NPL Resolution –

State of Play

Croatia Damir Odak, Vicegovernor, Croatian National Bank

Vienna Initiative Workshop

Vienna, June 26, 2015

Why is NPL resolution so important?

NPL isn’t accounting or financial problem, but it has

significant impact on competitiveness of “real” sector

Three major distortions caused by high NPL:

Higher interest costs for performing debtors

Suboptimal use of real economy resources

Higher risks and negative impact on corporate governances –

moral hazard

2

Higher interest costs

3

Corporate Retail

Banking System as of June/2014

Croatia about EU Average

Izvor: ECB (Consolidated banking data), Lipanj 2014.

*LTD ratio is ratio between total loans and non-banking deposits

4

Retained profitability

Strong capital

Mild deleveraging

Growth of NPL

Banking is in overall good shape

5

ROA before and after Value adjustment costs

(VAC)

Source: ECB (CBD)

Profitability of Croatian banks (ROA) is higher compared with CEE and Euro-zone

countries.

However, the difference from Euro-zone is even greater when operating profitability is

observed, indicating that the credit risk is “eating” higher margins of CEE banks.

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2008 2009 2010 2011 2012 2013 Jun-14

%

Euro zone - ROA CEE - ROA

Croatia - ROA Euro zone - ROA+VAC

CEE - ROA+VAC Croatia - ROA+VAC

Three phases in NPL resolution

1. Recognition and accounting

2. Workout

3. Write-off

6

In Croatia generally phase 1 is completed

Phases 2 and 3 would require significant additional effort

1. Recognition and accounting

7

Dynamics of NPL recognition

2005.-2014.

Decrease of coverage was consequence of inflow of new NPLs and application of very optimistic assumptions;

In period 2010-2012 on site supervision increased provisioning, but with high cost in terms of supervisory resources;

After implementation of new regulation in 2013 coverage dynamically increased.

Decrease of NPL coverage

began already in 2005.

As after beginning of the

crisis coverage plunged

below 40%, change of

regulation become

necessary.

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Share and coverage of NPLs

Source: HNB

6,2% 5,2% 4,8% 4,9%7,8%

11,2% 12,4% 13,9% 15,7% 17,1%

60,3%56,8%

54,4%

48,7%

42,8%38,8%

41,4% 42,6%46,2%

51,3%

0%

10%

20%

30%

40%

50%

60%

70%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

NPL ratio NPL coverage

Change of regulation

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in 2013 amendments to the Decision on the classification of loans were adopted

those amendments made the following changes: compulsory provisioning was regulated in detail:

compulsory 10% provisioning 90 days past due (delinquency), if no collateral was activated

compulsory 20% provisioning one year after delinquency, if adequate collateral was not activated

compulsory 30% provisioning two years after delinquency, regardless of legal action taken to activate a collateral;

after accounting for 30%, each 6 months an additional 5% compulsory provisioning

minimum of 1% provisions was established for NPLs

regulation of restructured loans (how to treat them after restructuring, criteria for their rehabilitation into performing loans)

compulsory minimum haircuts and collection periods were introduced for real estate and movable property

consecutive compulsory provisions (10%, 20%, 30%) were aimed at motivating banks to timely start foreclosure, while the additional 5% provisioning was a kind of “lump sum” correction for all other noticed aberrations from best practice; others are meant to adjust NPL & forbearance definition to the new definition approved by EBA BoS (ITS on supervisory reporting regarding forbearance and non-performing exposures)

NPLs and regulatory capital

10

ratio between carrying value of

NPLs and regulatory capital more

then tripled between 2008 and

2013

implementation of new regulation

in 2013 stabilized it about 40%

on average Croatian banking

system is able to maintain minimal

capital requirements even with full

write-down of NPLs

4,9 6,4 11,7 18,9 21,2 22,7 24,2 23,3

11,312,8

22,2

34,8

38,139,6

43,741,9

0

5

10

15

20

25

30

35

40

45

50

0

5

10

15

20

25

30

2007 2008 2009 2010 2011 2012 2013 2014

%HRK billions

NPLs CV NPLs CV/Capital - right

Product specific situation

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Corporates Households – home loans

7,9% 8,4%9,1% 9,5% 9,7%

68,7%72,9% 74,5% 75,0%

69,9%

0%

10%

20%

30%

40%

50%

60%

70%

80%

0%

4%

8%

12%

16%

20%

2010 2011 2012 2013 2014

NPL ratio NPL coverage - right

1,7% 1,6% 1,7% 2,7%4,5% 5,2% 6,2%

8,1% 8,8%

49,2% 50,0%

42,1%

35,7%

29,0%

33,4% 34,4%

39,4%

43,8%

0%

10%

20%

30%

40%

50%

60%

2006 2007 2008 2009 2010 2011 2012 2013 2014

NPL ratio NPL coverage

7,7% 7,3% 7,5%

12,9%

18,2%20,3%

25,0%28,3%

30,8%

52,2%

45,3%

38,1%

33,2% 32,0%35,1% 36,4%

41,2%

48,7%

0%

10%

20%

30%

40%

50%

60%

2006 2007 2008 2009 2010 2011 2012 2013 2014

NPL ratio NPL coverage

Households – general

purpose cash loans

Comparative NPL Coverage

Source: IMF, FSI data

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Comparation with countries having similar NPL ratio

0

10

20

30

40

50

60

70

80

90

100

2009 2010 2011 2012 2013 2014

%

Ireland Italy Slovenia Bulgaria

Croatia Hungary Romania

2. Workout

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Experiences with collection

Corporate:

in period 2008 – 2014 only 18% of all initiated foreclosures on business

properties were successful;

Out of that number, less then half occurred with third party, while

remaining estates were bought by the bank;

Achieved average price was below 50% of initial evaluation

Retail:

consumer loans are fully provided. Workout activities are significant

and involve also portfolio sales.

we are in process of collecting systematic data on workout of housing

loans. Existing evidences indicate that workout is very limited.

one middle-sized bank reported that in last 6 years they initiated 197

foreclosures. Of this number 10 was successfully completed, and 8 are

pending.

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Why is collection slow?

Major reason is illiquid housing and real estate market.

In 2012 real value of housing sales fell to 25% of 2008

figures.

Collected data about resolution through sale of

commercial real estates also indicate low turnover.

NPL ratio in critical industries: construction and real

estate development is over 60%, and it is all

collateralized.

Courts work slowly and sometimes unpredictable, but

low marketability is major obstacle for collection.

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3. Write-off

One of reasons for high NPL ratio in Croatia is the fact

that write-off isn’t tax deductable if creditor didn’t

previously use all available legal means to collect;

as using all legal means is time consuming process,

significant part of 100% provided loans remain on

balance sheet for extended period of time, creating

unrealistic NPL “bulge”.

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Conclusions

NPL resolution is significant factor with influence on

competitivity of real economy, therefore on economic

growth

It is necessary to recognise and properly account for

value of NPLs, and to write them off once preconditions

were met

For positive impact on real economy, effective workout

is a key.

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