ESTIA is fast-track ticket out of NPL crisis

But not a Trojan horse for a secret bailout for banks, say analysts

As Cyprus banks look for ways to further reduce their NPL portfolios, the ESTIA scheme for mortgage defaulters seems to be offering them an express ticket out of the toxic loans crisis.

The government scheme aimed to help distressed borrowers from losing their home is seen by analysts and institutions as essential for the future health of the banking system.

International rating agencies, while commemorating Cyprus for its efforts to bring down the banking system’s NPL ratio, have stressed that the country needs to speed up procedures of reducing its exposure.

Total non-performing loans (NPLs) dropped from EUR 20.9 bln in December 2017 to EUR 16.8 bln at the end of July and will drop further to under EUR 11 bln when the sale of the Cyprus Cooperative Bank is consolidated.

This has led Fitch and Standard and Poor’s in their latest reports to upgrade Cyprus’ creditworthiness, but they have in turn emphasised that the banking sector remains extremely weak due to high private debt.

Asset quality is low, with the still high number of NPLs in their portfolios burdening new lending and profitability of banks.

According to their H1 2018 results, the two biggest banks, Bank of Cyprus and Hellenic Bank, still have a high NPL ratio with 43.2% and 51.6% respectively.

With the BoC sale of an EUR 2.7 bln package of loans to the Apollo Fund and the absorption of the good assets of the Co-op by Hellenic, their NPLs are expected to drop to 38% and 25%, respectively.

In fact, the Bank of Cyprus is expected to reduce its NPLs by around EUR 3.5-4 bln by 2020 (including the sale of EUR 2.7 bln to Apollo). HB’s CEO Ioannis Matsis presenting the banks H1 results revealed that the bank is looking into packaging and selling a significant part of its NPLs within the next six months, with reports saying that the bank is to sell off loans worth EUR 1 bln.

Nevertheless, the NPL stockpile is still a daunting EUR 11.5 bln.

“Despite the decline in the NPL balance, the rates remain high,” DBRS said in a note under the title “Cyprus - Accelerating NPL Decrease in the Banking Sector”.

It said despite dropping significantly from May 2016 when NPLs were at 46% of banks loan portfolio, to 38.9% in June 2018, “Cyprus still has the second highest NPL rate in Europe after Greece”.

The rating agency said the role of ESTIA is key to bringing down NPLs, especially those by households. “The decline in nonperforming loans to households, accounting for more than half of total non-performing loans, was more limited. The household non-performing loans ratio was slightly above 50% in June 2018,” said the DBRS.

Not a bailout

The scheme essentially means that banks will be able to make considerably fewer provisions on their balance sheets, as without the scheme BoC would have to make provisions of EUR 580 mln for the EUR 950 mln worth of loans to be included in ESTIA, and HB an extra EUR 130 mln provisions for NPLs worth EUR 250 mln.

This has led many critics to look upon the ESTIA scheme as an ‘undercover bailout’ for the banks, as banks would need to urgently find capital to cover the above provisions.

Dr George Theocharides, Director of CIIM’s MSc Financial Services programme, feels the Estia scheme does indeed benefit the banks, as it gives them a tool to quickly reduce their NPL portfolios, “but would not go as far as to call it a bailout, as this also benefits borrowers and the society”.

He said that such a scheme should have been brought earlier to the table, as this could have helped to avoid developments such as the closure of the Co-op.

Theocharides said that if the scheme had not been brought to the table, “we could have been talking about a haircut on deposits of Co-op customers, especially if the Co-op had not been closed and its assets split with the state taking on the bad loans and HB the good assets”.

He explained that with the Co-op’s closure, a significant slice of NPLs have been removed from the banking system but are still a burden on society, as they are undertaken by the state “at a significant cost, but one which is underweighted by the benefits”.

Echoing the same arguments, Demetris Georgiades, President of the Fiscal Council, said that “In the case of the Estia scheme, the borrower and the lender are two sides of the same coin. If one side is strengthened by being subsidised, then the other side is to benefit”.

He added that the scheme comes at the cost to the taxpayer but there will be an indirect but equivalent benefit for the society such as “the stabilisation of the country’s banking system”.

Yiannis Tirkides, Economic Research Manager at the Bank of Cyprus, said that “the well- being of the economy depends on the efficiency and the effectiveness with which banks channel funds to their best uses”.

He argues that unless funds move from savers to investors through the banks, Cyprus cannot grow its capital stock, it cannot increase productivity and in the end, the economy stagnates and declines.

Prerequisites for NPL drop

On whether the banking system will be able to achieve the ultimate goal of reducing the NPLs ratio to below 5%, as indicated by the European monetary authorities, analysts like Tirkides believe this is connected to whether Cyprus’ economy will continue to grow at the current high rate.

Theocharides said that the country’s medium-term outlook should remain favourable, the macroeconomic conditions in the country continue to improve, unemployment must continue to decline, investment has to increase, tourism must remain strong, while private debt continues to fall, and the country continues to produce a surplus.

He stressed that there are a number of risks ahead such as the pressures exercised on Cyprus authorities by Brussels, that may endanger the ‘Citizenship for Investment’ scheme which is “of great importance for the Cypriot economy”.

He said that there are external risks such as Brexit and the slowdown of the world economy due to the trade wars between China and the USA.

But the government needs to find ways to ensure that the state-backed NPL management body will be run in a sound manner without any interferences, said Theocharides.

“If the NPL management body and the ESTIA are run wisely, then the state and the society are to see benefits and profits.”