A draft report under the title “IndependentduediligenceofthebankingsystemofCyprus, March 2013” describes in detail the in detail the idiosyncrasies of the Cypriot banking system and the parameters explaining the huge capital losses that eventually led the two major banks to a consolidation process.
The Cypriot banking system and the credit practices of organizations involved in the due diligence is characterized by a number of idiosyncratic features that differentiate Cyprus from other international banking systems, it said.
The report captures the capital needs of the banks until June 2015 and covers Bank of Cyprus, Cyprus Popular Bank, Hellenic Bank, Eurobank, Alpha Bank and a representative sample of the Cooperatives.
Total requirements recorded by the report reach €6 billion with the baseline scenario and €8,9 billion with the extreme scenario, excluding the support of €1,8 billion granted to Cyprus Popular and the Cooperative that were not included in the report.
The baseline scenario is based on a macroeconomic assessment for cumulative economic contraction of 2.8% in 2012-2015 and the extreme scenario on assessment for cumulative contraction of 7.3%.
It is also based on a provision for accumulated increase in unemployment by 1% with the baseline scenario and by 2.5% with the extreme.
The report describes in detail the special characteristics and the problems of the Cypriot banking system via the conduct of the duediligence.
Small emphasis on payment ability
A characteristic registered in many parts of the report is lending on the basis of collateral instead on the basis of repayment capacity. "A key feature of the Cypriot banking system is the practice of seeking loans based on assets, which means heavy dependence on securing the loan, usually with less emphasis on the ability of the borrower to service the loan."
Since temporal property prices were increasing, this did not create problems, however, this changed with the collapse of the housing market, it said.
Long period of disposal
The firm refers to the long time required for the disposal of property. The whole process may take between 10 to 12 years, it said.
For this reason, the Cypriot banks rarely handle problematic loans by selling property, and instead, they try to obtain additional collateral.
The legislation itself for loans is problematic, they say, because it does not allow banks to acquire ownership of the loan, but only to sell it. This means banks can not control the timing of property selling in the market.
As a result of the above, the creditors have no incentive to take legal action against the borrower and borrowers do not face the direct consequences of failure to service the loan, leading to reckless borrowing.
Collateral for many loans
A third characteristic identified by Pimco is that there is a high degree of collateral for different loans. Either many properties guarantee a loan or a property many loans or - even more complicated - many properties ensure many loans.
This involves great difficulty in calculating losses and Pimco has its own algorithm to handle many such cases.
Methodology for provisions and doubtful debts
Pimco noted in its report that "the methodology for projections is the key point that differentiates the Cypriot banks from other European banks”. It argues that the methodology does not cover for losses in the financial statements as in other methodologies.
There are two different points raised by Pimco.
Unlike the practice abroad, the Cypriot banks do not calculate the net present value of future cash flows of a troubled loan.
Also, they do not calculate the whole value of a loan that is not serviced in NPLs but only part of the value not covered by the collateral.
Due to the high size of borrowing with collateral in Cyprus and due to overestimated values of collateral, many loans that are not served long, are not calculated in the stock of non-performing loans.
Restructuring of loans
Pimco also identifies that changes in the terms of a loan is a common phenomenon.
Recognition of interest in income that is not paid
One of the most interesting findings of Pimco, which is expected to stimulate discussion, is that the Cypriot banks have recognized in their income considerable amounts of interest not paid. While it is based on accounting standards, "the amount of unpaid interest to the recent income of banks is unusually high."
Pimco notes that around 20% of interest income in the financial statements of the banks is non-paid interest compared with 7% in 2010.
Dependence on international operations
Another characteristic noted by Pimco, which is expected to change after the recent developments, is the high dependence of the revenues of banks on the financial transactions of foreign companies. "This is important stabilizing element for the Cypriot banks on the baseline and extreme scenario, as the level of foreign demand for these transaction services is expected to remain high and insensitive to macroeconomic conditions."
Non-payment culture in Coops
Pimco noted that the Cooperatives have not aggressive debt collection policy because they believe that they have a social role.
As a result, there is a culture of non-payment by members of these organizations. Sometimes there is a grace period of up to two years to start repayment. To some extent this is due to the fact that Cooperatives have conservative policy in the loan to value of the property ratio, and therefore, they believe that they have enough collateral.
- Get in StockWatch from your mobile phone with Vodafone live!
- Subscribe to the new StockWatch Newsletter.