Release of the PIMCO banking study
On Friday April 19th 2013 the PIMCO study was finally released. It is dated February 2013, comprises 103 pages and is called Independent Due Diligence of the Banking System of Cyprus. It is supposed to be availabe at the Central Bank of Cyprus but the link for final report on 19th April did not work. Press release and QA are working. Full report available at Cyprus Mail.
Update 20 April (6.58am New York time) - since writing this blog the FT's Alphaville has sourced a March 2013 edition of the Pimco Report. I will report on differences. The March 2013 report is here.
(7.28am) There appear to be no substantive differences between the Exec Summaries and Scenarios of the February and March releases of the #PimcoCY report. Headings in the March release have been emboldened and the links in the PDF no longer seem to work.
Its main and widely leaked conclusion is that the Cyprus banking system faces a capital shortfall, based on 2012 data and using assumptions of macroeconomic conditions that are now widly inaccurate, of between €6 and €8.9bn.
The Adverse Scenario in the report that results in the higher figure is based on a cummulative (three year compounded) drop in GDP between 2011-2015 of -7.3% and house price change of -23.8%.
The draft Debt Sustainability Analysis of 9th April 2013 prepared by the European Commission estimates a fall in GDP in the period 2012-15 of -15.2%.
On April 4 the Cyprus government's spokesperson, Christos Stylianides, said,
“In 2013 the recession may not be 8.7 percent as is estimated, it may reach 13 percent.” (ekathimeri 4 April 2013).
Here are the year-on-year GDP forecast figures compared for the Debt Sustainabillity Analysis (see Memorandum) and PIMCO adverse and base macroeconomic scenarios.
DSA and PIMCO GDP forecasts for Cyprus 2012-2015
|DSA (Apr 2013)
|PIMCO ADVERSE (Feb 2013)
|PIMCO BASE (Feb 2013)
Before leaving these now obsolete figures behind it is interesting to see how they are divided between domestic, foreign and cooperative banks. Of the €8.9bn shortfall €8.2bn is accounted for by domestic banks, €149m by the foreign banks and €589m by the coops p.19.
The overview of the banking system provides some useful information
Assets at €100bn are made up of 68 per cent loans and 13 per cent cash.
Liabilities of €94bn are made up of 71 per cent deposits and 15 per cent central bank. The report says that the total amount owed to the EU is €14bn made up of normal ECB funds and ELA - that is over 20% of the funding of participant institutions (p. 14).
Of net loans of €68bn 62 per cent are based in Cyprus, 29 per cent in Greece and 9 per cent elsewhere.
Of €67bn deposits 60 per cent originate from outside Cyprus as either Greek (19%) or Russian, other or UK (7%) or as Cyprus non-resident deposits (34%). The other 40 per cent of deposits are Cyprus resident deposits.
(These figures are of course before the fire-sale of Cypriot bank Greek operations.) It is interesting to note that while 29% of loans were in Greece only 19% of deposits came from that country.
The report lists its summary and significant findings.
The summary findings conclude that
- loans are conservatively made on assets as collateral rather than on ability to pay;
- that it typically takes 10-12 years to recover assets - ie through a forced house sale;
- that the identification of bad loans can be hampered by complex cross-collateralisation;
- that there can be little incentive for borrowers to keep up payments because there is no immediate consequence when they are missed;
- there is a tendency to reshcedule rather than to aggresssively resolve loans;
- unpaid interest is often reflected as accrued interest in balance sheets based on optimistic forecasts of eventual loan resolution through asset disposal;
- the above practices have been tenable in times of relatively fast property price rises but in times of collapsing real estate values they present a major problem in terms of - my words - chronic under-provisioning and forecasting of bad loans. To paraphrase loan recovery is based on a never-never rescheduling into a future of rising house values and consensual asset disposal;
- transaction revenues for offshore banking services provide a critical component on non-interest revenues for the island's big banks;
- this flow of revenue is reliant on tax optimisation strategies and the report expects the level of demand for these sdrvices to remain high independent of macroeconomic conditions on the island, thus providing important stabilisation in the scenarios presented. (The increase in corporate and other taxes may have a disastrous impact on this trade.)
- lending traditions in the cooperative sector have been lenient and encouraged a culture of non-payments and payment holidays justifed under the rubric of the 'social function' of the cooperative ethos. Non-performing loan levels are higher than those at many Cyprus banks and provisioning is woefully low. Again rising property prices have tended to hide these defects (but not any more).
- loss absorption capacity has been low due to poor provisioning for 90 day debts;
- the system is particularly reliant on non-resident deposits (nearly 50%) that are in turn attracted by low corporate interest rates and other tax incentives. A change in these is predicted to have a 'significant impact' on the level of funding in the system;
- there are relatively few alternative funding sources other than deposits and this has resulted in a major reliance on normal and emergency EU-type loans that constitute 20% of the system at a total of €14bn;
- there are signifcant levels of deferred tax assets and non-cash interest (which left me stumped!).
Loan loss analysis
- High rates of non-performing loans (NPLs) have been covered by high loan cure rates and collateral - falling property prices will adversely impact on these;
- the model of lending leads to high probabilities of default but low loss severities - because in a system of rising property values carried-over loans and accrued interest are usually and in the medium-term paid off, particularly as loans are often spread between a network of borrowers and third party guarantors;
- the corporate sector in Cyprus and Greece is highly leveraged resulting in high default probabilities;
- some of the largest exposures at participating institutions were made to affiliates of the instutition where loans were made to offshore vehicles that then bought shares in the loan-issuing institution. These resulted in higher than average losses.