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Singapore Bank Series – What are non-performing loans & how do they affect prices?

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Banks lend out money with the hope that whoever is borrowing it is going to pay it back. However, that doesn’t always happen and borrowers are sometime unable to pay the money back.

What that happens, you get the formation of non-performing loans (or NPL or short), which is exactly what it sounds like.

NPLs are formed when principal and interest payments are overdue by a certain number of days – and are considered bad debt because the likelihood of getting paid back on that debt decreases.

Secured vs Un-secured

Loans are typically secured or unsecured. Unsecured loans typically charge higher interest rates because in the event of a default, the bank has no collateral to liquidate and recovery is minimal.

Secured loans typically feature better recovery rates because of the underlying collateral pledged to the bank. Interestingly, banks can also bundle these NPLs into a portfolio and sell them off at discounts to face values to investors who will then seek recovery.

Secured.. by what?

Of course, a secured loan is only as good as the underlying collateral backing it. Housing in Singapore and Hong Kong has typically been a good bet and you don’t really have the mass auctions and fire-sale prices that you see in other countries.

Banks on the other hand had a much tougher time recovering their money with oil & gas loans as the underlying vessels and machinery were worth far less than their stated book values.

Key lesson: Underlying values of collateral do matter.

NPL Spike in 2016 was minor

Another takeaway is that the pain felt in 2016 – 2017 was really really minor and that in my view, stock prices had irrationally overreacted to 2008 valuations.

NPL formation had increased in a very small component of their loan book but the overall credit worthiness of the overall loan book was never in any real danger.

The same cannot be said for the Asian Financial Crisis where NPLs went through the roof. What was startling to me is how broad based the formation of NPLs across the different industries were too during that time.

Singapore / Hong Kong housing specific takeaways

An interesting to note that housing related loans in Singapore & Hong Kong have held up pretty well over the years, even in dire times like the Asian Financial Crisis.

Something interesting about Asia is that declaring bankruptcy is far more frowned upon and onerous then in the US which might explain some of it.

The same cannot be said for the US where underwriting quality went through the floor (and then some), and you had a huge surge of sub-prime mortgages which went into default precipitating one of the worst housing crisis on record and the near collapse of the world economy with it.

To give you a simplified understanding, think about how hard it is to get a home loan in Singapore. You need about 25% down these days, have income proof, fulfill TDSR requirements etc.

Well, back then in the good old days of 2005 – 2007 none of these requirements were necessary in the USA. You could literally get loans with stated incomes (no verification needed).

Of course none of this ended well and many of these loans went into default once property prices collapsed.

You can watch numerous shows like The Big Short or Too Big to Fail if you really want to know more.

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