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Cyprus' banks reduce their Non-Performing Loans. See how it is done, and weep.

There was an lol for me today, thanks to an article in the Cyprus Business Mail announcing that Non-performing loans (“NPLs”) in the Cypriot banking system had fallen in March 2018 by almost €2.1bn to €19.9bn compared to February’s figure, and that this was the lowest figure for NPLs since December 2014, according to figures issued by the Central Bank of Cyprus (“CBC”).

The NPLs ratio in the system fell in March from 45.3% in February 2018 and 46% in March 2017, to 43% – i.e. 43% of all loans extended by Cyprus’ banks are NPLs.

A bank should now have Tier 1 capital in the order of 9% of its loans, which should all be Performing bar a few, perhaps 1-2% of NPLs out of total loans. It should have Tier 1 capital of anything between 25% and 100% of its NPLs, depending on how bad they are. Cyprus’ banks may have 9% Tier 1 capital but only of total loans, without the extra capital to reflect the risk of loss on NPLs. There is glaring black hole where that extra capital should be and this absence renders Cyprus’ banks insolvent: unable to meet their liabilities as they fall due from the proceeds of their assets.

Cyprus’ banks are locked into a form of continuous bailout in this mode with rolling lines of credit from CBC and the other Eurozone central banks, until every now and again a bank does go over the edge, as Cyprus CoOperative Bank did recently, in which case another Cyprus bank (in this case Hellenic) was wheeled in to acquire its deposits and its Performing loans, and the Cyprus taxpayer was awarded the NPLs.

CBC tells us that the implementation of international financial reporting standard (IFRS) 9 in January led then to an increase in banks’ NPLs, but now a new classification methodology is in place which “provides for a minimum 12-month probation period for restructured facilities”.

We read that as meaning that when an NPL has been “restructured” – meaning things like the unpaid interest has been capitalised, the repayments have been stretched out and other forbearance actions taken - the NPL is then counted as Performing. It is backed out of NPLs, which reduce, and the loan cannot fall back into NPLs whatever happens for a year.

That is very bad, not very good; it means that Cyprus’ banks can enjoy a reduction in NPLs that will last at least a year by basically letting the borrower off the hook.

CBC’s further statements reinforce this unease: “The downward trend in NPFs (non-performing facilities) can be attributed to write-offs, increased restructurings successfully completed by the end of the observance period and reclassified as performing facilities, repayments as well as settlement of debt through swaps with immovable property that is expected to be sold with the aim of a faster cash collection”.

The point about “immovable property” is that any hope of the loan being repaid via the borrower’s cashflow is replaced by reliance on mortgage security, no doubt with suitably lax conditions around the Loan-to-Value, the size of the re-sale market for the asset if repossessed, the length of the legal process for repossession and so on. Nevertheless, the loan can then be classified back into Performing due to this new security, even if the security does not get sold. This sort of chicanery is what the ECB's Mme Nouy recently recommended for adoption across the entire Eurozone banking system.

CBC admits that loan restructurings do involve write-offs but adds, emolliently, that the write-offs are “amounts that already form part of credit institutions’ loan loss provisions,” which fell by €2.2bn in a month to €9.7bn in March.

It may well be that Cyprus’ banks had either built up a Loan Loss Provision on the liability side of their balance sheets to account for the impairment of the value of these loans on the Asset side, or that they had written off part of the value of the asset by taking a charge through the P&L account, and were now valuing the loans at a “carrying value” below face value.

It seems far-fetched to imagine that Cyprus’ banks can afford to put new write-offs through their P&L accounts, or that their loan loss provisions were already adequate to cushion the realisation of losses on the 43% of their loan book that had gone bad.

No, it is more plausible that the main factors that have reduced NPLs are restructurings involving forbearance techniques and the pledging of mortgage security of whatever quality.

The factor that normally reduces NPLs is not even mentioned: the ability of borrowers to meet their commitments when they could not do so before.

NPLs have been reduced thanks to accounting policies and the watering-down of borrowers' commitments, not thanks to a recovery of the economy or of the creditworthiness of borrowers.

That this should be recorded as some form of success is measure of the depth of the difficulties in which the Cyprus banking system remains mired, and the Cyprus banking system can be taken as a proxy for the Eurozone banking system as a whole.


Comments: (6)

A Finextra member
A Finextra member 16 July, 2018, 03:16Be the first to give this comment the thumbs up 0 likes

Mr Lyddon - Interesting note on Cyprus. Have you analysed the Non-Performing Loan issue in India? A decade of poor banking supervision, nexus between politicians and business, systemic corruption, poor lending policies have weakened the banking industry. Of my 30 years in the banking industry, I have spent about 20 years in risk management. In the case of credit risk, if banks can evaluate and monitor credit in the old-fashioned way, their balance sheets will look better. CVaR,PD,LGD,EAD are necessary. What is mandatory, is to ensure the credit worthiness of the customer, ensuring usage of funds for stated purposes, monitoring the exposure by visiting the factory / project-site and making proactive decisions in response to early warning signals. Banker has recover a loan in the manner in which he would, if the money belongs to him.

Couple of links that reflect present status of the crisis in India.


Bob Lyddon
Bob Lyddon - Lyddon Consulting Services - Thames Ditton 16 July, 2018, 12:01Be the first to give this comment the thumbs up 0 likes

Dear Kannan - thank you very much for your comment. You and I are swimming against the tide though, and the tide has become a tsunami because you have to add in the IT industry, Fintech, Regtech and all the charlatans getting into the banking business on the back of disruption (i.e. amateurish punting into an industry you know nothing about).

I have mainly been focussing on the problems in the Eurozone so I am sorry that the same has happened in India. I attribute it in part to credit scoring methodologies, where the same vandors sell the methodology to the bank and then sell a service to the applicants for improving their scores i.e. how to bamboozle the lender. Regulators seem blind to that practice.

Then it is the banks who rely wholly on such methodologies and on security, not on the ability of the borrower to pay.

Then there is the ongoing soft treatment for capital adequacy of any loan with real estate security or which has some tenuous connection to being public sector. Such loans, as long as they were to OECD-based borrowers, already had soft treatment under Basel 1, and this was softened even further under Basel 2, leading directly to both the sub-prime and Eurozone sovereign risk crises.

But it isn't just the bankers who never learn (and why would they if they are a good earner?), it's the politicians and regulators - those who are supposed to be protecting the taxpayer.

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 16 July, 2018, 13:43Be the first to give this comment the thumbs up 0 likes

@Bob Lyddon:

I'm from IT and I guess I'm guilty as charged. Your last paragraph is the money quote. To the list of culpabable parties, let me add CRAs. As I'd written at the time in my post entitled Credit Rating Agencies & The Financial Meltdown on my personal blog, consumers and banks were partaking in the festivities of easy loans and hefty fees whereas CRAs were sleeping at their post (if not worse). And, what's worse, for all the talk of disruption from fintechs and regtechs, the same CRAs still enjoy 94% market share today (Source: WSJ).

Bob Lyddon
Bob Lyddon - Lyddon Consulting Services - Thames Ditton 16 July, 2018, 13:57Be the first to give this comment the thumbs up 0 likes

You are so right there, Ketharaman. I get the LinkedIn feed from one of them and it is a mixture of superficiality and sycophancy, swallowing whatever line is fed them by the company CFO or by a finance minister.

Then you have the prize sycophants at industry magazines and awards bodies.

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 16 July, 2018, 15:57Be the first to give this comment the thumbs up 0 likes

@Bob Lyddon:

To summarize my understanding of what Michael Lewis wrote in his bestseller "Big Short", guys who created structured financial products are top of class from Ivy League colleges; guys who rated structured financial products are middle of class from Tier 2 colleges; GFC is not the first time that smart guys hoodwinked mediocre guys; it won't be the last time either.

Maybe his worldview is cynical, stereotyped and politically incorrect but it sounds quite plausible. It also explains why the same CRAs still have 94% market share - the smart guys wouldn't want the existing mediocre guys to be replaced.

Bob Lyddon
Bob Lyddon - Lyddon Consulting Services - Thames Ditton 16 July, 2018, 19:05Be the first to give this comment the thumbs up 0 likes

I fear that many of the analysts at the CRAs are former analysts at banks who handled the files that later were assigned to the internal Special Credit Department. So their inventory will include Mirror Group, Polly Peck, Bear Stearns, Global Crossing, Refco et al.

Bob Lyddon

Bob Lyddon


Lyddon Consulting Services

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