This article first appeared in The Edge Malaysia Weekly on April 19, 2021 - April 25, 2021

THERE is likely to be an increase in the sale of non-performing loans (NPLs) by Malaysian banks as some lenders look to clean up their Covid-19-impacted loan books more quickly, experts say.

“We expect Malaysian banks to look at NPL sales more actively, especially for corporate credit,” says Nancy Duan, a credit analyst at S&P Global Ratings.

CIMB Group Holdings Bhd, the country’s second-largest banking group, may have started the ball rolling. It sold a “small” portion of NPLs last year to a third party, according to an industry source. The actual amount of NPLs sold is not clear, although news reports last week cited a figure of around RM360 million.

CIMB has, however, clarified that the amount is actually much lower.

“The actual amount of NPLs sold in 2020 was significantly lower and is not-material,” CIMB said last Friday in response to questions from The Edge. It declined to disclose the exact amount or to name the buyer.

Duan believes that more banks will follow in CIMB’s footsteps. “We think that will become more of a trend going forward as banks try to clean up their Covid-19-related weak assets more quickly,” she says.

Interestingly, NPL sales — one way for banks to resolve bad debt quickly so they can focus on growing their business — have not been as common a practice among Malaysian banks as with their regional peers. CIMB has been one of very few local lenders in the past decade to have occasionally divested a small portion of their NPLs.

Other than CIMB, the most recent incidence of an NPL sale by a local lender was in early 2019 when AMMB Holdings Bhd sold NPLs from its two subsidiaries — AmBank (M) Bhd and AmBank Islamic Bhd — to Aiqon Capital Group Sdn Bhd for RM553.91 million. It was AMMB’s first such sale since 2007 and it made a net gain of RM229.94 million from it.

“NPL sales as a bad debt resolution channel has not been popular in Malaysia in the past decade,” Duan tells The Edge.

She says one of the main reasons for this is that the banking sector’s asset quality has been on a consistent recovery since the 1997/98 Asian financial crisis and, hence, the overall size of the Malaysian NPL market — at a yearly average of RM25 billion to RM30 billion over the last 10 years prior to Covid-19 — is not large.

“With a low NPL ratio of below 2% and limited NPL pressures, local banks were not in a rush to sell NPLs to third parties as those disposals are generally perceived as selling with deep haircuts compared with banks’ own in-house NPL recovery. Instead, NPL write-offs are also more preferred, in general, given the tax benefits. The written-off NPL will be tax deductible, thus positive to net profit,” she explains.

Even prior to the last decade, there were no large disposals of Malaysian NPLs. Between 2005 and mid-2012, NPLs sold by banks amounted to less than RM3 billion, according to past data by Bank Negara Malaysia.

“Whether NPL sales will become more popular in the current credit cycle triggered by Covid-19 depends on the pace of new NPL formation in this year and next, as banks start to deal with the crystallisation of asset quality in their loan portfolio,” Duan says.

Indeed, the asset quality of Malaysian banks is expected to deteriorate over this year and the next as existing measures to support borrowers gradually expire. S&P expects the sector’s gross NPL ratio, which stood at 1.6% as at end-2020, to rise to 2.5%-3% this year and to peak at 3%-3.5% in 2022.

Selling NPLs will help banks lower their NPL ratio faster, analysts note. CIMB’s gross NPL ratio was among the highest of local banking groups, at 3.6% as at end-2020.

“Banks will be more willing to sell if the NPL formation is faster than their loan growth and breaching their internal risk management threshold. It also depends on the regulatory supportiveness, as NPL disposals/transfers generally need Bank Negara’s approval,” says Duan.

“For NPLs where the underlying business remains sound but faces temporary difficulties during Covid-19, banks are likely to hold and restructure. But for those credits in certain vulnerable industries that have a long road to recover or become unviable, essentially, banks are more likely to resort to quick NPL sales in order to clean up their books faster,” she adds.

S&P expects that higher stress on asset quality could come from wholesale and retail trading, construction, transport and household sectors when the debt moratorium on retail and small and medium enterprise segments is phased out.

The NPL divestment market is more active in neighbouring countries such as Thailand, Indonesia and the Philippines. Banks there resort to NPL disposals from time to time as part of routine risk management.

“We do expect more active NPL disposal from regional peers given the sharply rising bad loans during the current credit downturn,” Duan opines.

She says it is difficult to say which Malaysian banks are more likely to sell NPLs in the next two years.

“We know small banks have a thinner buffer in a crisis like this, but whether they are more likely to divest NPLs [will] depend on their internal risk threshold and their outlook of the economy and affected industries as well. They are more likely to sell if the appetite is low and their view on recovery is more pessimistic. The same logic applies to big banks as well,” she says.

Duan believes that although NPL divestment will likely pick up steam in Malaysia, banks will largely still deal with NPLs in-house. “We believe that in-house solvency and also NPL write-offs will remain the preferred channel for Malaysian banks to deal with NPLs.”

The NPL divestment trend, a hot topic globally, is expected to play out more intensely especially in Europe and South America, says Elaine Ng, partner and financial services leader at PwC Malaysia.

She says Malaysian banks too are likely to start looking at NPL sales —both retail and corporate — more actively than before. However, the number of potential buyers is limited compared with other markets because of regulatory restrictions.

Under local banking regulations, banks can only sell NPLs to companies that are majority-owned by domestic shareholders. Purchasers are subject to a foreign equity cap of 49%.

“So, there are not many potential buyers [for Malaysian NPLs] unless they participate with a local. There are a lot of foreign buyers out there and they have been buying up NPLs in China and the region,” she tells The Edge.

Industry watchers say that Bank Negara has so far given no indication if it might want to relax NPL regulations anytime soon.

Globally, there is a large pool of specialist buyers, including private equity buyers, that have the expertise to take on NPLs and steer them back to profitability. Among the bigger names globally are Cerberus, Bain Capital and KKR.

In 2019, Aiqon bought AMMB’s NPLs in what was considered a related-party transaction as its controlling shareholder Ibrahim Hussain was the son-in-law of AMMB chairman and substantial shareholder, Tan Sri Azman Hashim. Aiqon clinched the deal through an open e-bidding process.

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