New Investor Competition in the NPL Markets?

South and Southeast Asian NPL markets are at a cross-roads. Most western NPL investors from the past decade have fled back to home jurisdictions. Few will return. GFC 2008 has triggered a crisis of confidence in western institutions and ushered in an era of reverse globalization that may last a generation. Making complex speculative investments far from home is now viewed as being far riskier, even though the track record, the fundamentals and future growth potential is substantially stronger than western markets. Compliance and regulatory issues make cross-border investment increasingly more difficult and expensive, to the extent that for some, it is now far easier to create reasons not to close a deal in developing markets. The foreign investors that remain in the region have tended to withdraw back to base in Hong Kong and Singapore where their local touch throughout the region will gently fade and their ability to execute speculative transactions will become ever more challenging.

The foreign investment vanguard in the region is maintained by a handful of entrepreneurial hedge funds and private equity investors. Most have limited origination capacity and insufficient capital to do whatever it takes to monetize high volumes of distressed debt. Few have sufficient size or resource to convince a big local bank to come to the transaction table. A handful of smaller funds have viewed the foreign investor exodus as an opportunity to ratchet up their returns to unrealistic levels. However, rather than sell substantially below market, most developing market institutions would prefer to sit on assets and do nothing, secure in the knowledge that inflation will ultimately soak up the excess. Watching western markets struggle under the scourge of weak demographics, a burgeoning welfare state, unsustainable public debt and a core loss of confidence in the concept of unbroken lifetime unemployment has engendered a massive local boost in confidence in the future strength of Asia and greater trust and belief in Asian institutions.

So who is most likely to roar into the gap left by the international NPL investors in developing Asia? NPL seller markets thrive on competitive friction amongst bidders in order to make top dollar. The NPL investor market is a niche sector with a limited number of buyers. It doesn't take many to withdraw to subdue the market. In the absence of buyers, Asian banks will be left with no alternative but to find their own homegrown solutions to optimizing NPL book sales.

In parallel with the regional banking sector expanding at 10% per annum, we have also witnessed enormous growth in the Asian investment banking industry. Since the Millennium we have seen far greater sophistication in local capital markets and a shift in reliance upon retail bank funding. Capital markets and investment banking revenues (CMIB) now constitute 30% of all banking revenues in ASEAN. Local investment banks have increasingly taken greater market share in equity and debt markets and M & A; a process that if anything looks set to increase further, particularly after the advent of the ASEAN Economic Community (AEC) in 2015.

In the same way that western investment banks moved from CMIB in the 1980s into NPL investment in the 1990s, it is logical that a similar trend will emerge in developing Asia. What is more, Asian investment banks tend mostly to be subsidiaries of larger domestic banking institutions, unlike western institutions in the early 1990s, which were still separated by Glass-Steagall. For an Asian banking institution now, given the lack of competitive friction amongst established international NPL bidders, it is a far easier decision to transfer loans at a deep discount to a related investment banking entity.

Exactly how this is achieved will vary across jurisdictions, dependant upon local banking regulations, the scale of the financial problem confronting banks, and banking sector liquidity. Trades to third party NPL investors will still occur, but there is also likely to be increasing use of two home-grown DIY models in the region:

The first model is an asset management company (AMC) subsidiary where loans are transferred internally to a "bad bank" work-out unit, where no sale occurs.

The second model is a true sale of loans by into a joint venture comprising an investment banking division (IBD), a new retail capital Fund raised by the IBD unit, and an independent third-party special servicer such as Capital Services Group

2013 turned out to be a solid year for NPL investment in established markets like Malaysia and especially in Thailand. In the latter jurisdiction, some competitive bids witnessed a bizarre situation where there was only one bidder, who as a result, was able to buy at return levels 50% higher than NPL portfolios had been purchased for in 2012. Not wishing to see this situation continue, banks in the region that need to sell NPL books have been looking at ways to increase future bid competition through their own IBD units. 2014 looks like it will be another promising year for NPL investment in South and Southeast Asia, particularly as we may see increased activity in newly emerged NPL jurisdictions like India and Vietnam, but international NPL investors are unlikely to fi nd things as open and easy as they have been in 2013.