In its annual report on the global state of non-performing loans, Ernst & Young has found that since the crisis, more than $1 trillion of NPLs have been taken off the books of Asia's asset management companies and banks. However, another $1 trillion of loans are still not performing.
"Asia's banks have made remarkable progress in disposing their bad loans, but they need to keep the momentum going - they cannot afford to become complacent," says Jack Rodman, an Ernst & Young managing director based in Beijing. "China and Japan together account for about 85% of Asia's NPLs, and they have strong reasons for resolving their NPL problems."
In China the prospect of foreign banks gaining full entry to the market in 2006 is forcing the state-owned banks to strengthen their balance sheets. Indeed, a rapid increase in the overall loan growth rate over the past year shows that banks are as much trying to grow their way out of trouble as they are attacking the problems at source.
In Japan, banks are relying on a combination of methods to resolve their NPLs; they are selling the loans to third parties and are raising fresh finance to boost their capital base.
Other strategies that Asian banks have used include securitization and other sale techniques. But key to the resolution of such a large number of NPLs has been a willingness by outsiders to acquire the loans. "Investment banks, opportunity funds and other international investors have amassed as much as $20 billion in equity to acquire distressed assets around the world [in 2004]," says Rodman. "The success of the NPL market depends on foreign investors taking the initiative to buy portfolios of bad loans and in some cases, bad banks," he commented.
In the report - which was released yesterday to coincide with a World Bank meeting on the subject in Washington, DC - Ernst & Young also highlights the key role that governments around the region have taken in forcing banks to deal with their NPLs. These measures include forcing banks to change the way they classify their loans, shortening the past due loan timing, setting up asset management companies and in some cases writing loans off.
"Government leadership is essential to the resolution of NPL problems," Rodman said. "Unless governments take swift and decisive action, NPL markets will languish."
Interestingly, Rodman believes the rest of the world has a lot to learn from the Asian experience, especially Germany and other areas of Europe that the report calls 'NPL hot spots'. The report estimates there are $300 billion of dud loans in Germany and Europe, which are only just beginning to be addressed. This is throwing up some interesting opportunities for NPL investors.
"[In Europe] investors are trying to get in on the ground floor of what could be the biggest NPL market outside of Asia," says Rodman. "Germany is a relatively new market for distressed loan sales, and few transactions have been completed to date. The investors are circling - the question is whether the banks will step up and sell at market-clearing prices."
As the Asian experience has shown, if banks do not do this of their own accord, circumstances usually force them into doing it at much lower prices in the future.