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Stemming the rise of non-performing loans

If the rise in non-performing loans is to be stopped, the Cypriot banks need to start thinking ‘out of the box’ and employ innovative approaches that can provide short and long-term solutions to the problem.

non-performing loansTHE CYPRIOT banking system, in common with those of many other EU countries, faces significant challenges, the greatest being the seemingly unavoidable increase in non-performing loans (NPLs).

Although there is obviously no ‘magic formula’ that can be applied to stop the rise of NPLs, the Cypriot banks will need to employ innovative approaches that can provide short and long-term solutions. These approaches are mostly new and outside the ‘normal’ banking processes.

Operationally, the banks have not had the experience of dealing with what is a very large portfolio of NPLs – both as a percentage of assets and as an absolute amount.

The traditional approaches, which include restructurings and write-offs (as per the Basel III guidelines) will of course always remain part of the solution. Disposing of the NPLs to specialised hedge funds is also a frequently used solution and could become part of the overall strategy here as well. But other, less “conventional”, methods will have to be considered too:

  • Debt restructuring with concurrent management by the bank of the collateral assets/businesses (under specific guidelines). Simply restructuring a NPL (without any other bank-driven action), in many cases merely provides for a postponement of the need for drastic action and in some cases exacerbates the problem.
  • Management of viable but insolvent businesses. Subject to the terms of specific loans, the bank could take an active role in managing (or co-managing) viable businesses that are heavily indebted. This could take place with or without the voluntary cooperation of the Company, with the former being the preferred route. One example of this approach would be the co-management of a revenue-generating real estate asset, like a hotel.
  • Converting debt to equity. In cases where the indebted Companies have a viable business model, converting part of the NPL into equity (with optional share buy-back scheme) could both enable the business to continue and maybe improve its profitable operations (thus paying off its debts in an orderly manner) and provide some upside for the bank as a shareholder. This strategy has been adopted in various cases across banks in Europe and it could be explored in Cyprus, especially in combination with other approaches such as the ones discussed above.

The banks will need to develop their technical competence and capacity in dealing with NPLs, as this will be a significant part of their operation for a number of years to come. Investment banking and venture capital approaches, tools and culture will be employed and the faster the banks move to tackle the NPL issues the more the already apparent return of confidence in the banking sector will accelerate. And with each NPL that will be resolved, activity and growth in the real economy will benefit.

Thankfully, the Cypriot bankers are well aware of the challenges and have lost no time in turning to experts that have the experience and technical know-how to help build a comprehensive system for dealing with NPLs. Take home message: The task of “cleaning up” the banks’ balance sheets will take time and a great deal of very specialised hard work.

Dr. George Mountis
Director, Business Development
Emergo Wealth

Readers' comments

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  • @Brian Lait – thanks for your comments. I’m please to say that a number of positive actions have been taken following the PIMCO report.

    The Central Bank has issued a number of directives on the definition and treatment of non-performing loans and John Hourican (ex RBS) has been appointed as the Bank of Cyprus CEO.

    There are also many Russians on the boards of the banks.

    Hopefully, things will improve (let’s face it, they couldn’t get much worse).

  • Brian Lait says:

    Some of the comments by PIMCO reported on this website under the heading: “Cyprus banking idiosyncracies laid bare”.

    “A single property can serve as collateral on multiple loans, or – even more complicated – multiple properties can serve as collateral on multiple loans.”

    “Lenders are willing to extend additional loans to a borrower group on the pledging of additional collateral, rather than based strictly on an assessment of the borrower’s ability to service the new loan.”

    “A key feature of the Cyprus banking system has been the practice of pursuing asset-based lending, meaning a high reliance on collateral in the underwriting of loans, often with less attention paid to a borrower’s ability to meet debt service payments on the loan.”

    And you are suggesting that Cypriot banks could possibly think “out of the box” ? Which planet are you on ? You’ll be suggesting that their auditors did a fine job under International Auditing Standards next.

  • Brian Lait says:

    I guess we may be reaching a point, if we have not already got there, whereby NPLs are properly valued. This will, of course, pretty much turn banks into property companies.

    I suggest that all NPLs be put into “bad bank” and be run by people who actually know what banking is all about.

  • andyp says:

    And all those affected by developer mortgages could hold hands and skipity hop down the road to the developer’s bank and hand in the house keys then trot off battered and broke into the sunset.

  • Anna says:

    Perhaps we should try a different tack. Talk up Cyprus and how wonderful it is, and how you are enjoying your lovely property. Stop demonstrating at property sales demos and tell everyone to buy, buy, buy in Cyprus. Thus encouraged, developers would finish off their half-built properties and sell them to eager new buyers whose money would then enable them to service their loans… Forget title deeds and just live for the moment…

  • Robert Briggs says:

    The innocent property buyers, without their Title deeds, are not to be held responsible for their developers debts.

    So what is the EU doing about this disgrace? RB.

  • Janner says:

    @Jim – Cyprus will not leave the Euro as long as the EU pay the bills for a bankrupt state. They will continue to milk for as long as possible safe in the knowledge that the EU needs Cyprus far more than Cyprus needs the EU. They all play the political game but that’s the truth and everyone knows it. Our money has long since gone and the title deeds will not follow. Withholding the title deeds amounts to the sovereignty of Cyprus. They will never give that up and nor will the EU try and make them.

  • Jim says:

    Most of the solutions for NPLs require the borrowers business to be viable, unfortunately that is not the case with the majority of Cyprus NPLs.

    There is usually very little in the way of assets, when compared to the loan amount.

    The rising NPL problem in Cyprus is virtually self sustaining & will be difficult to slow down, let alone halt, or reverse.

    I feel the worst is yet to come. It may possibly end with default, Euro exit, devalued new Cyprus pound, civil disorder etc.

  • Richard says:

    “Thankfully, the Cypriot bankers are well aware of the challenges and have lost no time in turning to experts that have the experience and technical know-how to help build a comprehensive system for dealing with NPLs.”

    Have they? Hmmm – I haven’t seen much evidence of that behaviour at all from our perspective.

    The only thing they’ve done so far is offer ‘deals’ to those caught up in NPL’s that – should even a 4 year old scrutinise the detail around them – the only conclusion to draw is that the banks are offering nothing except a golden opportunity to get into even more debt whilst they bear no commercial risk whatsoever.

    I’m not sure if they even know where ‘the box’ IS – never mind how to think outside it!

  • Janner says:

    @Steve.R – spot on. The Cypriot authorities do not want to sort it out. It’s not rocket science to sort the mess out. They simply do not want to do it……. The EU gravy train rolls on and while it does it is not in their interest to modernise.

  • Steve.R says:

    Even with all the threats the banks are putting out nobody will be interested in re-structuring a NPL when at the end of the loan period you would be still be landed with the developer debt and tax bill. Most developments remain unfinished and some need more work than others to be able to apply for a completion certificate. Lump this all together and take into consideration the massive interest fee that you have paid over the loan period. You could have the potential of paying up to 4 times the value of the property. You are then at the mercy of the system to provide you with your title deeds. Most people that bought in Cyprus were in their late or early 50s and will never, in their lifetime see these title deeds.

    I asked my children if they would be prepared to carry this on if it wasn’t sorted out before I die and they just laughed at me. I think that says it all. Sort out the title deeds issue and that would give people the encouragement to sort out the NPLs.

  • andyp says:

    Is it possible for Cyprus banks “to think outside the box”?

    If they had simply acted like banks and lent money based on ability to repay and pursued late payments sooner much of this grief could easily have been avoided.

  • Mike says:

    Did I read this right…”Thankfully, the Cypriot bankers are well aware of the challenges and have lost no time in turning to experts that have the experience and technical know-how to help build a comprehensive system for dealing with NPLs”.

    Am I just a Cynic or would I be right in thinking that those “experts” are the one and same individuals and organisations that got us into this mess in the first place. Was there not a report a little time ago where the developers association was offering advice as to how best to proceed – obviously with no hint of as to who the suggested policies would benefit the most!

    Thinking outside of the box is certainly a good suggestion but providing short and long term solutions to the problem, in fact any problem, is not something those charged with the task of doing so heave shown themselves to be capable of doing unless of course the terminal objective was to achieve self serving gain at the expense of all others and the national interest.

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