It said the amendments are “credit negative” for Cypriot banks because they hamper the banks’ organic efforts to reduce large stocks of non-performing exposures (NPEs), which were 30% of gross loans as of December, and also make inorganic sales of NPEs less attractive to investors.
“A failure to reduce NPEs will increase provisioning needs for the banks,” a Moody’s analysis said.
“The amendments will likely make it more challenging for banks to foreclose on collateral held against defaulted borrowers.”
Moody’s is worried the amendments broaden the reasons based on which a borrower may appeal the foreclosure process and challenge a property’s auction, “which will likely cause long delays in the process because of inefficiencies in Cyprus’ judicial system, and a big backlog of cases”.
The amendments passed almost a year after improvements to the foreclosure framework were adopted in response to International Monetary Fund and European Union pressure that facilitated banks’ efforts to foreclose and which have started to produce results.
According to central bank data, in first-quarter 2019, 16.6% of properties where the foreclosure process had commenced were sold at first auction, up from 4.4% for second-quarter 2016-fourth-quarter 2018.
“At the same time, the newly introduced amendments form a less credible threat to bring defaulters to the negotiating table, encouraging weak payment discipline and strategic defaults.”
“In addition to weakening banks’ capacity to recover from their high stock of problem loans and hampering banks’ organic NPE reduction efforts, the foreclosure process changes will likely either affect the price of potential sales of NPE portfolios or deter potential investors from acquiring them because of uncertainty about the time it will take to foreclose.”
The ratings agency said a large discount, compared to previous portfolio sales, would lead to losses and increased capital needs for the banks.
Bank of Cyprus benchmark €2.7 billion NPE sale completed in Q2 2019 and composed mainly of non-performing corporate and small and midsize enterprise exposures secured by real estate collateral was priced at 48 cents to €1 for the portfolio’s gross book value, or 24 cents to €1 for the contractual value.
“Uncertainty about the recovery value on collateral also increases the risk that banks will have to book higher provisions, also in response to increased regulatory pressure, eating into their profitability and eroding capital.”
Difficulty foreclosing will also make banks reluctant to extend mortgage loans.
“This would have repercussions for real estate prices, further weighing on recovery values and the wider economy.”
Moody’s expects all banks within the system to be affected by these changes, including Bank of Cyprus and Hellenic Bank.
As of the end of March 2019, Bank of Cyprus’ NPEs accounted for 35% of gross loans (incorporating the impact of the sale) while for Hellenic Bank, these accounted for 32.6% of gross loans (including NPEs that are guaranteed by the government and account for 6.1% of gross loans).
It said both banks are actively exploring both organic and inorganic strategies to reduce their large stock of NPEs.
The amendments allow the defaulted borrower to obtain a court decision that stalls a foreclosure process if it is proved that a bank has not taken all necessary actions required by the central bank directive to restructure a non-performing loan.
They clearly state the reasons a defaulted borrower can cite to challenge the auction of the property.
Amendments also include, extending to 45 days from 30 days the payment due date following a notice and the auction of a property following a notice; and preventing the sale of a property at below 80% of its market value for six months, from three months previously, while maintaining a floor of 50% of the market value for any potential sale.
Another set of amendments freezes foreclosures on Estia-eligible loans until 1 October, with the application process of eligible borrowers scheduled to begin in early September.
“We do not expect this to materially affect the banks, which are not currently foreclosing on Estia-eligible loans,” said Moody’s.