One of the first figures that hit twitter when Bank of Cyprus (BOC) issued its first-quarter results last week was the non-performing loan (NPL) ratio of 63%.
The person tweeting pondered of this meant that the bank was in serious trouble and that it would need yet more capital in a hurry.
However, there are a number of reasons to be cheerful about the results of that bank that single-handedly accounts for around 40% of the entire sector.
Define your NPL ratio
First, it is important to distinguish between the NPLS ratio defined by the European Banking Authority (EBA) – formerly the Central Bank of Cyprus – and the more standard definition known as the 90+ DPD (more than 90 days past due) basis.
On the EBA basis, BOC’s NPL ratio was indeed 63%. For Hellenic, the ratio was 59.5%. However, the EBA definition includes loans that have already been restructured in the past six months.
I am not sure why this is insisted upon by the authorities, but one can assume that it is a way of ensuring that the banks do not ‘cheat’, by restructuring debts that they know will soon fall back into bad loans.
If you look at the 90+DPD definition, however, BOC’s NPL ratio was 53.1% at the end of March, down slightly from 53.2% at the end of December.
Hellenic does not produce a 90+ DPD ratio but its nearest equivalent, namely “Grade 3 high risk”, produces, according to my calculations, an NPL ratio of 55.6% at the end of March, up from 53.8% at the end of December.
Don’t get me wrong. These are still enormous ratios. In the first half of 2014 according to ECB data, the EU average was a mere 4.7%. Ireland’s was around 22% and even Greece’s ratio was around 27%.
But at least in the case of BOC, which was once the most vulnerable, NPL levels have stabilised. Moreover, since the 90+ DPD basis measures actual NPLs, not restructured ones, it is a better indicator of how a bank is tackling its bad loan problem.
NPLs have stabilised
And here the news is rather better, at least for BOC.
At the end of 2012, NPLs on a 90+ DPD basis at BOC were €7.69bn. They shot up to €13.0bn at the end of 2013. But they have not reached that level since.
Although there was an absolute increase between December 2014 (€12.65bn) and March (€12.79bn), they have remained below their peak.
This also explains why BOC made a profit in the first quarter.
If your NPLs are rising fast, you must significantly increase your ‘provisions’. That is, you must set money aside in case you never get the money back.
But if they are stabilising, you do not have to provision as much.
In the first quarter of 2015 BOC provisioned €148m, down from €248m in the fourth quarter.
It therefore reported a small post-tax profit of €29m in the first quarter, after a loss of €337m in the fourth quarter.
Lower provisioning also helped Hellenic make a post-tax profit of €12.3m in the first quarter, up from €6.5m in the fourth quarter.
Although its NPLs rose, its coverage ratio (provisions as a proportion of bad loans) is already higher than BOC, at 46.8%, compared with 41.8% for BOC.
Profits also feed into capital. So BOC’s common equity Tier 1 (CET1) capital ratio has remained higher than the 9% threshold, at 13.9% in the first quarter. Hellenic’s was 13.3% in the same period.
BOC says its CET1 ratio is one of the highest in the business.
Here, it would have been good to compare with EU averages. But I am afraid that the cumbersome ECB database has defeated me. However, finance tweepers @jeuasommenulle @georgiemark and @oditorium confirmed that this is indeed high.
NPLs should now fall rapidly
The second reason to be cheerful is that banks can now, at long last, sell off bad loans.
According to various rumours, just 30 companies are responsible for around €6bn in bad loans at BOC, or about half of the total.
It is reasonable to assume that these are linked to big development projects. If these can be sold, then the NPL level falls, even if the bad debt is not entirely wiped out by the sale.
The other reason to believe that the ratio should fall rapidly is that the foreclosure legislation and accompanying regulations are now, at long last, in force.
I am sure we all know borrowers who had stopped paying but were reluctant to talk to the bank until they knew what the final deal would be.
These ‘strategic defaulters’ now have a stronger incentive to pay.
One banker told me he thought that half of their bad loans were strategic defaults.
A good reason to believe him is the retail sales figures.
How can a country with an NPL ratio of more than 50% have sales of electrical goods and furniture rising by 18.7% and ‘computer equipment books and other’ by 12.5%?
Yet these were the figures for the first quarter.
Nor was it a one-off. The average for the past four quarters was 15.6% for electrical goods and furniture and 8.8% for computers and books.
There is reason to believe, therefore, that we’ll see a good fall in the NPL ratio by the end of the year.
Once the NPL ratios decline, profitability will rise and, you never know, the banks might even start lending again.