(Tales of Vulnerability)
A Pressing Problem with Explosive Repercussions
It is an undisputed fact that home ownership is deeply engrained in, oftentimes ‘imposed’ by, Cypriot society.
It is also an undisputed fact that a great number of homes are collateralized to banks for housing, personal and business loans.
To complete the equation, Cyprus ‘boasts’ the highest private debt level, as a ratio of debt over Gross Domestic Product, in the EU. Non-performing loans among households and small to medium enterprises account for well over 50% of the respective total loans.
It doesn’t take a genius to work out the maths. A very large proportion of local homes are encumbered in favour of banks and a sizeable part of these relates to loans that are non-performing.This cocktail is like a bomb which may detonate at any time if left untreated,given that the burden of home ownership exertsfinancial, socio-economic, psychological and health stresses to a sizeable part of our fellow citizens.
Protection of ‘Vulnerable’ Households
It is for these reasons that the Estia scheme was set up in an attempt to assist the so-called ‘vulnerable’ households whose primary residence may be at risk.
In principle, a very welcome and valiant, even if somewhat belated, move. The rationale behind the scheme should be to support and assist truly vulnerable households by sharing the risks among borrowers, banks (possible loan write-down) and the State (the taxpayer’s money) which will be subsidizing one third of the loan’s instalment. This should be done, in the words of the Council of Ministers’ decision, in a fair and equitable way, stripping out strategic defaulters and preventing moral hazard.
A Tale of two ‘Vulnerable’ Households
Let us examine how the published scheme will work with two typical Cypriot households:
- All households with a declared (gross?) income of up to €50.000 will be eligible. The scheme seems to have ignored that around 80% of all households in Cyprus declare a total income within that range. It has not considered the fact that a number of self-employed people may not be declaring their full income. It has failed to take into account the composition of the household and the resulting reasonable living expenses. To put it simply, the scheme seems to assume that a household comprising of a young single member who has his own professional practice and has not been particularly affected by the recent economic crisis is equivalent with a household consisting of a lowly paid worker, an unemployed spouse as a result of the crisis,and four young dependents.
- The upper limits imposed on the household’s assets are not much more equitable either. €350.000 for the primary residence, which is by no means negligible, and a crude measure of up to 125% of the residence’s value in other assets. The nature of these assets is not defined but what the scheme defines is that this 125% will be the net value of those assets (ienet of any debt obligations attaching to them). So, to continue with our above example, our young professional comfortably lives in his luxury 300 square metrepenthouse which is valued at just below €350.000and also maintainsa nice beach house and a flashy sports car which are worth, say, €1.000.000 with a corresponding debt on those assets of €600.000 (hence, the net value is less than 125% of the residence’s value). Our six-member family, on the other hand, lives in a working class semi-detached200 square metrehouse, valued at €200.000, and has two cars collectively valued at €15.000; no other assets. Both households will beclassified in a blanket format as ‘vulnerable’ households.
- In his effort to fund his expensive lifestyle, but also in light of the ineffectual judicial and enforcement regime in Cyprus and the recent public hype about potential loan forgiveness, our young professional has never made any substantial pay-downs into his loan; the very definition of a strategic defaulter. On the other hand, our family of six has been trying to make even the smallest, even if irregular, contributions towards their loan out of the little wages they are earning. No need to say that both households are eligible for the Estia scheme.
(Almost) Everybody can get on the Estia Bandwagon
What are the traits then deriving from the very realistic and so common tale just described:
- Not a bad deal at all for the young professional. He gets to keep all his wealth and grandiose life style, has his housing loan written down, enjoys a low interest rate and has the State (ie, the taxpayer) subsiding one third of his housing loan instalments!
- Not such a bad deal for the bank either. It may have to write down itshousing loan to the present value of the primary residence, but for all intents and purposes one would reasonably expect that this write-down is already more than covered by impairment provisions (which are based on much stricter net present value criteria compared to the market value of collaterals). In all other respects, the bank wins,given that a non-performing loan will eventually be converted into performing and it will also get a welcome boost to the borrower’s repayment ability.
- What about the taxpayers? Well, this is not a very good deal is it?The law abiding taxpayer will be subsidizing a wealthy strategic defaulter’s loan instalments.
- And what about those lowly paid parents of four? This is what would reasonably be defined as a truly deprived household. It is cases such as these, whereby the household cannot make ends meet and is certainly in no position to regularly service the two thirds of any reduced loan instalments (as per the provisions of the Estia scheme), that any State-backed social scheme should be addressing.
As things currently stand, these households will be led to foreclosure. Where is the State’s social housing scheme then to protect from homelessness? Or a mortgage-to-rent scheme whereby the State buys the house, leases it back to the family at very low rent (with option to repurchase), allows the family to continue its life in the same surroundings andprotects them from the social stigma and the psychological hit? Or, at the very least, where is a free scheme, an electronic platform, where families can look, without cost, for a home trade-down transaction (sale of their home, purchase of one of lower value)and a simultaneous write-down of their debt in line with the Estia provisions?
- And what about all those thousands of conscientious households which have sacrificed their way of living to make ends meet and to keep up with their loan repayments? On top of their own loan instalments, they will now find themselves subsidizing the young professional strategic defaulter’s lavish way of life.
Not fair or equitable, is it?
The Final Verdict
Is the Estia scheme needed? Absolutely. There are so many primary residences collateralized for loans and so many households which cannot fully service their debts.
Is it fit for purpose? Not in the least, the way it has been structured. The scheme has totally missed its overriding objectives, it has been de-railed from its underpinning principles. It seems to have been set up haphazardly, it gives a shield to wealthy strategic defaulters, it leaves truly deprived households out in the cold.Although this is a nation-wide issue which affects all strata of our society, directly (eligible borrowers) or indirectly (taxpayers), it has not been openly and transparently discussed as it should.
Can it be made fit for purpose? Definitely. Through structured analysis and planning, proactive and holistic thinking to pragmatically put all the wrongs identified right:
- tighten the eligibility criteria with respect to income and the value of the primary residence vis-à-vis the structure of the household,
- reduce the allowable free assets of eligible households to a reasonable and fair (low) value,
- establish thresholds to eliminate strategic free-riders,
- institutesocial schemes(social housing, mortgage-to-rent, home trade-down scheme and platform) to assist and support truly deprived households, which will not be eligible for the Estia scheme,
- look at borrowers’ true sustainable debt servicing capacity across the banking system and not in isolation (eg, only the housing-related loans),
- introduce uniform decision-making rules and assessment criteria for borrowers’ viability which shall be applied universally by all participating banks,
- add provisions for a review of the eligibility criteria at regular future intervals,
- make perfectly clear, beyond any reasonable doubt, that in cases going sour, the State will have first priority in foreclosure procedures over the disposal proceeds (including interest),
- allowaffected stakeholders (not just banks!) to take part, and be heard, in the discussion,
- and last, but not least, have technocrats refine and calibrate a number of technical hitches which seem to have been missed out; if these are not put right, the operation of the whole scheme may simply collapse.
The take-away message is that the Estia scheme has been hastily put together in a reactive, piecemeal, fire-fighting approach, which is so typical of our overall way of handling the excessive private debt and the mountain of NPLs in this country.Isn’t it time that our inefficient legacies of the past, which have led to so much suffering, are changed?Isn’t it time that we do the self-evident? Isn’t it time that we start planning? It is not nuclear physics science! It is common sense!
… If we want to prosper as a nation that is!
Financial Analyst and Licensed Insolvency Practitioner