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Bankers’ Alert: Bloom or Wither? Revolutionise or Rationalise?

Posted by (Regular StockWatch Contributor) on June 1st, 2017 - 7 Comments


A Banking Revolution may open up Possibilities

To put everything in perspective in a nutshell, it doesn’t seem likely that the NPLs stock will be worked down to manageable, and economically sustainable, levels any time soon, via conventional and rationalised management.  It doesn’t seem at all likely, either, that large portions of debt can be sold off at prices which would not jeopardise banks’ solvency, at least in the foreseeable future.  And the pressures are, and will keep on, mounting.  To re-cap:

-  The slow improvement in the reduction of NPLs, has led the recent EU mission to Cyprus to recommend “more forceful loan restructuring efforts, notably by making full use of all available tools, in order to accelerate the pace of NPL reduction”.

-  Moreover, as the mission has noted, “the prevalence of restructurings of already restructured loans suggests that the quality of restructuring solutions needs to be further enhanced”.  The re-default rate of restructured loans appears to be around 28% as per the latest statistics published by the Central Bank of Cyprus, but this percentage is not further broken down into a vintage analysis to assess how the older, more mature, restructurings are behaving.

- Provisioning is still on the low side, given that the local banking coverage average is below that of the EU.  Inadequate provisioning invariablygives rise to large pricing gaps between potential buyers and potential sellers of loans.

- Corporate governance issues and cultural impediments may not afford a bank the flexibility in restructurings or resolutions that would be needed to make a substantial impact on NPL reduction and on debt servicing sustainability over the longer term.

-  Banks’ profitability is under severe stress by pressure on net interest margins and the need for additional provisioning.

-  Competition for the few healthy borrowers, in combination with the undisputable excess capacity of the local banking sector, is intensifying and is further pressing interest margins down whereas, as experience has repeatedly shown, it increases the risk of more lax credit standards and a possible new round of lower quality loan granting.

-  Repeated waves of regulation do not leave much breathing space to banks.

It is for these very or similar reasons that there has been much recent talk, among the European Central Bank, the European Banking Authority and the European Stability Mechanism, about the benefits of the set-up of a Europe-wide or, at the very least, local Asset Management Companies (AMCs) to deal with what is seen as excessive and non-manageable NPL stocks.For clarity’s sake, it is reminded that this ‘non-manageable NPL stock’ is equal to 5,1% on average across the EU, with only 7 countries reporting double digit percentages, all of which are mostly well below 20% (apart, of course, from Cyprus and Greece which exhibit official figures in the high forties).

History has proven that AMCs can swiftly clean up NPLs from bank balance sheets and resolve them over a longer period of time”, says Vitor Constancio, Vice-President of the European Central Bank.Andrea Enria, chair of the European Banking Authority, firmly believes that “without a European AMC, the lending function of the region’s banks will be impaired for a longer period of time than it would otherwise be”.  The chairperson of the Single Supervisory Mechanism, Daniele Nouy, says, on the other hand, that an AMC “is not a panacea”.  It can nevertheless undoubtedly “allow [precious] time for a smoother and longer resolution of bad loans, preventing in the process fire-sale pressures for banks”, until circumstances are mature for the sale of debt which will at least keep banks in a capital-neutral position.

The concept is simple and has served certain countries well in the past few years – Ireland, Spain, Slovenia, Hungary, Sweden, Malaysia, Indonesia to name but a few.  By segregating between the good and the bad loan portfolios, the bank keeps the bad assets from contaminating the good.  AMCs bring economies of scale, which may help banks,smaller ones in particular, to resolve problem loans by introducing specialisation and sufficient resources, reducing the fixed cost of debt resolution and increasing at the same time the efficiency of recoverability (IMF Staff Discussion Note, A Strategy for Resolving Europe’s Problem Loans).

And the split between good and bad loans brings in much clearerstrategic direction and focus, accountability, responsibility and rigour in the servicing and management of distressed loans,the modus operandi of which is entirely different compared to normal core banking business.  “A bad bank should also function as a work-out bank, which resolves the over-indebtedness of borrowers”, says Klaus Regling, Managing Director of the European Stability Mechanism.

But while the idea is simple, the practice is quite complicated. And in most cases, the state has taken central role in the establishment and financing of AMCs.  Indeed, Enria suggests that “you cannot deal with NPLs in a speedy way without the public sector”.Which brings us to two major and possibly insurmountable problems, namely

a. the state’s financial /fiscal capacity to undertake such a pivotal role, and

b. constraints resulting from, inter alia, EU state-aid rules.

 So then, what can we expect next from our banks?  What actions can they actually take to maximise their chances of survival?  Is the rationalised approach taken to date enough to do the trick?  Can they continue juggling with all these air-borne “balls” or will the “balls” all come tumbling down upon the banks with a bang?

In all honesty, it is not at all clear how the show can go on for much longer despite our banks’ best intentions and valiant efforts.  Banks cannot afford to absorb sizeable chunks of real estate property in debt to asset swaps nor can they really take the bull by the horns unless they make bold moves to counterbalance and reduce, in justifiable cases and in a fair and equitable way, the excessive-cum-unsustainable indebtedness of corporates and households alike.

Indeed, it is high time that our banks stop rationalising and start debating more radical and revolutionary ways, which may better sustain them in the medium to long term future. Accordingly, each bank’s peculiarities and appetite will ultimately drive the individual strategies they will follow.

 Renos Ioannides

Financial Analyst

Categories → Οικονομία

  1. avatar
    Savvakis C Savvides on June 1, 2017 - (permalink)

    The issue my dear Renos is not how to save the banks, but how to save the economy. Private debt is the real problem. Not the recovery of the banks for the sake of the shareholders or bondholders. Not much reconstruction can take place and surely not any time soon when almost 4 times the GDP weighs on the shoulders of Cypriot households and corporations as debt. Moreover, domestic demand is likely to become a lot worse when the dissaving eventually runs out of steam.

    • avatar
      Renos Ioannides on June 2, 2017 - (permalink)

      Thank you Savvaki for your comment.

      It is indeed a matter of saving our economy. As we all very well know, and as we have so violently experienced, the health of our economy is inextricably linked with the health of our banks.

      Ailing banks means, among other things, lack of fresh finance, which leads to ailing productive capacity, which results to an ailing economy.

      The excessive private debt is indeed one of the primary stumbling blocks which severely undermines the viability and sustainability of our economy. It is indeed one of the many issues discussed within the context of this series of articles; banks will have to boldly address the issue of re-adjusting debt levels, in justifiable cases,to the true / sustainable servicing ability of borrowers.

      This is just one (albeit critical) of a wider number of challenges facing banks, as discussed in more detail in the three parts of the article.

      • avatar
        Savvakis C Savvides on June 2, 2017 - (permalink)

        The equation “survival of the banks = survival of the economy” is not always true as the Icelandic experience has demonstrated. In fact, it was the closing of the banks and the renunciation of un-repayable debts that gave the country a near clean slate from which to start rebuilding the economy. Indeed, quite the opposite may also be argued, that in extreme cases of private debt when the primary activity of banks becomes one of “asset stripping” (where the economic agents of the country are in a balance sheet recession and productive capacity outstrips demand), there is no other way for putting the economy back on sound footing.

  2. avatar
    CONSTANTINOS CONSTANTINOU on June 1, 2017 - (permalink)

    Excellent article! Well written and documented.
    We have a long and thorny way to go..

    • avatar
      Renos Ioannides on June 7, 2017 - (permalink)

      Thank you Constantine.

      I agree, the road ahead is anything but rosy…

  3. avatar
    Panos Themistocleous on June 2, 2017 - (permalink)

    Thing is that bankers do not have skin in the game and if they sell loans on the cheap and take the hit on their balance sheets they will be liable for the losses and lose their precious little jobs (UK with wage suppression, unemployment and Cyprus reality senior bankers jobs are gold-dust at the moment).

    On another note are we sure that distress / vulture funds really want to invest in Cyprus NPLs? It might be a small market for them, Greece is another story.

    • avatar
      Renos Ioannides on June 2, 2017 - (permalink)

      A big unknown variable indeed Pano. But then again, wouldn’t these funds go where they can ‘smell’ profits? And haven’t international investors become involved in Cyprus (BOC, HB, real estate investments etc)? What’s more, we can never ignore their strategic thinking which revolves around geo-political and financial benefits. It is the multi-nationals after all which are running the political scene across the world.

      Major stumbling blocks, for the time being at least, are (a) the hefty bid-ask price differential (local banks do not have sufficient provision coverage to be in a position to sell at the low prices offered by these funds in such situations, and (b) the still ineffectual legal and enforcement framework which might deter investors (and reduce their offer price even further) from buying into local problem loans knowing that it will be very difficult / time-consuming to liquidate the corresponding collaterals.

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