By George Markides
Co-op banks were nationalised in December 2013 with the state injecting €1.5 billion in taxpayer money – part of €2.5 billion earmarked for banks in Cyprus’ €10 billion bailout.
Before signing the Memorandum of Understanding (MoU) co-ops were supervised by the Authority for the Supervision and Development for Cooperative Societies (ASDCS). ASDCS is a government department (not independent like the Central Bank) that is under the ministry of commerce. As per the MoU, co-op supervision was transferred to the Central Bank in August 2013.
Unlike commercial banks, co-ops escaped public scrutiny, despite them holding approximately 25 per cent of all deposits and 20 per cent of all loans in Cyprus.
At the end of June 2014, co-op banks produced their audited financial statements for 2013 adhering for the first time to Eurosystem standards.
Looking at their Profit and Loss statement for 2012 we find that co-ops had set aside an additional €174 million as provisions – an expense that reflects the bank’s estimate on how much money it stands to lose on its loan portfolio from customer defaults, revaluations etc.
In 2013 provisions increased by €1.9 billion, more than ten times the increase for 2012, with total provisions standing at €2.6 billion at the end of 2013.
This is a clear indication that co-ops underestimated risk prior to 2013 and speaks volumes about their lending practices.
Even more alarming is the sector’s Non Performing Loans (NPLs) reporting.
By the end of 2012 co-ops reported a mere 17 per cent of total loans as NPLs, and by the end of 2013 they reported 46 per cent.
There is no way NPLs increased in such a dramatic fashion in just one year, therefore it is obvious that prior to 2013 co-ops deliberately refused to acknowledge the full extent of losses to their loans portfolio and did not adhere to industry standards on NPL reporting.
Looking at their loan portfolio, 38 per cent of all loans are housing loans to natural persons (not real estate developers) and the overwhelming majority of those housing loans (89 per cent) are for building/purchasing primary residences. Another 32 per cent represent consumer credit.
More than half of consumer loans were non performing and 39 per cent of all housing loans were reported as NPLs by the end of 2013.
Since co-ops do not publish quarterly results there is no way of knowing if the situation has improved – highly doubtful – or how much it has deteriorated in 2014.
Unlike commercial banks, such as the Bank of Cyprus or Hellenic, where something close to one quarter of all NPLs are loans to a handful of real estate developers, almost all NPLs reported by co-ops are loans to natural persons.
Even under more favourable repossession legislation co-ops will find themselves falling out of favour with the public if they decide to call in on bad loans or foreclose on properties.
Setting the moral and societal aspect aside, going forward there is no way for co-ops other than to repossess properties.
In the notes accompanying the co-ops’ financial statements, under the section of uncertainties, we find a cautionary warning that says quite explicitly “The (co-ops) management is not a position to accurately foresee all developments that could have an impact on the Cypriot economy and on co-ops performance in the upcoming Asset Quality Review and Stress Tests (by the European Banking Authority and the European Central Bank respectively).” This is nothing more than an outright admission they will need additional capital after stress test/AQR results are in.
As mentioned above, Cyprus’ €10 billion bailout package includes €2.5 billion for future bank capital needs. The government and the central bank have already disbursed €1.5 billion to co-ops so there is another €1 billion left in the kitty, which should be enough to cover any capital shortfalls the tests may reveal.
However, if co-ops do not proceed forthwith with property repossessions including primary residencies, they will soon see their capital position depleted.
If the government kowtows to populist voices calling for the protection of primary residencies, there is a real danger that co-ops will request a second bailout since most of its NPLs will be unrecoverable by law.
George Markides, BSc and MBA, is an economics researcher