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Resolving NPLs with innovative solutions

Resolving Cyprus' NPLs with innovative solutionsON FRIDAY, February 5, a seminar on Resolving Non-Performing Loans (NPLs) with innovative solutions was held at the Filoxenia conference centre in Nicosia under the auspices of the European Investment Bank (EIB), the Ministry of Finance and the Cyprus Chamber of Commerce and Industry.

The seminar was organised to bring to Cyprus the key international financial institutions (IFIs), the major stakeholders in the global financial world which have the financial strength and know-how on best practice in resolving non-performing loans (NPLs) based on their global presence, observation and research. These are the IMF, the European Investment Bank, the European Bank for Reconstruction and Development and the International Finance Corporation (a wholly owned subsidiary of the World Bank).

The issue of NPLs, and the recent experience internationally, was presented together with the actions taken by other countries to address the problem. The IMF research clearly has been the most authoritative and comprehensive, and those present could have been left in no doubt that action over NPLs is necessary since a country cannot simply grow out of the problem. NPLs act as a drag on economic growth, thereby impacting swift bank resolution of NPLs.

It was generally accepted by all participants that the Cyprus economy has weathered the financial dislocation which the closure of Laiki and the bailing in of Bank of Cyprus created. The strict adherence to the MOU by the government has been on the whole beneficial for public finances, but the public finance correction in itself will not bring the growth that is essential to assist in the debt recovery and restructuring of NPLs by banks. In fact, the global economy is facing “unforgiving” developments to quote the Bank of England governor. The developments in China, the collapse of energy prices and the disinflation in the Eurozone are likely to impact Cyprus in a negative way.

The economy cannot rely on golden visas for real estate sales and tourismThe economy cannot rely on golden visas for real estate sales and tourism to get into a sustainable growth trajectory. This must raise the concern levels of the stakeholders across the spectrum since the effort to get the NPLs resolved has to be collective which means including the government, the banks and the business world.

The successful bank recapitalisation and recent increased provisions are very promising for the banking industry but are not enough. As one of the leading participants at the seminar highlighted “if there is another economic crisis and worsening of the banks collateral, there will not be enough capital cushion given the size of NPLs on the banks’ balance sheets.”

In terms of the tools the banks have at their disposal these were quite broad and supportive in managing their NPLs, as one banker suggested, however, there was scepticism about the implementation of the foreclosure law which has stalled over the last year.

Legislation without enforcement means trouble ahead

In the IMF’s opinion, legislation that does not translate into enforcement means trouble ahead. The House of Representatives has watered down the speed and efficacy of the laws passed so much that banks probably cannot act on the strength of swift court action and have to rely on out of court settlement which requires the co-operation of borrowers.

In this regard, an increasing number of borrowers are more amenable to restructuring. Hence we see loan for asset swaps and split loans for restructuring. These measures can support the efforts of the banks which have been trying to undertake work outs in a very hostile environment. Banks need to protect their capital positions and will not increase lending when there is so much uncertainty in the economy, and so few credit worthy borrowers. Bankers at the seminar felt they have substantial liquidity but not many creditworthy borrowing requests. One of the bank actions which can assist their debt collection is to outsource the loan servicing which is what the IFC has suggested works in several countries where there were high NPLs.

In addition, there are capital markets instruments, as we have seen in the case of Italy, where securitisation has been agreed. This would entail the issuance of senior debt by a special purpose company to acquire the NPLs via the issuance of several tranches of debt of which the senior would be guaranteed by the Italian government on conditions laid down by the EU. Such a transaction, however, would not work in Cyprus in view of the lack of significant loan diversification which is necessary to get the senior tranche of such a funding debt issue to investment grade. An asset management company with a centralised focus and funded by the government, as witnessed in most countries with smaller NPL problem in the world, would not be possible in Cyprus anymore due to the implementation of the EU Bank Resolution and Recovery Directive and the bail in implications.

Therefore, the banking system in Cyprus will focus on internal working out of the NPL problem using restructuring of loans and will depend on the recovery of businesses and the real economy at large.

In general the key observations of the IFIs and local participants were as follows:

  1. Swift action to resolve NPLs, via asset management companies publicly funded, has enabled countries to make progress and countries such as the Baltics were cited. The transfer of loans to asset management companies faces the problem of market values being significantly lower than book values due to low provision;
  2. Legal obstacles and watered down legislation hindering enforcement of laws have acted as a delaying and confusing feature and not helped resolution of NPLs;
  3. It is vital that banks are able to enforce claims on NPLs in relation to real estate, against debtors in a predictable and efficient manner;
  4. Assertive supervision and swift loss recognition has been shown to be successful;
  5. Development of a distressed debt market would be welcome in order to attract overseas investors;
  6. If NPLs are not restructured correctly it may lead to zombie companies being created which tend to slow economic growth;
  7. Banks with high NPLs are vulnerable and should another crisis develop they will have limited cushion to absorb additional losses and increased provisions;
  8. Internal work outs within banks require expertise and skill sets not found in banks;
  9. Collateral values were overvalued thereby overstating capital ratios; 10. Mass foreclosure do not help the economy, the more if the NPLs are real estate related;
  10. One of the ways that NPLs can be worked out is with increased provisions, additional capital requirements, and to encourage out of court settlement for restructuring. Single Supervisory Mechanism action will be to press for targets of restructuring of NPLs for banks, including in Cyprus where the pace of restructuring has not been satisfactory;
  11. The Central bank of Cyprus has established sufficient monitoring of NPL healing trajectory and has enough ground to be optimistic that banks have done a good job in the second half of 2015;
  12. Banks in Cyprus have a focus on complying with swift restructuring and good momentum exists with positive results based on organic reduction of NPLs. Also banks have a wide range of financial products to assist borrowers.

The progress will be slow and painful but the reality is that the private sector is over borrowed and what is needed is additional equity. The IFIs represented at the seminar, particularly the EIB and IFC, outlined some of the innovative tools that have been used in other countries. These were as follows:

  1. Assuming sufficient provisions on bank balance sheets so as not to create a big hole in their capital ratios an asset management company (AMC) could be introduced. Such a resolution would though have to limit the involvement of the state since experience has shown that political interference is inherent. Governance of such an AMC would have to be in line with best practice and bankers should not be involved in the management. The state could provide guarantees if these would facilitate the sale of funding instruments but have to take into account DG Competition of the EU views in terms of state aid.
  2. The recent Italian agreement with the EU to use securitisation of NPLs for banks wishing to sell loans would be one option, however, the diversification of NPLs in Cyprus is not wide enough and would not achieve the minimum investment grade that would be necessary. In any case the absence of a tested securitisation law in place and lack of previous experience in securitisation make this very difficult to consider;
  3. The most practicable, and likely supportive measure for Cypriot banks, is to outsource the loan servicing of NPLs which may lead to improving the cash collection at banks. Apparently official bank culture in Cyprus is hindering rather than improving the process, and a third party, experienced in such a business, would produce better results for banks.

The NPL problem will not be resolved swiftly

To sum up the essential messages of the seminar, one can say are that the NPL problem will not be resolved swiftly and banks will continue with their work out solutions employing the wide range of products at their disposal. There is not much scope for government intervention. The government has passed most of the legislation required to empower banks to enforce their claims but as expected untested laws take their time and hence banks will build on their recent improved performance.

The efforts of the banks can be supported by outsourcing of loan servicing and where it is feasible, by additional equity that is used to reduce indebtedness of borrowers. The preferred solution of banks is to continue the current approach with the Central Bank overseeing and monitoring the progress of banks. (The impressions are from views expressed by participants).

Erol Riza is founder and managing partner of SME Markets Limited


  1. Long ago I realised there is an uncomfortable gap between ‘legal’ & ‘ethical’. That gap would now appear to be widening into a chasm.

    My only hope is enough people wake up to this unhealthy trend before too many people fall down said chasm.

  2. What I can’t understand is why it is ok for the banks to get all this EU support of finding new ways of piling pressure onto individual victims, many of whom have felt suicidal, and yet nothing for us, the victims?

    The banks have no feelings, and no emotions – they are not people! If I had a bus full of passengers and drove recklessly off the road into a tree, I would not expect to have free garage services to restore the bus! I wouldn’t be finding new ways of kicking the injured passengers harder into paying up for the damage either! Criminal, and I would be locked up.

    Apart from that, I can’t understand anyone agreeing to pay back more than they originally agreed to pay the banks – just as no-one would expect to have to compensate a criminal that had wrecked your life!

  3. Thank you. Distressed Debt Market would therefore just appear to be another name for Debt factoring.

    And there lies the point. Often in many situations, the names of the products, services and practices are changed so it creates the ‘illusion’ of something new (as ‘spin’) when in fact – on closer investigation – it’s a simple case of “meet the new boss – same as the old boss”.

    That’s why I feel strongly we need to continually push for clarity around everything to do with banks and their NPL resolution process.

    I can heartily recommend the film “The Big Short” currently on release in selected theatres. It’s ‘based on a true story’ and plots the rise of how (mainly) U.S banks crashed the world’s economy by building massive debt based around Collateralised Debt Obligations (or C.D.O’s). At the end of the film – it’s clear C.D.O’s (and the idiots peddling them) have not gone away. They’ve simply changed the name of them to something else.

    Meet the new boss – same as the old boss…..

  4. @John. There is no need for facetious and childish observations – thank you.

    I am pushing for clarity. Not everyone embroiled in this situation has the time (retired) or even internet access (tech-aware) to ‘Google’.

    That’s why the ‘Plain English’ marking system for public facing documents was created in the United Kingdom.

    (Editor’s comment: ‘Assertive supervision and swift loss recognition’ is all about keeping a close watchful eye on loans and when any become non-performing take effective action to resolve the problem.

    Effectively dealing with strategic loan defaulters. I.e. Those who are able to repay the loan but refuse to do so.

    ‘distressed debt’ is a bad debt that could be bought for a fraction of its value at a high risk to a purchaser. E.g. the debt is €100 and is bought for €10.)

  5. There are a number of terms in the above article that are too ‘corporate speak’. Some clarity around them would be nice if anyone out there can shed any light?

    1) “Assertive supervision and swift loss recognition” And in plain English….?

    2) “Development of a distressed debt market would be welcome in order to attract overseas investors” What exactly is a “distressed debt market” ?

    I agree completely with Steve R below that the Cypriot based banks (and Alpha Bank in particular) have not done nearly enough due diligence on recognising & accepting their woefully reckless mis-selling practices and flagrant abuse of loan instruction processes that led directly led to the creation this crisis in the first place (fuelled in most cases – by greedy & devious brokers).

    There are too many words flying around and not nearly enough basic common sense. Basic common sense will always win out over verbosity.

  6. I just think that the banks are sidestepping the real issue of mis selling. Not one individual person or a collective group have brought forward a case for mis selling to the courts. The banks are too big to take on I fear.

    This whole article is focussed around the banks ability to be able to come up with a plan that will best suit them, not the borrower. The financial cushion Troika has dried up now so it up to the banks to stand on their own two feet.

    It is just a matter of waiting to see what they come up with next. I have just had a restructuring deal with Alpha Bank where they have accepted a reduced payment plan and they will look at it again in another two years. That gets the solicitors off my back for that period. Don’t ignore the banks because they will not go away. All you are doing is giving them fuel to make the fire even bigger.

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