Hercules bad loan plan poses traps, political challenges for Greece

Greece may be facing difficult times ahead as it deals with the thorny issue of bad loans. The country's financial landscape is fast changing as banks sell off more sour debt to loan servicing companies, posing a series of political challenges for the government.

More than 30 billion euros of nonperforming loans have been sold by banks to funds in an amount that is seen exceeding the 70 billion euro mark by the end of the year.

Bad loans are not something new in Greece. In fact, they are as old as the crisis itself. However, no previous Greek government showed any determination to address the issue, as international creditors adopted a similar stance. Since the crisis arose in 2008, Greek governments kept putting the issue on the back burner by blocking efforts by lenders to recover nonperforming loans (NPLs), providing loan holders with protection.

At the same time, political parties made unrealistic promises, such as Syriza in the run-up to the 2015 elections, when it encouraged loan holders to default on their obligations. This contributed to the level of bad loans growing sharply to more than 80 billion euros in 2016, from 12.4 billion euros in 2008 - a number that reaches more than 100 billion euros, after also taking into account loans that may go sour.

The country's loan repayment culture further weakened as the threat of penalties on those who defaulted waned.

These views gradually became fixed among loan holders as only a few responded to attempts by banks to restructure their debt. Around five percent of those in default agreed to new loan terms, along with an 80 percent haircut on money owed to the lender. These customers were given a final chance to pay back the money before the loan was passed onto a fund, though many ignored it in the belief that they will ultimately not have to pay anything at all.

A tricky situation

Loan servicing companies that have acquired a large number of loans at low prices will have to not only get back the money they have invested, but also recover costs and earn a satisfactory profit. All this is leading to the end of protection offered to bad debt holders.

Forcing developments is the Hercules Asset Protection Scheme. A proposal that has been hailed as a game-changer by the government in helping banks improve the health of their balance sheets. Although the action is more related to pressure from bank supervisors, rather than the determination shown by the government, the Hercules plan has placed the government in front of political hurdles, which it may not have seen yet.

The Hercules plan will help banks get rid of bad loans by offering an incentive to private investors to buy a bond that is some 50 percent state-backed. Essentially, the government is calling on investors to pick up problem loans, assuring them that if the amounts recovered are not satisfactory, then the state will pitch in to help reach a satisfactory rate of return.

With Hercules, Greece is directly participating in an attempt to reduce bad loans and any lack of action will have a large cost and specific consequences. From now on, the funds must be allowed to implement their strategies and recover loans, in steps that will include selling assets tied to the credit. This means that all problems to relevant laws must be dealt with, such as the Katseli law, and replaced with functional and efficient bankruptcy law.

These are issues that may put pressure on the government as a large number of people will be affected, in either a big or a small way. The political tone is already being set. Syriza officials argue that the Hercules plan will result in the largest transfer of wealth seen in Greece since the bubble burst on the Athens stock market from the 1998-1999 rally. All this even though the plan has been initially put together by the former finance minister Euclid Tsakalotos under the Syriza government.

Any further foot-dragging by the government, that may include keeping the same bankruptcy laws, will cause more problems. In this case, state guarantees of 12 billion euros will be activated in a move that will weigh on public debt and limit Greece's ability to create more fiscal space that can go towards growth measures.

This, however, does not mean that no solution is in sight. The bad loan problem can be solved for loan holders, funds, lenders and the government if all sides move ahead in a well-intentioned manner.