When does a loan become non-performing?
European supervisors usually consider a non-performing loan when there are indications that the borrower is unlikely to repay the loan because of financial difficulties or when he is late in paying his agreed installments for more than 90 days. This can happen, for example, when someone is unemployed and can no longer repay their mortgage loan as agreed or when a company is facing financial difficulties.
In the worst case scenario, the borrower is completely unable to repay the loan and the bank has to correct the value of the loan it has entered on its balance sheet, sometimes even if it is zero. This is often referred to as a "write-off" of a loan.
Accelerating the reduction of non-performing loans is the biggest challenge for the economy of the country. With a total change in the legislative framework, the government is trying to tackle this challenge and find solutions to this serious problem, which affects the economy of Cyprus to a large extent.
Customers of Cooperative Central Bank did not pay their loans, and, instead of the Bank lowering non-performing loans, the loans were increasing without the targets being met. Reporting data of the Cyprus Managing Authority for the Ownership Structure of Credit Institutions is bringing the situation in the troubled portfolio to light.
The non-performing loans for June 2018 were expected to decline to € 5.81 billion or 54.86% of total loans. The projected target was not reached and as a result, the non-performing loans increased by € 328.6 million or 2.21%, i.e. € 6.14 billion or 57.3%. For loans with more than 90 days' delay, the provision for June was that they would decrease to around €4,36 billion or 41,19%.
The projected target was not achieved, with the result that they increased by € 695.2 million or 6.02%, or € 5.06 billion or 47.21%. Interestingly, the province of Cyprus in which there is the largest proportion of non-performing loans and bad payers can be determined. On 30/09/2017, the average non-performing loans for professional savings banks stood at 19.44%, for the non-performing loans in Nicosia were at 67.71%, in Limassol at 65.87% and in Larnaca-Famagusta at 73.46%.
The highest index belongs to the Paphos Co-operative Savings Bank, which nevertheless dropped to 76.96% from the high of 80.23% in December 2015. As a result, we can see that the average of the non-performing loans of the whole sector was decreasing. With respect to overdue advances over 90 days, on 30/09/2017, the average for Business Savings Banks was 14.51%, for the Nicosia District Cooperative Banks it was at 54.41%, for Limassol 53.17% and the Larnaca-Famagusta district 60.71%. Lastly, the average of Paphos was reduced to 60.19% from the high of 75.56% in December 2014.
The Ministry of Finance issued a warning statement, pointing out how necessary it was for the proposed changes to have been made. Dialogue and submission of proposals on governmental contributions needed to be undertaken as soon as possible. The Ministry of Finance and the Central Bank of Cyprus, together with political parties have discussed proposals to resolve the non-performing loans problem by improving the current legislative framework as participants said banks are running out of time.
The Ministry of Finance pointed out, in its Stability Program 2018-2021, a document outlining its economic and fiscal policy framework submitted to the European Commission two months ago, that it plans to reduce non-performing loans by one third of the current stock accounting for €22bn with a three-pronged strategy. The strategy provides for the sale of the Cyprus Cooperative Bank operations, into which it injected more than €4bn over the past four years, the creation of ‘ESTIA’, a body that would aim at assisting vulnerable groups to repay their loans, and a stricter legislative framework governing foreclosures and insolvency.
In 2013, depositors lost €8bn when the Bank of Cyprus was forced to convert almost half of its uninsured deposits into equity while those of Cyprus Popular Bank, also known as Laiki, lost all their deposits in excess of €100,000 after the bank failed to find an investor willing to bail it out once more, after the Cypriot Government recapitalized it with €1.8bn the year before.
Speaking at the 8th Nicosia Economic Congress, the Minister said that, depending on investor interest in the Co-op Bank the government planned to set up a loan management body to handle its non-performing loans. He specifically said that:
“In any event however, it must be understood the view that no loan will be written off,” he said. “Precisely because the administrator’s proceeds from the borrowers and not from taxpayers, will repay the debt the state has now assumed.”
The Ministry of Finance also expressed the view that “the Government has set as a priority to effectively and swiftly tackle the most challenging issue facing the financial sector and the broader economy,” adding “to this end a comprehensive strategy has been designed in order to successfully resolve, during the course of 2018, the final hurdle to full normalization of the economy that of non-performing facilities burdening the banking sector.”
The first pillar involves a series of reforms in the legal framework governing the non-performing loans management, including the introduction of electronic auctions of foreclosed property, the improvement of the foreclosure framework “to act as a credible thread especially to strategic defaulters,” and the completion of a secondary non-performing loan market.
According to the document published by the Finance Ministry, the second pillar of the Government’s strategy addresses the most challenging segment among non-performing facilities in the entire system: that of mortgage non-performing loans and non-performing loans collateralized with the primary residence of the borrower.
According to the Ministry of Finance, “it is envisaged that for the participation in the scheme, eligible portfolio will be NPFs that have been classified as such in 2017 while borrowers should meet specific pre-defined income and asset criteria in order to exclude free riders or strategic defaulters exploiting the government’s support, thus ensuring fairness and limiting moral hazard.”
The third pillar concerns the privatization process of the state-owned Cyprus Cooperative Bank launched in March this year. The Cooperative Central Bank faces mounting NPLs amounting close to 60% and a provisioning gap due to capital requirements by the European Central Bank.
“In order to meet supervising requirements, a process has been initiated which includes selling the whole or part of assets and liabilities of the Cooperative Central Bank,” the Ministry of Finance said.
New legal framework
The House of Representatives voted on five bills at the Plenary Session and adopted the Non-Performing Loans Regulation. The House of Representatives also approved the government guarantee for the agreement on the absorption of the work of the Co-operative Cyprus Bank by Hellenic Bank.
Specifically, the House of Representatives voted for:
- The Law on Property Transfers and Mortgaging (amending Regulation). This law, with an amendment to the current law, aims to ensure that in the case of loans sold, to enable the mortgage lender to split a mortgage that secures multiple loan agreements to smaller mortgages in order not to leave unsecured loans that will not be sold when the collateral is transferred to the buyer of the loan and to revise Part VIA of the current law, which deals with mortgages by the mortgage lender.
- The Credit Aggregation and Related Matters (Amending) Law of 2018 on amendments to the current law to ensure that all collateral is transferred to the buyer without the payment of fees, regulating the results of the transfer, in particular the transfer of rights and duties, priority order, document storage, and the right to netting agreements.
- The Insolvency of Natural Persons (Personal Repayment Schemes and Debt Relief Ordinance) (Amendment) (No. 2) Law of 2018, which amends and clarifies the provisions of the basic law, because debtors continue to face difficulties in meeting obligations resulting from loans that they have entered into, resulting in their insolvency. Furthermore, the amendment makes the insolvency mechanisms set out in the current law more effective.
- The Companies (Amendment) (No.4) Law of 2018, amending the current law to strengthen the corporate debt restructuring plan and to encourage the widest possible use of this plan by both debtors and creditors. The amendments also provide that, any company protection that is late in paying to any creditor for a period of three months and receives state funding to cover it debt in part, is terminated.
- The amendment to the basic regulations in the Insolvency Advisors Regulations, in order to further increase the fixed percentage of the Insolvency Adviser's remuneration from 20% to 30%, in case a Personal Repayment Plan enters into force.
- The Securities Act of 2018, which establishes the regulation of the securitization market in the Republic and secures its proper operation through the supervision of its activities by the Central Bank (securitization of loans), was passed with 28 votes in favour and 23 against.
It is important to note that Cyprus economy's first assessment for 2018, according to Moody's House was positive. The upgrading of Cyprus to Ba2 ratings from Ba3 is due to the following factors:
- The continued recovery of Cyprus's banking system, in the context of the liquidation of Cyprus Cooperative Bank Ltd through the sale of sound assets and obligations, has significantly reduced the systemic risks that arise from the banking sector.
- In addition, the positive fundamental trend relative to the government balance sheet is based on robust nominal growth and primary surplus, regardless of the one-off amount associated with the recent Cooperative Central Bank transaction.