Tackling joblessness will reduce NPLs

The protracted recession continues to swell the ranks of the unemployed and compress personal incomes, making it more likely nonperforming loans will keep increasing in the coming months albeit at a decelerating pace. This may create a capital shortfall in some recapitalized banks which has to be filled. So combating unemployment seems to be the most effective way to reverse the trend in nonperforming loans (NPLs).

The contraction of economic activity for six consecutive years has been the driving force behind the constant deterioration in the labor market. The figures from the Hellenic Statistical Authority (ELSTAT) speak volumes. In the last quarter of 2009, about 514,000 people were without a job and 43 percent of them had been out of work for more than 12 months. The unemployment rate stood at 10.3 percent. In the last quarter of 2010, the number of unemployed had jumped to 712,000, with 340,000 having been jobless for more than a year – the definition of long-term unemployed.

A year later, the ranks of the unemployed had swollen to more than 1 million for the first time since such statistics were first recorded and the long-term unemployed to 55 percent of the total, or 560,000 people. In the last three months of 2012, the unemployed had reached 1.295 million individuals, of whom 847,000 or 65 percent had been without a job for more than a year and 311,000 were young. In the January-March period of 2013, the total number of unemployed rose to 1.355 million, of whom 889,000 had been jobless for more than a year, or 66 percent of the total, pointing to a constant deterioration in labor market conditions. The unemployment rate stood at 27.4 percent.

If the pundits are right, the unemployment rate will dip in the summer for seasonal reasons – namely the tourism period when hotels, shops and others hire workers on a temporary basis – and head up again in the autumn and winter. If confirmed, this will not be good news since it entails more social and economic output losses.

It will not be good news for banks since the high and rising unemployment rate is considered the main driving force behind the constant increase in nonperforming loans in Greece. Of course the sharp decline in households’ purchasing power, the budget cuts and the declining liquidity have also played a role in limiting the repayment capacity of bank customers.

However, a strong correlation between changes in the Greek unemployment rate and the NPL ratio – that is the portion of gross loans which is not serviced for more than 90 days – has long been detected. Nonperforming loans tend to increase with a time lag of six to 12 months after the unemployment rate heads higher.

The total NPL ratio stood at 7.7 percent in the last quarter of 2009. It reached 10.4 percent a year later and 15.9 percent in the last quarter of 2011. Moody’s rating agency expects NPLs to exceed 30 percent of gross loans this year after reaching 24.6 percent at end-2012. Some analysts put cumulative NPLs at 34 percent in the adverse scenario utilized by Blackrock Solutions to calculate three-year loans losses in working out the capital needs of the four main pillar banks. It also assumes 50 percent coverage, meaning having collateral amounting to 50 percent of loans.

On a positive note, the data point to a deceleration in the formation of new nonperforming loans in the last few quarters. Whether this reflects the impact of restructured loans or/and a greater willingness by some customers to repay since concerns about a euro exit have receded since the summer of 2012, as suggested by a senior banker at National Bank in a conference call, or/and the effect of providing very few new loans to clients with a conservative profile remains to be seen.

There is no question, though, that the formation of NPLs plays a central role in determining credit provisions. This is an area closely watched by market participants since Greek banks are due to undergo new stress tests under the economic adjustment program in the fall. To this end, a new stress testing methodology is set to be finalized by the end of this month.

Analysts and high-level bankers alike expect the new stress tests to identify greater capital needs which will have to be addressed by banks to satisfy the capital adequacy ratio. It is noted the recently completed recapitalization exercise of the four core banks has raised the minimum Core Tier I ratio above 9 percent of their risk-weighted assets. This is binding and therefore credit institutions will have to cover any capital shortfall which may arise from the new stress tests.

In anticipation, banks have tried to boost their capital buffer by engaging in liability management exercises involving hybrid and other subordinated securities issued by them in the past. However, this may not be enough, necessitating asset sales, further deleveraging and even share capital increases if the gap cannot close by the previous means.

Of course Greece is not alone in seeing high and rising unemployment driving NPLs higher. The same pattern has been observed in Portugal, Spain and Ireland, although the latter’s jobless rate has come off its peak of 15.6 percent. However, the Spanish mortgage NPLs stand out since the country’s unemployment rate is very high, but they are very low as a percentage of all mortgage loans – just 4 percent in 2012 according to Nomura.

There are many and often more important reasons to tackle very high unemployment rates in Greece and elsewhere. Driving down nonperforming loans may be an additional reason given the correlation between the two so that banks can provide more credit to the economy, facilitating its return to growth.

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