To the Rescue: How mortgaged homes may be protected – an alternative

The Grim Facts Cyprus ‘boasts’ the highest private debt level, as a ratio of debt over Gross Domestic Product, across the world (World Bank data, 2015)!  According to the Central Bank of Cyprus’ ‘Household and Non-Financial Corporations Indebtedness Report’ (April 2017), total private debt (the sum of household and corporate debt) is equal to 273% of GDP.  Household debt, in isolation, was equal to 124% as opposed to the Euro zone average of 59%. Total non-performing loans (NPL) in the Cyprus economy is just over €23 billion in the private sector (households and corporate businesses excluding government and financial corporations) representing around56% of household and corporate total debt (as per the latest Central Bank of Cyprus data). No further breakdown analysis is provided but we do know that housing loans were equal to approximately €11,5 billion as at the end 2016 and represented over 55% of total household debt. Housing loans are typically almost always collateralized by a first charge on the underlying residence.However, encumbering the household residence is not exclusive to housing loans.  Admittedly, many other private loans, be it of a personal nature (for example consumer loans, student loans and so on), or of a business nature (for instance small, medium or large business loans, professional / freelancer loans and others), are very commonly secured by a mortgage on the shareholders’ home. 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. The Pressing Problemand its Explosive Repercussions The excessive private indebtedness in relation to the extremely high NPL ratios, combined with the significant proportion of homes which are charged as security for these loans, is like a bomb about to detonate. The road to NPL resolution and reduction has, to this date, proven slow and cumbersome, with more success exhibited insofar as corporate debt is concerned. Table 1 below is indicative of the trend. Most progress to date has been made via debt to asset swaps, mostly in relation to large corporate deals, and the run-down of deposits to reduce debt. Debt restructuring in isolation cannot really be sustainable long-term, and can actually be counter-productive, if the level of indebtedness is not adjusted, in some instances liberally, to match the true debt servicing capacity of borrowers. It would of course take much more than this to actually lead to a meaningful impact on the NPLs level: a joint-bank effort to resolve multiple-creditor debts, a concerted and disciplined approach to deal with the vast number of loans, possibly bringing in or utilizing outside expert skills and resources in sufficient numbers and, alternatively, other more unconventional actions such as outsourcing the management of these debts to shared debt servicing platforms, setting up an Asset Management Company and so forth. Notwithstanding the above, what this article is aiming at, is the substantial number of borrowers (households) who undeniably and categorically cannot service even part of their debts, despite their best intentions.  It is not unfair to say that this may be the result of a mixture of events, past and present: -  the economic downturn which has severely reduced incomes, -  the acquisition of property at the top of the real estate market a few years ago, - our past (?) unsubstantiated optimism that we can always handle a lifestyle, and corresponding debt burden, which goes beyond our means, - situation-specific circumstances such as long-term unemployment, illness and disability, and - bankers’ excessive eagerness to provide new finance and achieve, often reward-related, business goals during the times when ‘growth’ was the only business word of any real meaning… So then, how do we deal with these borrowers-households from the business-financial angle on the one hand but also from the societal-ethical-communalperspective on the other? Dealing with Distressed Households Foreclosing on these borrowers is not really an option, unless of course they are uncooperative and are simply riding the wave of the, as yet, immature and ineffectual legal and enforcement frameworks, gaining time in the process.  Not doing anything is of course not an option either.  What then? The typical solutions offered to these borrowers such as extending the loan duration with a corresponding reduction in instalment, temporarily reducing or suspending scheduled instalments,or warehousing part of the loan for future payment whilst amortizing the remaining, lower part of the loan, may afford some breathing space to certain segments of the market but leave exposed a significant part of the market who find themselves in severe hardship. This hardship is often the result of household income loss due to long-term unemployment, illness or disability, relationship breakdown, over-indebtedness which simply goes well over one’s means, or a mixture of some or all of these factors.  To top it off, many borrowers find themselves in severe negative equity or ‘under water’, in other words, the total debt which is secured,often via multiple charges, over the borrower’s home, exceeds the present market value of the property. Admittedly, the excessive level of existing indebtedness makes these householdseven more financially vulnerable when abnormal events unexpectedly come up, such as the need for a major capital investment (eg house repairs, a new car etc), the appearance of a serious illness etc. The essence of the matter is, that this specific segment of the market simply cannot sustain their debt.  More specifically, these borrowers do not have the capacity to even partially service the debt over the long – term whatever typical solution is offered to them by the lender.  Nor can it be reasonably expected that their situation will reverse so dramatically that it will give them some hope of being able to service the debt in the future. Although in certain instances, a borrower may be in aposition to ‘trade down’, that is to sell the home and buy a smaller one, of lower value, using the surplus proceeds to pay down a part of the debt, thus reducing the overall debt servicing requirement, this option is only open to an exceptionally few cases, whereby there is positive equity in the home and there is a steady income inflow which can sustain the amortization of a smaller loan.  This ‘trade down’ scenario is really not open to the lower end of the housing market and is, in any event, further obstructed by the slow and illiquid housing market, whereby sales of second hand homes are taking back seat. Furthermore, the situation becomes even more complicated and unmanageable in those instances arising from negative equity and multiple debts, often from different lenders, and corresponding charges registered on the property. The recently implemented Home Protection Scheme, offered by the Cyprus Land Development Corporation (CLDC), affords only temporary and partial relief given that it subsidizes up to 60% of the mortgage instalments (capped at €10.000 per annum) for up to three years only.  In addition to housing loans, the scheme covers mortgaged homes securing small business loans too; small businessesdefined,in this instance, as only those companies with an annual turnover of up to €250.000 and up to four employees. In conclusion, there are certain borrowers-households who need truly permanent solutions for their particular circumstances and needs which are not catered for by the typical schemes offered by banks or the CLDC. The social and economic impact of threatened and actual foreclosures, upon individual borrowers and their children, is immense and comes in a number of forms.  Affected borrowers and their families typically suffer stigma, ill-health, breakdown in personal relationships and, commonly, family upheaval and friendship destruction given the intricate layers of personal guarantees in the local economy.  Regrettably, children’s well-being and education also suffer as a result. Lenders, on the other hand, are impacted by the financial exposure but also, and possibly greater so,by a loss of reputation and an increasing hostility against them. Arguably, the true extent of the problem is not really known since the size of the vulnerable segment of the society is typically camouflaged by the web of family help and support but also by the social stigma which is attached to financial distress and homelessness. AnAlternative: a Permanent Solution If we turn our attention internationally, to sieve best practices from countries which have much more extensive experience in dealing with similar problems, we will typically find so-called ‘mortgage rescue schemes’ which have been set up with the laudable aim of helping the most vulnerable home borrowers at immediate risk of repossession. These schemes provide a supported and structured exit from homeownership for vulnerable households (Evaluation of the Mortgage Rescue Scheme and Homeowners Mortgage Support, The Centre for Housing Policy, University of York School of the Built Environment, Heriot Watt University July 2010, for the Department for Communities and Local Government, UK).According to this study, the overarching rationale for these schemes is twofold: - Avoid the desperation of families, adults and children, which arises out of the pervasive threat of homelessness and / or the stress of relocation or the stigma of personal bankruptcy and home repossession. - Alleviate the economic and social costs of repossession for both borrowers and lenders alike. The most common and most beneficial, in line with the peculiarities described above, of these schemes is the ‘mortgage to rent scheme’.  Depending on a number of qualifying criteria, which revolve around household income measures, wealth benchmarks in the form of the value of total owned real estate or other assets, but also, in certain instances, around special societal circumstances such as long-term unemployment or disability due to physical or mental impairment, the borrower voluntarily surrenders possession of the home to a third party who will immediately rent the property back to the borrower. The nuts and bolts of the scheme such as the sale price, the rental amount, the rental tenancy duration and so on, may vary from scheme to scheme.  Typically though, the sale price is at, or close to, the independently valued open market value of the property.  Moreover, the rental amount is lower than the market rental rate, or it is customized according to affordability criteria, and the tenancy agreement usually offers renewal rights or may even last for 25 years, whereas in certain instances the borrower-cum-tenant may be given a buy-back option. Under any scenario, any remaining debt following the application of the sales proceeds towards reducing the secured loan, will have to be negotiated with the financing bank to be either written off or, if this not feasible, for a new manageable repayment programme which may include a write-down portion. The scheme should normallybe under the auspices of the Cyprus Government and could well come under the umbrella of the Cyprus Land Development Corporation and /or the Housing Finance Corporation and / or a new organization to be specifically set up for this purpose. The Perceived Benefits: A Win-Win Situation As already explained there may be a sizeable part of the population which is facing the financial threat of survival and homelessness.  This part of the population is not easily identifiable for reasons already described, nor is it conducive to the conventional resolutions typically provided by banks. The proposed scheme has the potential to afford the key stakeholders the following significant benefits:

  Adapted from: “Evaluation of the Mortgage Rescue Scheme and Homeowners Mortgage Support,The Centre for Housing Policy, University of York School of the Built Environment, Heriot Watt University July 2010, Department for Communities and Local Government, UK” In conclusion, the scheme described above would go a long way towardsdefusing the explosive mortgage bomb, by offeringa mutually beneficial and sustainable resolution to that vulnerable part of society in need and to financing banks respectively. This would, in turn, restore confidence and stability in the market and would fulfil the Government’s social and communal role, aiding the weakest members of society by easing their financial burdens without the need of re-location. This would be the springboard for the reinstatement of our fellow citizens’ well-being and prosperity.  The scheme would bring back their sense of pride and their belief in life, following the long period of acute anxiety, when whatever they were earning was never enough to make ends meet and when the risk of losing their homewas ominously hanging over their heads at all times. Rennos Ioannides Financial Analyst / Insolvency Practitioner [email protected] https://www.linkedin.com/in/rennosioannides/