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Bad Bank or Rehab Fund for the Bank of Cyprus NPLs?

Posted by (Guest Contributor) on March 31st, 2014 - 28 Comments

In the aftermath of the Eurogroup’s decision last March Cyprus was forced to accept the harshest conditions imposed on the financial sector of any program country; the forcible closure of the second largest bank, the transfer of EUR9.5bln in ELA financing to Bank of Cyprus, the assets which provided the collateral and a bail in of the largest bank of Cyprus with a final bail in number of 47.5% of depositor’s funds.  The mandate of the interim board of Bank of Cyprus last Spring was primarily to maintain the bank solvent and to prepare a restructuring plan which the new shareholders of the Bank of Cyprus would implement. This was the correct decision since the new owners of the bank should have the first say on how the bank was to be managed. As part of the restructuring plan one of the options was to implement a solution akin to what was used inIrelandandSpaini.e. an Asset Management Company (AMC). This much was the essence of the decision which the Ministry of Finance, the Troika and the Central Bank agreed in August 2013 and asked the management of the Bank of Cyprus to study, in the form of a business plan, the viability of a Real Estate Investment Bank; the decision was to look at a Real estate investment bank since an AMC was not able to take ELA. In the opinion of the author the decision to explore the option of selling the Non- Performing Loans (NPLSs) was the right one. In this article the author will attempt to explain the reasons why a solution of this nature should be urgently considered and to this end will try to provide the apparent costs/benefits.

The statement by the CEO of the Bank of Cyprus to Reuters is thus welcomed since 6 months after the restructuring plan agreed with the Troika is not delivering the desired results and the progressive worsening of the NPLs within the Bank of Cyprus should be concerning all the stakeholders of the financial sector which are the Bank of Cyprus, the Central Bank of Cyprus and the Ministry of Finance. The Bank of Cyprus, albeit a private company, is the largest bank on the island and its fortunes go hand in hand with the economy whether we like to admit it or not. The term used to implement a solution where NPLs are sold to another entity has been coined as «bad bank» as it assumes the recovery/asset manage loans which may be considered as bad or unlikely to perform so that the bank has no continued issues of provisions and hits on its capital. This is not a good term and not correct in terms of recovery of loans. The asset management company may be a better description of the type of company that buys the NPLs but in the opinion of the author a better term would be a Loan Rehabilitation Fund. The choice of rehabilitation is purposeful in that the borrowers, given time and support from an asset manager with experience in real estate, will have a better opportunity to maximize recovery than if these loans are held within a bank. The sale of the loans to a separate company which has a different funding base (longer term view) and has no capital adequacy issues will provide the Bank of Cyprus with a huge relief in terms of additional provisions and a Core Tier 1 capital just above the minimum required.

The author fully appreciates the difficult decisions of the Bank of Cyprus management and agrees with the appointment of an advisor to review the success or not of the restructuring plan and consider what would be best for the Bank of Cyprus, its shareholders and the economy at large. For how can trust return to the Bank if there is a handicap of NPLs rising and all that this means for provisions and capital? An experienced investment banker like the CEO of Bank of Cyprus must have realized that the 6 month «grace period» is more than enough to judge the next move. In the IMF report on theCyprusfinancial sector published last December it was clear to those that read it that the implementation risk was the main concern of the IMF. The implementation risk, having in mind the nature of the NPLs, and the lack of a creditor friendly bankruptcy law has if anything increased in the last few weeks as Parliament has sought to interfere making the restructuring of loans ever more difficult; in fact the proposal to force banks to use the original valuation of the security instead of current market is one step that any sensible banker would never accept. Hence in the light of the NPLs climbing to above 50% it is high time another solution is considered and in this the CEO deserves credit to approach in the way he has explained.

If one considers the costs of not doing anything I would list the following:

1)  A high level of interest rates to make profit to cover losses of NPLs which penalizes those good borrowers who meet their obligations;

2)  NPL dynamics are such that in a recession they continue to increase long before their stabilize which puts pressure on provisions and capital;

3)  The bank is unable to lend to businesses desperate for credit and a credit crunch develops causing more pain to the economy; in such an environment the risk premium of lending goes up and a bank under distress seeks to minimize risky lending;

4)  The trust required to get depositors back to the bank takes longer and hence the capital restrictions may have to stay longer;

5)  High NPLs and interest rates and a weak economy are a disincentive to foreign investors;

6)  While ELA may not an issue it was last summer the creditors would expect to have a roadmap on how they will repaid which places the Bank under pressure since any asset disposal does not enrich the banks liquidity since the first claim on sale proceeds of assets pledge as ELA collateral will be used to repay ELA down. This deprives the bank of much needed liquidity to provide new loans and improve profitability.

In my opinion the benefits of following the examples ofSpainandIrelandand sell off the NPLs to a separate entity (call it what you like) are the following:

1)  The bank will halve its NPLs by selling EUR6-7bln distressed real estate loans thereby improving the provisions outlook and thus capital;

2)  The bank will focus on its core business strategy with a sounder business plan to attract a strategic investor. The author believes that it would not be the best time to sell the 18% shareholding of the former Laiki before a solution to the NPLs is found.

3)  Interest rates could be significantly reduced;

4)  Capital restrictions could be lifted earlier

5)  The bank would have reduced legacy problem loans inherited and would be better placed to regain the trust of depositors

6)  Investment in the real estate sector could pick once prices are deemed to have bottomed with overseas investors taking advantage to invest as we have seen both inIrelandadSpain; in fact inSpainrecent investments by major international institutional investors has been very notable. There is no reason whyCypruscannot attract such investors especially if Real Estate Investment Trusts (REITS) akin to Ireland or Spain are introduced. REITS are listed funds which invest in real estate and enjoy certain tax privileges.

7)  Investment in real estate can lead to recovery of real estate values much quicker. This will improve the collateral value of the whole banking system;

8)  The Bank of Cyprus asset portfolio could benefit from the general improvement in economic activity which lower interest rates and foreign capital will bring.

In the opinion of the author the Troika should revisit the creation of an AMC or Loan Rehabilitation Fund for the NPLs linked to real estate for the Bank of Cyprus. There is no other alternative which offers itself the same promise to the Government of Cyprus which has been used as a model of how bank resolution will be done in the Eurozone. Although there is a cost to be assumed from the large discount at which the NPLs will be sold, and thus the loss to be crystallized upfront, the European Stability Mechanism (ESM) can provide the recapitalization required via a loan to the Cyprus Government. It may that this recapitalization can be done directly with the Bank of Cyprus but this will only be possible when the European Central Bank becomes the Single Supervisory Mechanism which is likely to be at the end of 2014 and Bank of Cyprus qualifies for such support following the asset quality review being conducted. The ECB President referred to the proactive cleansing of bank balance sheet before the final decision of the ECB and this comes at a time when many Eurozone banks are having their asset quality reviews. Is it a case of read my words from Mr Draghi?

The author fully appreciates that the solution to the NPLs is a complex one and there is a need to aim for the least damage to the economy and the bank itself. While the borrowers may be concerned about their businesses and real estate the author believes that a Spanish type of AMC which has a life of 15 years and aims for maximum recovery provides ample time for real estate prices to recover thus giving borrowers an opportunity to buy back their land at face/near face value and pay off their loan. The AMC or Bank Rehabilitation Fund may actually offer the borrowers the best opportunity to rehabilitate themselves and this can be best done outside a bank.  The author believes that borrowers should have an option to buy their property at agreed recovery levels with the Bank of Cyprus having some revenue sharing agreement with the AMC/Fund whereby above a recovery threshold the Bank of Cyprus shares in the revenue. These issues and other matters of funding the AMC (be that with shares, bonds sub debt or mezzanine) the bank will require are best left to advisors such HSBC who are better placed to advise.

In closing the author is a strong believer that the solution requires political support from fellow member states such asGermanyandFrance. It was the Eurogroup that imposed onCyprusthe harsh terms and it is these key member states in the Eurozone that can provide the political support required to get the ESM t support for the Bank of Cyprus. It is hard to believe that the Irish closed Anglo Irish bank and converted ELA into 40 year bonds without political support. I am not suggestingCyprusdoes the same but instead propose that theCyprusgovernment wins political support to have the Bank of Cyprus be recapitalized by the ESM.Cyprusdeserves the solidarity from its Eurozone partners.

Categories → Οικονομία

  1. avatar
    KikisM on March 31, 2014 - (permalink)

    Welcome home Mr. Riza. Your article appears to be well structured and the result of mature thought , albeit it comes 12 months after disaster , and following the bubble of continued high interest rates which threatens to blow up the remaining functioning economy.

    I am sure you would share with me , that the motives of not moving to the direction you are proposing today are political , and driven by the large enterprices who are heavily indebted to the local banks. As you know these corporations finance the media and the politicians who have pushed the other way round. Not forgetting to mention the archbishops statements last August, intensely highlighted by the media , that people’s homes should not be allowed to be sold at fire sale prices.

  2. avatar
    The Invisible Hand on March 31, 2014 - (permalink)

    Mr Riza has not clarified the important details in his otherwise interesting proposal:

    1. Can the banks sell some or all of the NPL’s for cash to help their liquidity? Probably Yes, a vulture fund.
    2. If they find a cash buyer, will he pay a price reasonably close to the book value (nominal value less provisions)? Probably No, funds want a IRR of 25-30%.
    3. If the cash buyer pays significantly less, will it be due to inadequate provisions (which must be adjusted accordingly and accompanied by raising additional bank capital) or will it be due to the hasty “forced” sale which would not be the case if the recovery was handled better? I think the losses (and additional capital requirements) will be substantially increased by a forced sale.
    4. If the NPL’s are sold to an AMC “on credit” to be repaid as and when the underlying assets are disposed, how is this different from a professional recoveries department within the bank? Will the “IOU” from the AMC have a better risk rating or faster repayment than the existing collateral? I think not.

    I am afraid I disagree with Mr Riza’s point that the BoC should seek a strategic partner after the NPL’s have been resolved. The BoC needs a sound strategic banking partner (definitely NOT a hedge fund) now and the 18% “Laiki” package is the best chance to get one, even at a less than satisfactory price. The alternative will be a slow death for the BoC and for the Cyprus economy.

    • avatar
      Μ on March 31, 2014 - (permalink)

      Invisible Hand,

      I partially disagree with your views. The collateral of those NPL’s appeared to be mostly of overvalued real estates.
      Hence the difference would be, the elimination of risk derived by the possibility of further collapse to real estate prices. The removal of that burden from BOC, would be in my opinion a major contributory factor to trust enhancement. Therefore it would be much easier to find a strategic partner, in accordance with the second part of your opinion, with which I absolutely agree.

      • avatar
        The Invisible Hand on March 31, 2014 - (permalink)

        I would agree with you if BoC can find a cash buyer of their NPL’s at the book value less provisions. The book value would be what you call the value of the overvalued real estate held as collateral. The provisions (general or specific) would represent a fair estimate of the already lost overvalue as calculated by Pimco or the bank’s valuers or the Central Bank index, whichever is more conservative.
        However I assume any buyer (and specially a vulture fund) would offer very substantially less, to translate into an internal rate of return for the fund of 25% or more per annum, which translates into a further 50-70% value reduction up front over the 2-3 year investment by the fund. Such a sale should be considered only if a catastrophic future additional reduction of over 50% in property prices is expected. I don’t believe the bank would survive such additional write-offs on a portfolio that includes, besides the usual developer suspects, the retail trade, home loans, consumer loans, hotels etc, all secured on property.
        If my assumption is correct a 2-3 year work out by the bank’s own recovery department would be more beneficial for the bank and its small shareholders.
        It is possible that some of the larger bailed-in shareholders may wish to force the exchange of their frozen funds for property at vulture fund prices, even though this will not benefit the bank. I am sure that the BoC management professionals will not fall for this.

    • avatar
      Anonymous on March 31, 2014 - (permalink)

      Dear invisible hand I will try to answer to the best of my knowledge not claiming to have the answer that may be right.
      1. The bank will be able to sell to investors that can asset manage the underlying collateral, with or without the borrower. If we look at the experience of Spain there were two types of loans; one that was a semi completed or completed asset and loans linked to land solely. These attracted different prices and these are directly comparable to Cyprus. I believe private equity with experience in distressed real estate loans and not vulture funds would be the buyers.
      2 while I agree with the possibility that the expected return of a buyer would be north of 20% in the case of Cyprus the return is typically achieved by leverage and hence a yield in mid to high teens should be sufficient.
      3. I do not suggest a forced sale and in fact the experience with Ireland and Spain the sale price was close to 50%. One cannot guess at this point unless there are discussions with investors. One should consider that in Cyprus there is a huge difference which works in favour of the investor. The amount of borrowers is 20-30 whilst in Ireland and Spain they were in thousands. Also some of the property is in prime locations and with time the property should be attractive for development where this a plot of land only.
      4 such transactions are not closed on credit. There has to be a true sale to get these off balance sheet. Certainly not an IOU.

      If an investor can be found to buy the 18% this will be used to pay down the depositors of Laiki. The new investor will probably have to invest additional capital linked to expected provisions and the quality of the loan portfolio which after the asset quality review will be clearer. If the participation of the EBRD or IFC were feasible to bring other investors it could possibly work hence the suggestion to clean the balance sheet is based on the experience of Ireland. I have thus no strong view on this and would be very pleased if a strategic investor were found before loans are disposed.

  3. avatar
    ΜΜ on March 31, 2014 - (permalink)

    1. At what price will the Bank sell these, or better, at what price will the AMC agree to buy these. If at the Net Loans price (i.e. Loans-Provisions formed) or higher, then this is ok. If at a lower price then the Bank will need to form more provisions
    2. Why does the Bank need to sell these loans in order to have a sounder business plan? I take it that the Bank has enough units whereby one can center on managing the NPLs and another one on growth opportunities
    3. Why will interest rates be significantly reduced? The Cyprus economy will still be faced with significant uncertainties given that these NPL Assets are still part of the economy (!!!) and BoC will still not be able to gain access to cheap funding eg. if we look at the Greek Banking, Bank of Peireaus (the now leader in the sector, owing to a large part to the acquisition of the Cypriot banks’ Greek operations which was a scandal-never-questioned) recently went to the markets after 5 years in isolation and the cost was 5.25%. By adding to that the normal Bank’s profit, it is highly unlikely that interest rates will be low.
    4. How are capital restrictions and the NPL treatment linked exactly? As I can recollect, there is no link in the official press releases
    5. You really believe that legacy issues will be less? Really?
    6. How are real estate investment interest and the NPL treatment linked exactly? What you describe is how the real estate sector will pick up, not how transferring the real estate NPLs to an AMC will help the real estate sector – these assets will still be part of the real estate sector in Cyprus
    7. Again, as in point 6, this has no relevance if the NPLs will be transferred to the AMC or not
    8. Again, a general statement.

    BoC has accumulated significnat weaknesses in its structure over the years, which can not be treated by an outright sale!!!!!

    • avatar
      Anonymous on March 31, 2014 - (permalink)

      Dear MM, I will try to answer the valid questions you raise with best efforts.
      1. The bank will, after price discovery with advisors, sell at a price which makes sense. This will depend on how much upfront loss, not provisions, is crystallised and if there a source to recapitalise the loss and its impact on capital. Hence my suggestion that the ESM be the provider of the funding that will be required.
      2. All the evidence from many other countries which experienced similar real estate distressed loans have sought to dispose the loans with exception of UK and Germany which had strong government support. The issue is one of the dynamics of NPLs and the level of capital. If the bank had Core tier capital of 14-15% I would be more comfortable but as we know it is closer to the minimum required and there is a need to deleverage continuously which cannot be good for the economy as we see in Europe.
      3 lending rates are high because the bank needs to make sufficient profit to make up for the losses on the NPLs where it does not receive interest. Hence if the assets are no longer on the bank’s balance sheet there would be no need to have a net interest margin of 4-5%. This could be 2-3%.
      4. A significant reduction of NPLs will be the best message the bank would send to depositors that the bank is taking action to de risk the balance sheet and this would bring trust back to the bank. If we accept that trust will return it would mean that partial relaxation of capital restrictions can be introduced and monitored to see the impact on deposits of such relaxation.
      5. Not sure what you mean by legacy issues but the proposal submitted is one that has been used in other countries and I am not seeking to reinvent the wheel. If there is a better proposal would be glad to hear. The resolution has to be based on similar experience and this is the best guide one has.
      6. Instead of having real estate distressed on a bank’s balance the asset management is best served by investors who can take a longer term view ie 7-10 years where the investor has. O capital adequacy issues and does not have to increase provisions if real estate prices continue to decline. In the event that the market does not perceive forced sales of real estate there is a bottoming out of prices much quicker.
      7 I believe that NPLs transferred to a separate entity has been proved to be the best solution. Please review the experience and where this has not taken place it is where the governments were able to provide guarantees and I wonder if this is feasible in the case of Cyprus.

      • avatar
        CP on March 31, 2014 - (permalink)

        I Agree on all your points Mr Riza except the part where ESM recapitalizes BOC. That would result in a large dilution of the existing shareholders (a double whammy bail-in impact)! ESM should preferably fund the “bad bank”. The loans transferred to the “bad bank” in this case could be priced close to their book value (at 10-15% discount, instead of 50-60%) and allow plenty of time to recover short-falls from the bank’s future profits and a potential property market recovery (15-20 years down the road)!

        ELA should be converted into a long term bond as it was done with Ireland! In what form? Well, financial engineering always finds ways around conventional and non-conventional financial instruments! Since money is created out of thin air it can find its way back there in one
        way or another!

        • avatar
          E.R Izba on April 2, 2014 - (permalink)

          Dear CP

          The manner in which the ESM recapitalises can be such that the ordinary shareholders are not diluted if this was a direct loan to the BoC. In fact the capital structure of a bank can offer different classes of shares. A bad bank for all banks would be ideal but this would require the approval of stakeholders who may not agree.
          I very much doubt that the transfer price of NPLs to a bad bank will deviate from what has been the observed best practise. On ELA there is. I need for financial engineering as there is a precedent which the ECB “noted”, which was the wording used indicating acceptance but in the language of the ECB

          • avatar
            CP on April 2, 2014 - (permalink)

            Dear Mr Riza,

            Thank you for your reply,

            As a general rule the ESM will acquire Common Stock when funding Financial Institutions (after the Banking Union is established)! It remains to be seen whether they will make an exception in the case of BOC- if and when it takes place! In the case of Spain discounts as low as 32.4% (finished property) and as high as 79.5% (foreclosed land owned by developers and promoters) were applied! Let’s see how (and if) it goes in the case of Cyprus!

  4. avatar
    IoannisTakis on March 31, 2014 - (permalink)

    Αγαπητέ κ. ‘Ερολ,

    Συμφωνώ με την εισήγηση σας σε ότι αφορά την Τράπεζα Κύπρου, το σκεπτικό πίσω από αυτή και τις θετικές επιπτώσεις που θα έχει η όσο το δυνατό γρηγορότερη εφαρμογή της όπως ακριβώς όλα τα πιο πάνω αναλύονται στο άρθρο σας. Καλό θα ήταν εάν δημιουργείτο κάτι παρόμοιο ή ακόμα και μια ενιαία κοινή νομική οντότητα για τα προβληματικά και μη βιώσιμα δάνεια και της Ελληνικής και των ΣΠΕ αλλά αυτό θέλει ακόμα περισσότερη συζήτηση και μελέτη και όπως γνωρίζετε δεν υπάρχει χρόνος για χάσιμο στην προσπάθεια εξυγίανσης και επαναφοράς της εμπιστοσύνης στην μεγαλύτερη τράπεζα του τόπου.

    Από ότι φαίνεται όμως, όπως σωστά διατυπώνετε στο άρθρο σας, η εφαρμογή της προτεινόμενης λύσης δεν θα είναι καθόλου εύκολη υπόθεση αφού προϋποθέτει μεταξύ άλλων την (α) εξεύρεση του τρόπου χρηματοδότησης της «κακής τράπεζας» και (β) των μηχανισμών μέσω των οποίων αυτή θα λειτουργήσει. Συμφωνώ επίσης ότι για να μπορέσει να επιτύχει ένα τέτοιο εγχείρημα χρειάζεται την πολιτική υποστήριξη του Eurogroup και της ΕΚΤ οι οποίοι οφείλουν να μας συμπαρασταθούν αντισταθμίζοντας εν μέρει τις αρνητικές συνέπειες που έχουμε υποστεί τόσο σε σχέση με την επιβολή του κουρέματος καταθέσεων και την χρησιμοποίηση μας ως πειραματόζωο όσο και σε σχέση με την απώλεια δισεκατομμυρίων που έχουμε απολέσει για να στηριχθεί η Ελλάδα χωρίς καν να ερωτηθούμε.

    Προχωρώντας ένα βήμα παρακάτω, και παρατηρώντας τα πράγματα από μια μακροοικονομική σκοπιά θα ήθελα να προσθέσω ότι ακόμα και εάν εφαρμοσθεί σωστά και χωρίς καθυστερήσεις η πιο πάνω εισήγηση δεν θα σημαίνει και αυτόματη ανάκαμψη της Κυπριακής οικονομίας και του τραπεζικού συστήματος. Αυτή μου η θέση πηγάζει από το γεγονός ότι τα τελευταία 5-6 χρόνια η Κυπριακή οικονομία απώλεσε πέραν των €25 δισεκατομμυρίων! λόγω (α) της άθλιας διαχείρισης των δημόσιων οικονομικών με αύξηση του δημόσιου χρέους γύρω στα €7δισ και (β) κυρίως λόγω της τρισάθλιας και εγκληματικής διαχείρισης αλλά και ανύπαρκτης εποπτείας των τραπεζών που κόστισαν στους μετόχους, στους κάτοχους αξιογράφων και στους καταθέτες με αλυσιδωτές αρνητικές συνέπειες σε όλους ακόμα τουλάχιστον €18δις. (€5δις κακούς δανεισμούς στην Κύπρο που θα διαγραφούν και ζημιά €13δις λόγω Ελλάδας από τα €4,5δις. κούρεμα Ελληνικών ομολόγων, τα €3,4δισ. ξεπούλημα Ελληνικών εργασιών των Κυπριακών τραπεζών και διοχέτευση ELA €5δισ στην Ελληνική οικονομία που μας έμεινε βαρίδι).

    Το ποσό των €25δις. αποτελεί ένα τεράστιο και συνάμα τρομακτικό νούμερο σε σχέση με το μέγεθος του ΑΕΠ (σχεδόν διπλάσιο) και κυρίως σε σχέση με την δυνατότητα της οικονομίας της Κύπρου για να το αναπληρώσει όπως έχουν τα πράγματα σήμερα με ένα βαριά τραυματισμένο τραπεζικό σύστημα και έλλειψη, εμπιστοσύνης, ρευστότητας, κεφαλαίων και ξένων επενδύσεων.

    Στηριζόμενοι ακριβώς στην πιο πάνω διαπίστωση αλλά κυρίως στην ζημιά ύψους €13δις. που έχουμε υποστεί χωρίς την θέληση μας (πλην ίσως του ELA €5δις. το οποίο βλακωδώς αφήναμε να πηγαίνει προς Ελλάδα μεριά χωρίς να κάνουμε κάτι για να το σταματήσουμε) για στήριξη της Ελληνικής οικονομίας, θα πρέπει να ξεκινήσουμε να απαιτούμε όχι απλά μετατροπή του μεγάλου βαριδίου του ELA ύψους €9,5δις. σε μακροχρόνιο δάνειο ή μετατροπή του σε κεφάλαια που θα προέλθουν από τo ESM αλλά σταδιακή διαγραφή του! Αυτή μας η απαίτηση θα πρέπει να στηριχθεί πέραν από οικονομικούς και πολιτικούς λόγους και σε νομικά επιχειρήματα επικαλούμενοι την μη-τήρηση των αρχών της ισονομίας αλλά και της αλληλεγγύης που ίσχυσε στην στήριξη άλλων χωρών της Ε.Ε. οι οποίες ενώ είχαν μεγαλύτερο πρόβλημα από αυτό της Κύπρου δεν υπέστηκαν ούτε κούρεμα καταθέσεων και ούτε απώλεσαν σε μια νύχτα την αξιοπιστία του τραπεζικού τους συστήματος και προπαντός δεν έχασαν μια ολόκληρη γενιά νέων ανθρώπων…

    • avatar
      Anonymous on March 31, 2014 - (permalink)

      Dear Mr Takis, I share in your feelings of injustice and the losses incurred which are disproportionate to the size of the economy. I believe the IMF was extremely severe on insisting that the debt tomGDP be kept at 100% instead of 120% as in the case of Greece. In fact the IMf stance gave Germany the opportunity to insist on the participation of the IMF.
      While we have reasons to seek a redress from the EU this is something for the government and I do hope it is an option which they will consider at the right time. The Irish did convert ELA when the political support was in place.
      Whilst we cannot change the past we certainly can do better in the future and once viable and credible business plans are in place there could be foreign direct investment. The data on the economy have proved all the Cassandra’s wrong and there is tourism, shipping and business services which can be used to boost the economy in the next 12 months. The real estate market may be a drag on economic activity but herein lies an opportunity to seek other business models to develop and attract institutional investors.
      The rehabilitation of the banking system will take some time but small steps in the right direction will produce the desired results. I do not think there is a short cut to regain trust other than better governance, stability, transparency and professionalism at all levels.

  5. avatar
    E.riza on March 31, 2014 - (permalink)

    I am sorry due to oversight I did not sign in so the anonymous replies are mine :)

    • avatar
      IoannisTakis on April 1, 2014 - (permalink)

      Dear Mr. Riza,

      Thanks for your reply. I agree, that we should look forward, focus and further develop sectors such as tourism, shipping and professional services. In addition, there is space for improvement and growth in the fields of health, education and energy. Until we are able to commercially exploit the hydrocarbon reserves, we should focus on areas that can increase our revenues in a short term horizon such as tourism and shipping. Specifically with regard to tourism, we should redesign its’ whole strategy so as to increase the number of hotels and beds, to improve the quality (buildings, employees, culture, professionalism), to offer related activities and facilities (marinas, casino, golf etc.) setting a decisive target of boosting arrivals to 4,000,000.

      • avatar
        E.Riza on April 1, 2014 - (permalink)

        Dear Mr Takis,

        I fully agree with you that we can develop other services and in fact I am actively promoting health services in the context of medical tourism. I think Cyprus can regain the trust of investors and become a centre of high quality services which can be offered across three continents. This will not be a short term fix but with perseverance Cypriots have shown that they are entrepreneurs and hard working when their back is on the wall. I fully support the efforts to restructure the economy and reduce the role of the public sector which has stifled investment and new services.

  6. avatar
    Σάββας Τταντής on March 31, 2014 - (permalink)

    Mr Erol

    I strngly agree with you . A fund/company needs to be establisehed and absorb non performing loans from ALL banks.

    I would like to have your comments or the comments of the other members of this blog on the following idea.

    The new fund is financed in the following way. Takes the laons and issues to the Banks , interest bearing Bonds. The Bonds have a guarantee from the minister of Finance.

    The quarantee is not included in the public debt.

    Any losses that may arise in 20 years are at the risk of the Bank and not the government.

    Please comment. ( With the above idea we do not need to SELL any loans or immovable properties now……at NO discount.)

    • avatar
      E.Riza on April 1, 2014 - (permalink)

      Dear Mr Tantis,

      I suspect that being a country under a MOU with the Troika it is not something that can be done without their participation. I suspect that the ECB which assumes the supervisory role will not agree as the loans will be transferred at face value if I understood you correctly. This is not in line with best practise seen in other similar transactions.
      Even if Cyprus was not under a MOU program you will appreciate that any government guarantee is illegal state aid unless approved by the Commissioner of State Aid hence it is not certain this will be granted. Where this was approved ie UK, Germany Netherlands ( countries not under a program) there were conditions which had to be met within a deadline.

  7. avatar
    καχ on April 1, 2014 - (permalink)

    The article and subsequent comments by Mr Riza and other commentators give food for thought.I see however insurmountable problems in this idea ,unless of course the ECB provides the money.If the ECB is willing to provide capital then the Cypriot banks,including BOC,will have no problems hence it is not necessary to make a bad bank or sell loans.

    In particular I feel that if private equity companies are interested to invest they can buy shares in the various projects of our developpers,or their companies.The same for hotels.We must not forget that the assets do not belong to the bank,the bank can sell the loans with the collateral but not the assets.Afterall there is such a big discussion regarding forced sales and repossessions.If the banks need minimum 18 months to seize the assets,the same time will be needed by anybody else.Nobody would be interested to invest now and have to go to court to secure the assets,even at half price .

    Everybody seems to prefer a strategic investor as opposed to a hedge fund for the 18% of BOC belonging to the bad Laiki.However it is not clear to me why this 18% should not be sold to the higher bidder maximizing the proceeds from the sale as should be the ONLY consideration of the receiver.Of course it is good for BOC to find a strategic investor but not at the expense of the Laiki depositors.I would say it is even better for Cyprus if BOC is sold to a strong international bank.

    Obviously if the directors of BOC feel a bad bank,or whatever we call
    it is a good idea by all means it is their right to do so.They can sell loans and take any action they want provided they do not need extra funds from the government.If they can find investors for a fund like the one proposed by Mr Riza at a price they can accept and afford this is fair enough.If this was possible they would have done it without asking anybody.However my understanding of the various proposals is that BOC unloads the assets to clean its books with a few billion loss which the Government will have to absorb.

    • avatar
      E.Riza on April 1, 2014 - (permalink)

      Dear Kax,

      I believe the ECB provides liquidity and not capital. Recapitalisation would be provided by the ESM and they have their guidelines for such recapitalisation which are linked to asset disposal. Please see their guidelines on the RSM website under legal documents. For now this support is offered by way of loans to member states but this may change after the ECB assumes the single supervisory role. In the event then the ESM could lend directly to the BoC with their conditions.

      I would agree that if Private equity were to find selected projects which are providing the required return then your idea could be possible. The observed preference though is for PE to buy distressed loans and maximise recovery from asset management. I believe banks can foreclose and take possession of the underlying real estate and this is the essence of the new laws which are part of the MOU.
      I believe that we would all be very pleased if a strong international bank were to buy the 18%..

    • avatar
      The Invisible Hand on April 1, 2014 - (permalink)


      I agree that the duty of the receiver appointed at Laiki is to obtain the best possible price for the creditors on all assets sold, including the 18% shares in the BoC. I do believe though that under its regulatory obligations the Central Bank has a say on who acquires 10% or more in a bank. I would expect the CB to scrutinize the prospective buyer and prefer a partner with banking experience and capital adequacy who will take a long term view of the bank and not approve an opportunistic fund more likely to play asset strip or other games, even if the immediateprice is higher.

  8. avatar
    Savvakis Savvides on April 1, 2014 - (permalink)

    It is ironic that after 6 months of basically completely ignoring the directions that were being carved out by the Interim Board it is “dejavu” time and everyone concerned has been forced to start thinking what politicians, economists and even the Archbishop himself at the time so quickly rushed to brand as “the unthinkable”. You and I Erol have discussed and sometimes argued this issue extensively during our tenure on the Interim Board. My only disagreement then, as it is now, is that what needs to be done is more important than any pre-set idea or model about splitting the Bank of Cyprus.

    Splitting the Bank into two and doing nothing significantly different than what was happening before is not going to help much. Neither, any support from Europe or elsewhere on its own. We need to acknowledge and fully accept our predicament and dire outlook it puts us in. The margins of error as you very well know are very thin. BoC cannot sell off its loans and other assets almost at any discount. On the other hand, investors will not buy, without a substantial discount, especially with the economic outlook remaining negative for the next few years. So, who is to bridge this gap? The official response from the Eurogroup President, Jeroen Dijsselbloem came today when he exclaimed that there is no need for any help as we seem to be doing better than expected (and I think he mentioned better than Greece, as if that was of any relevance to what we are going through). For me that is another way of avoiding the burning question which has always been, “that there is too much debt and we have been firmly put on a downward slopping route to ever deteriorating bank assets”.

    We need to find ways to arrest that fall and start financing the viable and development projects in the Economy. But we can’t do that by just splitting the Balance Sheet of the Bank. That is why, as Chairman of the Restructuring Committee of the Bank of Cyprus, I pressed hard for the idea of creating a Reconstruction and Development Bank. It doesn’t matter what one calls it really. But what matters is type of expertise you put together and what you do to soften the impact of the asset decay and fallout of projects. Such an Institution can be funded be EIB, KfW, the World Bank and many other multi-lateral financing institutions. And if we were to work diligently on a Business Plan to approach these institutions and our European partners I believe, as I said then, that we have every chance of persuading them to take equity positions and give the new Development Bank lines of credit for new projects.

    The essential difference is that with a development bank the emphasis is on reconstructing projects rather then on disposing the assets. In addition, it will provide a much needed expertise and advice to the Government and Public Sector during a time of aggressive pursuit of privatisation and attraction of foreign investment. In a short article I have just written I outline some of the reasons why this so, highlighting the fact that only viable and competitive projects contribute to economic development. Here below is part of the abstract of the paper which is called “The pursuit of Economic Development” and is to be published in the next issue of the Journal of Finance and Investment Analysis”:

    “The article poses the question of what is economic development and how it should be pursued. In the aftermath of the Cyprus bail-in and the blanket approach of the Government to attract foreign investment the author reminds that failed projects do not promote the cause of sustainable economic development. The point is also made that although cost benefit analysis and risk analysis can indicate viable capital investment projects (public and private), one should bear in mind that a developmental project should be both viable financially (from the Owner’s and Bank’s perspective) but also from the point of view of the Economy. Special concessions, subsidies, relaxations and tax exemptions made by a Government over-eager to attract foreign investment may indeed make a financially viable project non-viable from the Economy’s perspective. In order to successfully accelerate the pace of economic development, three areas of focus are suggested to take measures for so as to: 1) institutionalise and enhance the credit risk assessment of commercial banks, 2) set up a Development Bank to source and position new long term loan funds and lead the way in the financing of major projects in the economy, 3) create the capability of Government to have independent expert advise on the structuring, evaluation and financing of public sector and Public-Private-Partnership (PPP) projects.”

    So, to sum up, it is what you do with the non-performing loans and the economy that matters and not how you split in an accounting sense the Balance Sheet of a Bank. I am in favour of it only because of the things it may allow us to do to reverse this free fall we find the economy to be in. But we need to do much more to be effective. I am afraid we have wasted 9 months for people to realise that there is really no other way out.

  9. avatar
    CP on April 1, 2014 - (permalink)

    During the past 10-15 years Cyprus has been overflowed with grandiose ideas about projects that had been thought out (and some undertaken) to rival others’ ill-conceived, hubris-driven projects. Of course they did not risk their own money as true entrepreneurs should do but largely used bank loans, happily handed over to them by too eager and hubris-stricken bankers. Hence, we have already several golf courses, the majority of them sparsely used (for some reason all now concentrated in the Paphos area), and for some peculiar reason we want to build more of them (as if all the golfers in the world are somehow strangely attracted to this island). There are other projects of course more generous in terms of conception and design! Marinas accompanied by even more offices/shops and dwellings, to be built on several coastal locations (what we are left with, since 1974). We now hear that an even more grandeur project (worth about €7 billion) is now being conceived and put on paper! We do not seem to run out of big ideas! A casino resort could be the exception here, as its viability is more close at hand! Do we realize that if these projects in some magical way are completed with what sort of capacity we will end up (or do we think that if we build them more people will definitely show up)? It seems that we have learned nothing from the calamities we are all (well, most of us) still suffering! The banks are left with billions of Euros of Bad Ideas on their balance sheets, now trying to figure out how to get rid of them! So I think the “Bad Bank” or “Rehab”, as E.R prefers to call it, is the best idea we now have, so that we may turn infested banks into healthy ones!

    • avatar
      E.Riza on April 2, 2014 - (permalink)

      Dear CP,

      I agree that project financing cannot depend on the notion of “build and they will come”. The projects going forward will have to show viable business plans and certainly equity funding. At this point the equity funding is likely to come from foreign sources and herein lies the opportunity be that in the hospitality sector, healthcare or other projects with very sound business plans.
      My proposition is that the empirical evidence is that we have seen in Spain or Ireland. Internal bad banks may not be answer since a bank has regulatory capital issues and funding that is short term. A separate entity funded by long term investors and with a profile of 7-10 years be the best place to park the distressed loans so that asset managers have time to work out the problem.

  10. avatar
    E.Riza on April 1, 2014 - (permalink)

    Dear Savva,

    I understand your preference for a real estate development bank but the key question one is being challenged to answer is the following; what is best for the BoC, its depositors/ shareholders, the cost of money and the economy. Are all these best served with the NPLs, having regard to the dynamics and impact on capital, being asset managed within the bank or off the balance sheet?
    My contention if you like,having empirical evidence of asset relief measures during recent crisis there three types of measures; asset guarantees, bad banks and AMC see IMF note on Crisis Management and Resolution; Early lessons from the financial crisis published in 2011. The use of bad banks was introduced according to this note in Belgium, Germany, Latvia, UK, and Sweden. In Ireland, Spain and Slovenia we had AMC. Hence while we may wish to seek out the best that would suit Cyprus we are in agreement that the borrowers would require time to find the project and investor to undertake the projects as you suggest. Is this better done by experts in a Loan Rehab Fund or a bank. My view is in a fund as the costs of having a bank which has to comply with much stiffer regulation, especially under Basel, will not be the best.

    • avatar
      Savvakis Savvides on April 1, 2014 - (permalink)

      My preference is for a Reconstruction and Development Bank, not just for a Real Estate Development Bank (although real estate will be a big part of it). The objectives for me are:

      1. To build up a capability to deconstruct and reconstruct projects in he economy so as to put them back as refinanced viable enterprises with a capability to repay the new loans with which they will be re-financed. In order to effectively do that you need the highest level of expertise in project finance and evaluation. You will not get that with any of the models you quote and used elsewhere which in any case rely on an orderly disposal of assets rather than the re-engineering of the foundations of an ailing small economy such is Cyprus at present.

      2. Such a Bank will have new lines of credit made available to it by multi-lateral financing institutions and our European partners if we are clever enough to propose a coherent plan to them. This is not going to happen with an AMC model. And based on the comments made by the Eurogroup President, Jeroen Dijsselbloem yesterday, they are happy to let us think we are doing fine as long as we do not ask anything difficult and painful from them. At the heart of the problem, I suspect that Germany is not willing to put up their tax payers’ money so that the foreign depositors can safely withdraw their deposits.

      3. Last but not least, there will be a need to create a capability to manage and orderly dispose of assets which cannot be re-employed/utilised in a major reconstruction effort. But this cannot take precedent over the need to spin back as soon as possible viable and credit worthy business enterprises. The problem with Cyprus, rather unlike the countries you quote, is that debt insolvency has struck at heart of the economic engine. If we look at these businesses as just assets to be sold we are doomed. The downward spiral will continue and accelerate. Not to mention that Cyprus is so small as compared to the total of problematic loans that any attempt to dump repossessed assets will be met with such short demand that would make matters abundantly worse than they are now.

      • avatar
        E.Riza on April 1, 2014 - (permalink)

        Dear Savva,

        I am not dogmatic about my proposed solution. The fact is that the management and board of the BoC will appoint an advisor who will surely consider all options and presumably they will come up with a proposal that will be discussed with the Troika, the Central Bank and the MOF.
        Nothing is cast in stone and surely the approach of the BoC management is correct.

        • avatar
          Savvakis Savvides on April 2, 2014 - (permalink)

          For BoC to consider its options is surely correct, even with some delay. I am just putting forward (as I did when I was a member of the previous Board of the Bank) why I think that in my view the correct way forward is through a Reconstruction and Development Bank rather than with a “bad bank” in some form of an Asset Management Company/bank format.

  11. avatar
    Exposure on April 2, 2014 - (permalink)

    All these discussions are pointless if the legal framework is not normalised to the new state of affairs. The legal framework needs to be fixed and apply proper company accountability, ownership rights and asset seizures when companies/legal entities/persons bankrupt. If we let the current situation go on, with zero accountability and a dozen loopholes in the system which an airplane carrier can pass through will only result in more pain to the true economy.

    So stop arguing about the bad/good bank/AMC and so on and face the facts. Fix the system and then fix the bank. Ofc the issue here is a matter of who will be affected by fixing the system and who will be affected by creating a bad bank/AMC etc.
    On the one hand we have the big lenders whose loans are sufficiently collateralized and in the event of a creation of a bad bank they will need to loose their collateral cause despite what you say the fact is that they renegated on their agreement and it is within the banks right to liquidate them. On the other hand you have all the “services” firms with their army of lawyers accountants which prefer a broken legal system in order to accommodate their suspect clientele.

    A proper solution would address all of the problems and not individual issues based on vested interests.

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