Non Performing Loans - DiVA portal

[Pages:30]UPPSALA UNIVERSITY Department of Business Studies

Jessica Petersson Isac Wadman

A1207

Bachelor Thesis Fall 2004

Non Performing Loans

- The markets of Italy and Sweden

Tutor: Joachim Landstr?m

Abstract

Many countries are suffering from Non Performing Loans (NPLs), which are defaulted loans that banks are unable to profit from. There are two general ways to secure NPLs. One is for banks to handle them themselves, which is common in Sweden where the NPL market is not so widespread. The alternative is for banks to auction them in public to Asset Management Companies (AMCs), which purpose is to dispose of the assets as profitably as possible. This procedure is used at the vast Italian NPL market.

Our purpose is to describe how these countries secure their NPLs from three aspects; the market, legal and financial aspect. We investigate how Svenska Handelsbanken (Handelsbanken) in Sweden and Morgan Stanley Real Estate Fund (MSREF) in Italy handle their NPLs. The study has been made through interviews at respective companies.

Our study reveals that historic actions of the government, credit culture and management decisions have shown to be crucial causes to the spread of NPLs. The Swedish legal system allows banks to secure their own defaulted loans in a fast and efficient way, while the Italian is more unwieldy and does not give banks any incentive to work out their NPLs. From a financial perspective, neither one nor the other method can be stated better since the companies operate in different fields. The main reasons that affect the financial result are the specific national conditions. Credit culture and legal system are two vital factors that benefit Handelsbanken while they obstruct MSREF. However, both Italian and Swedish AMCs respective banks must continue to review their routines and adaptation ability in order to excel in the future.

Acknowledgements

There are several people we would like to thank for their help and support throughout the study. Our tutor, Joachim Landstr?m, for his feedback and availability whenever we were in need of advice; Mr. Glenn Aaronson at Morgan Stanley Real Estate Fund, who willingly obliged us to an interview and further guidance in the djungle of NPLs. Thanks to Mr. Bo Kaijser at Svenska Handelsbanken who took the time for an interview which helped us to grasp the NPL processes of his company; Sarah Barton and Robert Paterson at Morgan Stanley Fixed Income Research for your quick e-mail correspondence and supplies of material. Last but not least, thanks to Tabitha Leitner and ?sa Scharfe who have helped us with the proofreading of our thesis.

Uppsala, Januari 2005

1.1 Background.......................................................................................................................5 1.2 Definition and classification of NPLs ..............................................................................5 1.3 Problem discussion ...........................................................................................................6 1.4 Limitations........................................................................................................................7 1.5 Disposition........................................................................................................................7

2.1 Choice of method..............................................................................................................8 2.2 Data collection..................................................................................................................8 2.3 Selection ...........................................................................................................................8 2.4 Interview...........................................................................................................................9 2.5 Analyzing methods ...........................................................................................................9

3.1 Market.............................................................................................................................11 3.2 Legal system ...................................................................................................................12 3.3 Finance............................................................................................................................13

3.3.1 The Morgan Stanley Real Estate Fund (MSREF) ...................................................13 3.3.2 Due Diligence ..........................................................................................................14 3.3.3 The extension of Gross Book Value........................................................................14

4.1 Market.............................................................................................................................16 4.2 Legal ...............................................................................................................................17

4.2.1 Handelsbanken ........................................................................................................17 4.3 Finance............................................................................................................................18

5.1 Market Analysis..............................................................................................................19 5.2 Legal analysis .................................................................................................................21 5.3 Financial analysis ...........................................................................................................22

1. Introduction

This chapter introduces background, definition and markets of Non Performing Loans to increase the understanding for the reader. It continues with purpose, limitations and finally disposition for the essay.

1.1 Background

The banking crises throughout the world have contributed to ineffectiveness in the financial systems and have in some countries, depending on the effects, put a delay in the economic development. With the enormous amounts of Non Performing Loans (NPLs) on bank balance sheets, many countries have established public asset management companies that manage the disposal of defaulted loans. Today, markets are more open and many of these public companies have become privatized. As a result of above, many Asset Management Companies (AMCs) have entered markets where they can see potential profits in handling NPLs. The first NPLs occurred in the USA in 1987 after that one of the most severe financial crises hit the American stock market. (Morgan Stanley, 2004) Surrounded by the Savings and Loan crisis, Federal Savings and Loans Insurance Cooperation (FSLIC) was the first company to be created in order to work out defaulted loans. However, the task of solving these loans turned out to be too extensive and FSLIC lost considerable amounts of money. In pace with growing problems the US government entered the market and invested huge amounts in the creation of the Resolution Trust Company (RTC). (Aaronson, 2004) Nevertheless, problems with NPLs are not in any way specific for the US market. Defaulted loans arise all over the world and governments are still struggling to come up with solutions. (Morgan Stanley, 2004)

1.2 Definition and classification of NPLs

NPLs can be defined as defaulted loans, which banks are unable to profit from. Usually loans falls due if no interest has been paid in 90 days, but this may vary between different countries and actors. Defaulted loans force banks to take certain measures in order to recover and securitize them in the best way. (Ernst & Young, 2004)

The definition of impaired loans is loans that have not expired, but it is uncertain whether the borrowers could repay their debts. Generally banks and other credit institutes do not class them as potential non-performing loans and therefore calculate with little or no loss provision from them. (Ernst & Young, 2004)

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1.3 Problem discussion

During booms markets are often full of expectations. More liquid assets are in business which affects the behaviour of different actors as well as the general politics of society. Banks may wish to increase their lending in order to expand their market share. This could in worst case lead to a more easy-going lending policy, which in turn can result in many loans given to customers who are far from credit worthy. Commonly in times of recession, liquid assets decline, collaterals may loose value and suddenly banks might find themselves with large amounts of non-coverage loans. (Nyberg, 2000)

To secure these loans there are two common methods practiced. One is for banks to work out their defaulted loans themselves, by taking the case to court and get a verdict for compulsory auction. This system is very common in Sweden, where banks can hand in an application to the Swedish enforcement officer. (Head of enforcement district, 2004)

The other alternative is if banks decide to auction out defaulted loans in public. The procedure captures the interest of many companies who sees opportunities in making profit from bad loans. These AMCs purpose is to dispose of the assets as quickly and profitable as possible. This method where banks involve a third party is common in Italy due to different reasons. One is that Italy has a complex legal system which complicates the bank s ability to sell collateral at compulsory auction. (Morgan Stanley, 2004)

From this information presented one can draw the conclusion that different countries obviously have different methods of solving NPLs. The systems used by Sweden and Italy are quite different, nevertheless both methods seem to work out. Is the choice of method just questions of national basic conditions e.g. the legal systems or are there other factors involved? Companies like Ernst & Young (E&Y) have during the years produced several reports regarding NPLs; some with reference to the Italian market because of its extensive NPL market. However, there has not been enough substantial material published about the Swedish NPL market since it is not as extensive as the Italian. With these underlying facts we wish to observe the NPL situation and how the securitizations of these loans are conducted in these countries.

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The purpose of this paper is to describe the Swedish and the Italian NPL markets and their rise of NPLs out of three aspects; the market, legal and financial aspect. Our intention is to analyze how different markets secure their NPLs. We explore the different procedures between Svenska Handelsbanken (Handelsbanken) and Morgan Stanley Real Estate Fund (MSREF). In doing so, we hope to create an awareness of the various solutions of these problems.

1.4 Limitations

This essay is adjusted to fit within the limits of time and possibility. We have decided to limit our paper to the Swedish and Italian NPL markets. We have limited our research to two companies; MSREF, a multinational AMC acting on the Italian market, and Handelsbanken, one of the leading banks in Sweden. We discuss their activities and how the securitize defaulted loans from a business economy perspective.

1.5 Disposition

This essay is divided into six parts with the first chapter presenting the background to NPLs and the thesis objectives. The second chapter treats the methodological procedures used to gather empirical data. Chapter three and four presents the empirical material, both primary and secondary data, and reveals how the actors in Italy and Sweden cope and manage to securitize NPLs. Chapter five analyzes the empirical material and chapter six concludes the outcomes from the analysis.

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2. Method

The aim of this chapter is to describe the methodological procedures when gathering and compiling data, in order to enable the credibility of the investigation and its final results.

2.1 Choice of method

For this essay, literature is studied on the subject to give a fundamental introduction to the topic. In view of the fact that the secondary data on NPLs can only provide us with general information, we are in need of more specific data. The qualitative method is best suited for complex investigations where the ambition is to understand and analyze the overall picture (Patel 1994). The alternative is to use a quantitative method; however, this cannot generate thorough information in the same way (Svenning, 1999). One last aspect in favour for the qualitative method is that quantitative techniques are mostly a way of measuring variables. Whenever larger statistic selections are used in investigations, results often tend to become more standardized in comparison with qualitative techniques. (Newbold, 2002) Therefore, the approach for this essay is founded on a qualitative method with the intention to provide a deeper understanding for companies securitization processes.

2.2 Data collection

The search for literature is an ongoing process. During our research for secondary material, we discover that it was not enough to lead us to our objectives. Therefore, we find we are in need of primary data for the empirical part of the essay. In order to obtain the supplementary data we conduct interviews with employees at respective company. Interviews are powerful since they open the opportunity for two-way communication (Andersen 1994). This involves follow up questions and enhanced discussions within reasonable limits. Apart from the primary data received from interviews, the essay is further complemented with secondary material.

2.3 Selection

Qualitative interviews do not require a classified way of choosing the selection. However, the main principle is that the selection should be made in interest of the investigations aim (Patel, 1994). Our intention was to choose one country with an extensive NPL market and one where NPLs barely exists. Our choice fell on Italy and Sweden since they both fit the description.

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