Non-Performing Loans

When banks accumulate a significant amount of NPLs, they may need to allocate more capital to cover potential losses, which can restrict their ability to lend to other borrowers. This reduction in lending capacity can have ripple effects throughout the economy, leading to a credit squeeze. Businesses and individuals may find it increasingly difficult to obtain financing for investments, expansion, or even day-to-day operations. As a result, economic activity may slow down, as businesses postpone or cancel projects, and consumers reduce spending due to uncertainty about the future. In extreme cases, a widespread credit crunch can lead to broader financial instability, exacerbating economic downturns and prolonging recovery periods. 

The overall dollar amount of non-performing loans in the US has been steadily increasing since Q3 of 2022. According to estimates, the volume of non-performing loans at the four largest U.S. financial institutions is expected to have grown to 24.4 billion dollars, a 6 billion dollar increase as compared to the end of 2022.  

This increase in non-performing loans is occurring during a time of larger turmoil in the American banking industry. The FDIC special assessment to fund the losses from the 2023 banking crisis and other charges complicated large bank earnings. Earnings at big banks are markedly lower for Q4 23’ headlined by a 13% drop. 

As the specter of non-performing loans looms large over the financial landscape, it is imperative for borrowers to remain vigilant and proactive in managing their credit risk, actively managing their portfolio and implementing early warning systems. By implementing effective strategies and maintaining steadfast dedication to repayment plans, we can mitigate the risks posed by NPLs, foster a healthier lending environment, and pave the way for sustained economic resilience and growth. 

The uptick in non-performing loans within the US can be directly tied into the commercial real estate crisis the nation has been facing. The commercial real estate industry in 2023 saw a 22% increase on non-performing loans. The volume of commercial real estate loans designated as non-performing at three major large banks grew to $5.9 billion from $3.7 billion in the third quarter of 2023, the highest level for each of the three since at least 2019.  

In addition to the significant increase in non-performing commercial real estate loans, it is worth noting that banks currently hold a substantial exposure with nearly $3 trillion of US CRE debt maturing through 2028. With high volumes of commercial real estate credits scheduled to mature in the coming years, banks reported moving more office loans into the nonperforming category to reduce their sector exposure. PNC has reported the largest proportional increase in commercial real estate non-performing loans (CRE NPLs), with its figure more than doubling to $723 million at end-Q3 from $350 million three months prior. Furthermore, as reported by Fitch Ratings, deterioration is expected to increase on office properties and throughout retail, home, multifamily, and industrial properties. Loans are expected to continue to deteriorate through 2025 for commercial mortgage-backed securities. The greatest decline in property net cash flows occurs from office and non-trophy malls as growing macroeconomic headwinds and high interest rates lead to increased maturity defaults and increased non-performing loans.  

Sia Partners’ NPL Approaches: 

Considering the current growing state of the market of NPLs in the United States, Sia Partners has identified several approaches to reducing the risks related to NPLs, regardless of their maturity or the party involved: 

1. Loan Originators: Sia Partners ensures that loan originators have proper Know your Customer (KYC) processes in place and are conducting thorough due diligence on their borrowers. 
2. Loan Servicers: Sia Partners ensures that loan servicers have sufficient early warning systems in place and utilizes technologies such as machine learning to build these systems. 
3. Recovery and exit strategies: In dealing with an existing NPL portfolio, Sia Partners offers several management strategies that align with FHFA’s guidance such as hold/forbearance, outsourcing of servicing, active portfolio reductions to change exposure types, and legal options. 

The FHFA has issued guidelines for the sale of NPLs by Fannie Mae and Freddie Mac to reduce delinquent loans, transfer credit risk, and improve outcomes for borrowers and communities. Given the increasing NPLs and the commercial real estate crisis, adhering to FHFA guidelines is crucial for effective risk management. These guidelines offer a structured approach, aiding institutions in navigating economic challenges, minimizing losses, ensuring transparency, and supporting community stability while resolving NPLs. 

NPL Sale Requirements: 

1. Bidder Qualifications: FHFA requires bidder qualifications, including identifying servicing partners with a successful record in resolving loans through alternatives to foreclosure.  
2. Loss Mitigation Waterfall Requirements: Servicers must adhere to loss mitigation waterfall requirements, prioritizing resolution tactics such as loan modification and payment deferral before foreclosure.  
3. Modification Requirements: NPL servicers must evaluate borrowers for loan modifications, including principal and/or arrearage forgiveness.  
4. Reporting Requirements: Reporting requirements mandate NPL buyers' servicers to report loan resolution outcomes for four years post-sale, aiding in program evaluation. Public reports on aggregate borrower outcomes are also provided, enhancing transparency. 

Sia Partners has an understanding of these current regulations and can assist clients in coming up with compliant NPL strategies, as well as keep a pulse on changing regulations within the US and abroad with solutions such as Reg Review, a tool developed by the data science centre at Sia Partners. The tool can be used to ensure continuous compliance through its automation of the regulatory identification process. Some features of the tool include: 

1. Regulatory Watch: The Reg Review platform utilizes search engines to monitor an exhaustive body of regulatory sources.  
2. Evaluation: AI pre-identifies regulatory documents that impact your organization. 
3. Communications: AI identifies stakeholders impacted by each regulatory document, automatically allocating tasks via a newsletter.  
4. Follow-up: Tasks are centralized within the Reg Review platform tool. 
5. Reporting: Records and traces all actions carried out with each regulation identified.  

Our offerings are tailored to accommodate our clients’ evolving needs in the digital era. Sia Partners is here to support our clients with a variety of strategic and operational initiatives.

Data Quality & Management ​
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Data quality and enhancement are important for non-performing exposures (NPEs) because accurate data helps identify and classify NPEs, improves collection efforts, reduces risk, and ensures regulatory compliance.​

Artificial Intelligence & Machine Learning
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Sia’s Heka.AI solutions can aid clients in creating a finance & exposure strategy. Machine Learning can aid in evaluating and estimating credit risk as well as for early warning indicators.​

Customer Focus​

Sia Partners can help create a customer-focused approach to solving NPEs to help financial institutions understand the root cause of what causes NPEs and, create proactive and customized solutions on how to solve the issue.

Analytical tools
Analytical tools can be used to identify NPEs. In addition, provides an overview of the value-add of adopting analytical tools proactively. ​

Automation & Innovation​
Automation tools can be used to identify & classify NPEs, create early warning systems, perform risk assessments, and aid in collections or recovery.​

Operational Enhancement
We at Sia Partners work with our​ clients to understand their end-to-end processes to identify pain points and opportunities for​ enhancement including full risk​ and control assessments.​

Sia Partners worked to implement updated processes & procedures on the Application of the Definition of Default & Non-Performing Loans based on guidelines set by the Internal Monitoring & Reporting ECB/EBA regulatory bodies  

Sia Partners approach:   

• Defined the required data elements to adhere to the DoD and NPL regulatory guidelines.  
• Managed the identified gaps with internal business owners including the Audit and the Joint Supervisory Team.  
• Coordinated and established the implementation of the required reporting practices in order to comply with the final guidelines of the ECB/EBA.   
• Managed and drove the implementation of the required reporting standards within the Credit Risk Data & Reporting area in the roles of Product Owner, Lead Business Analyst, and Lead Data Quality & Handling.  

Sia Partners aided in the implementation of the credit requirements inferred from the ECB/EBA regulatory guidelines on the Application of the Definition of Default / Non-performing loans   

Sia Partners Approach:  

• Drove the adequate implementation of the requirements into the operating model.   
• Ensured regulatory compliance of the credit servicing processes across the organization and its business partners.   
• Ensured regulatory compliance of the existing data architecture including establishing an interface with the Rabobank Group IT landscape concerning Vista Hypotheken data.   
• Developed an effective monitoring and reporting process across the organization.