But some funds still see opportunities — provided you pick the right spots. Balbec Capital, an alternative credit manager specialising in non-performing credit and navigating insolvency processes, has invested in 16 countries across Europe but is increasingly eyeing up deals in Spain, aggregating portfolios with a view to securitisation.

“Our view is that many of the servicer-oriented firms have historically been about ‘feeding the beast’, which often means overpaying for portfolios to ensure they can continue their operations,” said Ryan Singer, who runs international mortgage investing for Balbec. “We avoid that scenario by working with trusted local servicing partners and therefore are positioned to rotate capital where we see the best risk-reward.”

A big part of making the NPL trade attractive comes from sourcing the right portfolios. Over the last decade, many of the large NPL portfolios went to the biggest alternative asset managers, the likes of Pimco, Bain, KKR, Fortress, Cerberus and Elliott.

Now the flow of giant portfolios has slowed up, but it is still possible to find smaller deals which work.

“Transaction sizes today are more in our favour given that we tend to target smaller sized transactions,” said Singer. “Often banks have two divisions handling NPLs: a portfolio team working on the larger deals and a collection recovery team that is selling €5-10m portfolios at a time. Strong banking relationships allow you to get bilateral deals done efficiently, receive access to follow-on deals directly, and have better opportunities for diligence.”

Size matters but sourcing also matters. Some of the corporate NPL buyers facing upcoming bond maturities have sought to sell assets (Intrum’s deal with Cerberus for example), and servicers of Italian and Greek government-guaranteed NPL deals have been desperate to catch up with their business plans, which were struck on overambitious assumptions.

“We execute some of the €10m tickets where servicers are trying to meet their business plans,” said Singer. “In these cases, we can be selective and look at a portfolio of €50m, but just bid on the best €10m of assets on terms that we find attractive”.

The problem with buying small portfolios (’hunting squirrels’) can be financing. Small tickets make it harder to find attractive leverage on a deal-by-deal basis — until the portfolios can be aggregated together.

Once at sufficient scale, this provides the basis for a securitisation, generally the most efficient form of leverage for an NPL or RPL portfolio.

Balbec is an established user of securitisation markets in the US, and has done a rated Irish NPL deal, PRPM Lagado 2022-1 via JP Morgan.

“Aggregation of smaller portfolios is not a traditional route, especially by those in Europe, which is why we find our strategy particularly compelling,” said Singer. “A lot of the banks on the financing side want to execute big ticket transactions and don’t want to take the risk of executing an aggregation strategy. For example, if a bank has given a six to 12-month bridge to securitisation, they’re relying on a firm like us winning the next portfolios to get up to the right size.”

Singer continued: “We have been able to execute an aggregation strategy successfully in the US, and as such, are working to execute it with banks in Europe.”

For funds like Balbec who rely on securitisation funding, RPLs, rather than NPLs, can have more attractive characteristics. These are loans which were formerly non-performing, but which have started paying a reduced rate, as borrowers have been placed on payment plans.

“We’re focused on amicable resolutions as well as payment plans/RPL conversions,” said Singer. “We think that it is an overlooked area for a lot of European asset buyers who are very focused on NPV realisation. The financing terms you get are much better on RPLs, and you don’t have to deal with REOs in your portfolio, which is where a lot of volatility comes from.”

REOs are ‘real estate-owned’ assets, essentially NPLs where the underlying security has been enforced and the NPL buyer becomes the direct owner of real estate. Some funds make a specialism of purchasing REOs out of larger NPL portfolios, but valuations are heavily geared to local real estate markets. House prices are often quite depressed in regions that generated a lot of NPLs, and prices at auction can be volatile.

Securitisation financing gives term leverage, but it also gives flexibility.

Singer noted that the liquidity for selling RPL portfolios is much worse in Europe than in the US, so it’s important to be able to call and combine securitisations

“In the US, we can put out a portfolio of RPLs and receive an attractive bid in a week for it,” said Singer. “For European RPL portfolios, however, a lot of the risk lies in the ability to successfully exit because if you pursue an RPL strategy, that leaves a bigger portion of realizations based on sales. We’d rather take that risk and have a good quality portfolio to manage, combined with the securitisation market as a financing strategy.”