The share of overdue debts remains low in the short term, but slowing economic growth and record high base interest rates in Europe predict a change in the medium term, according to an analysis of the DCA
The low level of non-performing bank loans in Bulgaria will remain at least until mid-2024, and the trend may then reverse, more markedly in 2025, but the growth in overdue payments will be rather smooth and without sharp upward movements. This is predicted by Debt Collection Agency EAD (DCA), one of the leading debt purchase and management companies in Bulgaria.
The scenario is based on an analysis of macroeconomic data, the dynamics of lending in Bulgaria and Europe and the management of banks’ loan portfolios.
Bank asset quality in Bulgaria remains stable so far
The sharp rise in interest rates and the rising cost of servicing debts in Europe, combined with the slowdown in economic growth and high inflation, have not yet had a noticeable impact on consumers and businesses in Bulgaria, according to the experts of DCA. Therefore, no significant appreciation of loans and deterioration in the quality of loan portfolios is expected in the short term. Currently, interest rates on loans in Bulgaria, especially mortgage loans, are lower than those in a number of euro area countries due to the excess liquidity of local banks.
The tightening of monetary policy in Europe and the measures of the Bulgarian National Bank (BNB) to cool lending – the countercyclical buffers and the increase in the minimum reserve requirements, will certainly leave an imprint, but rather in the medium term, and in the next 12 months the momentum in the sector of recent years will continue, predicts DCA. The reason – on the one hand, the still high employment and rising average incomes in the Bulgarian economy, and with a growth rate outpacing that of expenditure and inflation in general (from January 2022 to September 2023, the average gross salary in Bulgaria has risen by more than 30% and already exceeds BGN 2 thousand. – The average annual interest rate for newly granted mortgage loans in BGN in September was 2.61% , while according to the ECB the average annual interest rate for new mortgages in the euro area countries was 3.93%).
“Bulgaria is so far among the few countries in Europe that have remained financially calm regarding interest rates on loans. With current employment and continued income growth, consumers in the country are managing their costs and servicing their debts relatively well. The share of overdue loans is currently at a record low, people are employed in large numbers and their salaries are still generally rising. This helps them to cope with the repayment of their debts, while the cost of living is also increasing,” said Dimitar Bonchev, Chairman of the Board of Directors of DCA. His forecast is that arrears will not rise appreciably in the months to the end of next year. “Economic growth will inevitably slow down as a result of the spillover effects from other economies in Europe, but this will not lead to a significant increase in bad loans in the short term,” he reassured.
Debt purchases are ongoing
Despite the forecast for keeping bad loans at a low level in the coming months, banks and non-bank financial institutions continue to clean their balance sheets of old non-performing loans, it is also clear from DCA’s data. There has been no shortage of deals in the market in the past two years, albeit nowhere near the size of those in the 2018-2019 period. DCA said its investment in new portfolios for the first 10 months of 2023 grew just over two times compared to the same period in 2022. This is partly due to DCA’s strategy to regain market share and remain a leading company in the sector following its change of ownership.
Debt purchase and collection companies are a key partner for banks and non-bank lenders in the write-off and sale of portfolios of non-performing loans. They were also at the heart of the clean-up of toxic assets accumulated in the economic crisis after 2009. According to data from DCA, for the period 2017-2022, financial institutions have offered for sale portfolios with a total nominal value of nearly BGN 10 billion. A record volume was achieved in 2019, when the total nominal value of portfolios traded exceeded BGN 3 billion (see chart below).
The new normal – selling overdue payments early and regularly
One of the main changes in the sector over the past years, dynamic for the market, is the established habit of financial institutions to sell their portfolios of overdue loans actively, regularly and at an increasingly early stage, so that they do not accumulate on the balance sheets. As a result of the active participation of debt purchasing companies and the development of the secondary market, even with a reversal of the current favourable trend and a new build-up of bad debts, banks and non-bank financial institutions are far more prepared and resilient compared to the post-2009 period.
Regulations and measures of the European institutions also contribute to this change in the behaviour of creditors. The entry into force in 2018 of the International Financial Reporting Standard (IFRS) 9 has forced credit institutions to significantly increase the cost of provisions for non-performing loans. The year before, member states’ finance ministers adopted a plan to combat non-performing loans, which evolved in 2021 into a directive that each EU country is committed to implement in its legislation within two years. Separately, two years ago the European Commission adopted a strategy to prevent the accumulation of bad loans, which focused precisely on the development of a secondary market for the purchase of portfolios of arrears.
Trends in Europe favor adverse consequences
Now, however, exactly the trends and processes that are taking place in Europe are the factor that could worsen lending in Bulgaria in the medium term, warns DCA. After years of loose monetary policy with zero and even negative interest rates, credit boom and fiscal expansion through budget deficits and debt, the trend on the Old Continent seems to be reversing. After an unprecedented run of 10 consecutive hikes, starting from negative levels of minus 0.25%, the ECB base interest rate has reached 4%, the highest level since the creation of the euro. Moreover, the European economy is facing a recession, and high inflation is eating into household incomes, which is a prerequisite for a rise in bad loans.
According to the latest ECB data as of June 2023, euro area banks’ non-performing loans remain at less than 2% of the total loan book, the lowest level since data have been collected. However, there is no shortage of leading indicators of a trend reversal. Over the past four years, during which the EU’s total loan book has risen by 25%, loans classified as phase 2 – “non-performing” – have jumped twice as much, by more than 50%, heralding trouble. Also, according to this year’s European Consumer Payments Report, over a third of Europeans (35%) have failed to pay at least one bill on time in the last 12 months – the highest proportion since 2019. Inflation and the rising cost of servicing loans are further squeezing households in Europe whose real incomes are stagnating and even declining, the report’s authors warn (more on this 👉 here).
The not so bad prospects for bad loans in Bulgaria
In Bulgaria, the level of non-performing loans in the banking sector, although record low, is still above the EU average. According to BNB data, at the end of September their share was 3.81%. In the last few years it has been decreasing almost continuously, mainly due to the sale of portfolios to specialised companies.
According to DCA’s team, the share of arrears will start rising after the middle of next year, but gradually and without dramatic increases like those after the 2009 crisis. BNB also warns of risks in the sector. In the latest edition of “Banks in Bulgaria”, the central bank notes that the ability to pay debts could weaken, leading to an increase in NPLs and impairment charges.
From mountains to molehills of NPLs
The record low share of overdue bank loans in Europe and Bulgaria comes after a decade of purging them. It all started with the 2008-2009 financial crisis, followed by a decade of accumulating volumes of NPLs. In 2015, their level reached a peak of €1.2 trillion, or 6% of the total EU loan portfolio. Since then, their share has gradually declined. As of June 2023, their total value is estimated at €361 billion or 1.8% of all loans in member states, the lowest ever. Thus, in a decade, Europe’s banks have managed to reduce their loan arrears by 70% and largely deal with the effects of the financial crisis and its aftermath, and are in a much stronger position today compared to the post-2008-2009 period.
The trend is similar in the banking sector in Bulgaria. Over the years, the country’s banks have reported a higher share of non-performing loans compared to the EU average, but this is compensated by much higher levels of liquidity and capital adequacy compared to other Member States.
The new risks
Over the past decade, Europe has managed to achieve remarkable results and tackle the problem of bad loans. However, in recent years up to and including 2021, there has been a strong growth in lending due to loose monetary policy. Separately, with the cowardly pandemic that broke out in 2020 and the subsequent energy crisis in 2022, governments in Europe have granted huge subsidies and transfers to support businesses and citizens. All of this could mean new challenges for bank asset quality, especially with the sharp spike in interest rates making financing more expensive for businesses and consumers. Measures to curb the growth of NPLs will therefore be key to preserving economic stability, and the debt purchasing and collection companies will play a key role in securing timely payments and enabling banks to unload their balance sheets of bad debts.
About the Debt Collection Agency EAD (DCA)
DCA was established in 2010 and is fast becoming one of the leading debt purchasing companies in Bulgaria. In 2016 it was acquired by Norway’s B2 Impact ASA (formerly B2Holding), which is among the ten largest in the sector in Europe, and since the end of September this year it has been owned by Bulgaria’s DCA Management AD. DCA is registered as a financial institution with the Bulgarian National Bank and is a member of the Receivables Management Association.
