seeing huge demand for restructuring services and has approached IFC for support for its upcoming special situations fund.
While operating in different parts of the market, both companies believe as Covid-19 relief measures like interest deferrals come to an end, and impairment costs take their toll, banks will be forced to find more creative ways to deal with bad loans.
“The double whammy of increased regulatory provisioning requirements and real market stress brought a well-capitalized sector a little closer to heat of the fire,” says Ryan Wood-Collier, CEO of Greenpoint. “There is now more reason for banks to consider how best to sort out their problem credits.”
While the overall percentage of corporate NPLs may be low – the country’s top four banks disclosed a total of ZAR28.8bn in corporate NPLs relative to ZAR1.65trn of lending to corporates and institutions, a ratio of 1.8% – Wood-Collier says every company in South Africa has been hit by Covid-19 in some way, with many of those needing an injection of liquidity and a recapitalisation of their balance sheets.
“Banks don’t have a balance sheet or the bandwidth to properly deal with these issues on their own,” says Wood-Collier. “Banks are recognizing that you need third parties to come in.”
For both firms, educating banks on the services they offer and encouraging them to offload loans before they become delinquent are key objectives.
Not all agree with this assessment.
James Formby, CEO of Rand Merchant Bank in South Africa, says that for corporate South Africa, NPLs are currently easily manageable. Given that each situation is different, they are better worked out by specialist teams in banks, he says.
“We are not seeing anything that would warrant major concern,” he says. “Clearly we are in the middle of economic depression, so banks have upped corporate provisioning levels to above global financial crisis levels, which you would expect.”
While stage 2 assets, being exposures with higher risk, stood at ZAR167bn, Formby does not believe that the economic performance of corporate South Africa has deteriorated since June, given that the economy has opened up since then.
In Kenya, where NPL ratios are expected to rise to 17% by year end, Stanbic Bank Kenya CFO Abraham Ongenge says taking a proactive approach to restructuring, speaking to clients and offering to extend repayment periods is a better approach than offloading portfolios to asset management firms or bad banks.
“There is significant capital injection when you start thinking about bad banks and [having one standalone solution] this is not something we have seen appetite for from an investment point of view,” he says.
The bank offered relief on some $400m of loans during the first 6 months of the pandemic. Its NPLs increased to 10.2% in H1 2020 from 8.12% in H12019.
Challenges of expanding the scheme
In other markets, scaling up the IFC’s technical and financial assistance and attracting foreign capital, will be more challenging.
In many cases, it has had to start from scratch, mapping the volume and ratio of NPLs in each country, analysing legal frameworks and making an assessment on the needs and servicing ability of each country.
Lack of supportive regulation, small NPL portfolio sizes, reluctance of banks to offload loans and a lack of available data to determine NPL pricing are all challenges.
In Nigeria, where NPLs stood at 6.01% in December 2020, according to its central bank, solutions for resolving NPLs have been met with moderate success.
Asset Management Corporation of Nigeria (AMCON), a “bad bank”, was set up in 2010 to clean up the banking system following a $4bn rescue of nine lenders. AMCON still holds a portfolio of around $15bn and is pursuing some N4.4trn in debts owed, according to local media reports. It has operated with mixed success.
Tayo Oduwole, a director at Frontier Capital Alternative Assets (FCAAL), one of a small number of distressed asset managers in Nigeria, says the regulation is the main challenge for NPL resolution.
In July 2017 FCAAL purchased a N400bn ($1bn) portfolio from one of the local banks, but says resolving the loans has not been easy.
“We inherited a lot of legal suits, and the process of finalising can sometimes take 10 years up to the supreme court,” he says. “We’ve been doing ok and have a positive relationship with the obligers [but] we’ve a long way to go.”
Oduwole says that the regulatory regime is improving, with an emerging arbitration scene and the CBN open to dialogue with firms like FCAAL.
“Because of what we have done the Central Bank of Nigeria is very interested in encouraging other players to come to the market,” he says.
Ensuring the regulatory and legal framework is viable and allows for the sale of NPLs to a third party is the first step in catalysing a secondary NPL market. “Investors need attractive conditions: no regulatory or legal constraints to buy NPLs,” says Rosa Sacre, a Managing Director in Asset Recovery & Restructuring Management at Société Générale.
“The tax deductibility of losses resulting from NPL sales is an important condition as the banks cannot afford selling with a discount and paying on top of it a tax on their losses!”
In other countries, regulatory regimes are improving. The West African Economic and Monetary Union (UEMOA) is harmonizing business law and published a directive about tax deductibility of losses from NPLs in the union.
In Tanzania and Tunisia, banking regulators encourage accelerated write-offs or the transfer of problem loans to asset management companies, while Egypt is streamlining its insolvency rules.
But the issue still remains that Africa is made up of 54 countries with disparate legal regimes, meaning a pan-African solution to the NPL problem is still some way off.
Jim Ho, partner at the global law firm Cleary Gottlieb Steen & Hamilton, says that developing a secondary market for distressed assets is only one prong.
“Policymakers need to look at the bigger picture ranging from improving banking supervisory frameworks to enhancing insolvency laws and speeding up debt recovery processes while protecting consumers.”
Ho points out that diversity of legal systems is something the Europeans are grappling with and that establishing a pan-African NPL market or subgroups of African regional markets that will create economies of scale is “not something that can be achieved overnight.”
“Similar efforts are being explored at the European Union level and it is still very much a work-in-progress,” he says.
Another barrier to attracting more established global distressed asset managers is the small ticket sizes on offer.
“Small countries in Africa may only have $100m of NPLs in volume but if NPL ratios are high across the banking system, it is still a substantial problem”, says Mainz.
“Investors are attracted by high volumes and therefore mobilization of private investors to small countries is a significant challenge for the creation of secondary NPL markets.”
This is why the IFC is looking to establish regional platforms which will create economies of scale in West Africa, North Africa, sub-Saharan Africa and East Africa.
With toxic loans on the rise, the IFC’s initiative, together with supportive policy and regulation, could provide an important and necessary risk management tool for banks in Africa, before the problem becomes too big to solve, like in Europe.