An asset management company would be the boost the economy needs
In last 18 months we have watched how the various stakeholders of the financial system in Cyprus and the Troika have acted showing complacency at one extreme (remember Mrs.Velculescu saying that NPLs were within the PIMCO assumptions in January 2014) to repeated concern by recent statements of EU/ECB officials on the other. In fact the non-performing loans from their mid-30s as a percentage of total loans in July 2013 are now over 50% now and possibly rising. The recent newspaper report attributed a 1/3 of loans restructured reverting to NPL status. At the same time the banks have slowly deleveraged and until very recently very high interest rates were paid by business. In such a financial state of affairs it is hard to see how the economy can recover when Cyprus relies on the banking system for its financing of business and investment. Banks should not have been the managers of NPLs linked to real estates as this is not the job of banks and this is one of the reasons why banks in similar position in the rest of the EU were split into a good /bad bank or where it was deemed best for the bad to be an asset management company. In this article the writer will seek to explain why Cyprus needs an asset management very soon and there is no need to reinvent the wheel by three internal bad banks to manage their NPLs.
Non-performing loans linked to real estate are typically the assets which have a tendency to get worse before getting better assuming the market corrects and price of property falls to attractive levels such that buyers appear to buy at a discounted real estate; such capital is not from domestic sources and as we saw in the cases of Ireland and Spain they are private equity and not hedge funds. These financial firms have the capital and the patience to asset manage the real estate and seek maximum recovery hence the long term perspective of their investment horizon unlike hedge funds. The Irish real estate market last year was the best performing thanks to the correction prices experienced and the investment of billions by foreign private equity firms and real estate investment trusts (REITS). The same, to a large extent, has happened in Spain albeit not with such success due to the large amount of small loans which represented the loans transferred to SAREB by BANKIA.
Hence the two most identical comparisons that one can look to see the result of how banks managed their portfolios show that an alternative firm should manage the NPLs and such firm that has no regulatory capital requirements as banks have. In the case of |SAREB it has a portfolio of NPLs (real estate owned and real estate developments) which are identical to Cyprus and has been my choice from the summer of 2013. The most attractive feature of SAREB is that it has a 15 year life span and hence ample time to recover NPLs unlike banks which face risks from regulatory changes or declines in real estate prices.
One might be right in asking so why is this such a good idea to get the economy to recover; there are several reasons. These include the following:
- Banks would take a one off loss from sales of NPLs (NPLs of large borrowers) and then revert to lending as the banks would have to build their asset portfolio;
- The rates of interest would be lower since the good borrowers were paying for the delinquent borrowers and still do today. This will not be necessary once banks have rid themselves of the NPLs;
- There could be foreign investment interest by firms who would see an opportunity to invest in real estate at discounted prices as we have seen in Ireland and Spain;
- The capital position of banks would be better with much less risk from a downside in real estate prices;
- The banks would not be vulnerable to legislators protecting borrowers as they have done recently which makes banks business hard to operate when they cannot foreclosure and hence will probably impact their provisions;
- The correction and recovery of the real estate market would be sharp and the market would find its equilibrium at a lower level. Quite clearly the levels of 2007-09 were the result of a huge bubble which the banks funded and unlikely to be seen in the near future;
- The long term investment horizon of the asset manager will allow borrowers to recover rather than live under the threat of foreclosure, especially the distressed borrowers who are now “protected”. We will see how the long and bureaucratic process of the new legislation works out.
The above would have spillover benefits to the economy as foreign investment and the stabilsation of the real estate market at lower levels would provide the market with a renewed interest in investment. So long as there is an overhang of property that can be sold it makes investment decisions put off which is the very essence of deflation and the worries of the ECB which led to quantitative easing. Deflation in real estate prices has deleterious effects on banks’ balance sheets and this is why the situation as is at present should not continue.
It is noteworthy that the need for an asset management company to manage NPLs has come recently from the Chair of Hellenic Bank and now some politicians talk of a bad bank. In my view the bad bank idea should be totally ignored since banks have regulatory capital needs and banks are not known to better manage such assets. The option which the government and the Central Bank should consider is for specialist private firms with real estate expertise providing the majority of the equity required and the EUR1 billion, which remains unutilized as a buffer (pillow in Greek), to be used to fund an asset management company to acquire these NPLs. The fact that Cyprus is within the single supervisory mechanism means the European Stability Mechanism can recapitalize banks directly for disposal of assets is in my view the best way forward since the losses banks face from selling at a discount the NPLs will have to be funded by new investment. If the government can get the ECB to convert ELA to a 20 year loan this would be the icing on the cake.