Non Performing Loan Market Activity Reaches 20-year High
May 03 2006
The total global market for nonperforming
loans (NPLs) is in the midst of its hottest of period of transaction
activity in the last 20 years — and the market shows little
signs of cooling, according to the Ernst & Young 2006 Global
Nonperforming Loan Report released today. With almost three dozen major
NPL sales over the last 24 months by German lenders and the expected
escalation in NPL sales activity in China over the next year, worldwide
transaction activity is expected to quicken signaling that the NPL
market has evolved from a series of regional market opportunities to a
full-fledged, mature global marketplace.
Born out of
the collapse and subsequent government-backed rescue of the U.S.
Savings and Loan industry in the late 1980s, the burgeoning investment
market for packages of NPLs has now almost completely circled the globe
with major NPL sales in Asia and Europe over the last few years. At its
peak, the NPL market totaled US$4 trillion, or roughly one and a half
times the entire proposed U.S. fiscal budget for 2007.
global market began to develop when NPLs ballooned dramatically
throughout Asia following the region's 1997 financial crisis. Today,
NPLs are traded in more than a dozen global markets, including Japan,
Germany, China and India. "The development of this global
multi-trillion dollar market has resulted in a huge learning curve for
banks, regulators and investors alike," said Jack Rodman, a real estate
partner in Ernst & Young Hua Ming in China, and a primary
author of the report.
"A combination of poor
lending practices, inadequate regulation and failures to reform banking
systems has created huge losses for banks over the last 20 years, with
a worldwide recovery average of about 33 cents on the dollar," said
Rodman. "To make matters worse, the economic impact of NPLs has created
staggering losses for many regions and caused their economies to
languish for as long as ten years."
statistics have caused many observers concern about the possibility of
large scale loan foreclosures in the U.S. following several years of
robust lending activity, particularly in the highly cyclical real
Of those regions that have
historically grappled with NPL issues, many have managed to reduce
their legacy NPLs (loans made before 1997). Japan, Taiwan and Korea
have all successfully addressed major NPL problems in the last few
years. "As these regions have established mature NPL markets, they have
put their banks on stronger footing," said Rodman. The report cautions
that regulators need to be on guard for signs of overreaching by banks
to avoid further NPL problems such as those currently experienced by
Indonesia, where NPL levels rose in 2005, or India, which is expected
to become a major market for NPL investors in the next few years. Even
China is poised to allow foreign investor's access to its banking
industry. Despite a slow start, the NPL disposition process has
accelerated in the last 12 months. However, China's NPL problems appear
far from over considering China's large numbers of legacy (pre-1997)
loans still to resolve and an estimated total NPL exposure of US$900
billion — substantially more than any other region in the
report. "China's overheated property markets are certain to produce
fresh NPLs in coming years," said Rodman.
the largest NPL market in Europe is Germany where, despite any public
acknowledgement of an NPL problem by banking regulators, there is an
estimated US$300 billion in bad loans in various stages of resolution
and 32 separate transactions reported since late 2003. This level of
activity makes Germany the most active NPL market in the world.
interest is particularly strong in Germany right now due to positive
factors like transparency, a good mix of NPL products and a growing
appetite among investors for NPLs backed by real estate," said Chris
Seyfarth, a Transaction Real Estate partner at Ernst & Young
LLP who works closely with the real estate professionals at Ernst
& Young AG in Germany. "But the growing investor appetite is
creating a seller's market. We expect the transaction frenzy to
continue, but the days of mega auctions are mostly behind us. Smaller
deals are more likely to come to market, allowing more and smaller
foreign and local investors to participate." Globally, a
robust market is maturing for NPLs in which the health of the banks and
the quality of their NPL offerings has improved, and the market is
attracting a greater array of investors. The convergence of regulatory,
accounting and reporting standards and best practices have brought even
greater transparency to the disposition and management of NPLs and have
positioned the market to flourish in the coming years.
the first time in the 20-year history of this Cinderella market,
nonperforming loans in regions as diverse as the United States, China,
Japan and Germany will be measured and evaluated equally, using
relatively comparable reporting standards," said Rodman. "These
developments, in turn, breed confidence and greater investor interest.
Accordingly, we expect that capital flows to distressed assets will
reach record levels over the next few years," said Rodman.