So as I reported yesterday afternoon Cyprus has agreed on the pre-requisite for a €10bn Troika initiated bailout. I thought I’d spend a bit of time today going over some of the finer details that have come out since then.
Firstly the 8 points release in the statement by the EZ financial ministers:
1. Laiki will be resolved immediately – with full contribution of equity shareholders, bond holders and uninsured depositors – based on a decision by the Central Bank of Cyprus, using the newly adopted Bank Resolution Framework.
2. Laiki will be split into a good bank and a bad bank. The bad bank will be run down over time.
3. The good bank will be folded into Bank of Cyprus (BoC), using the Bank Resolution Framework, after having heard the Boards of Directors of BoC and Laiki. It will take 9 billion Euros of ELA with it. Only uninsured deposits in BoC will remain frozen until recapitalization has been effected, and may subsequently be subject to appropriate conditions.
4. The Governing Council of the ECB will provide liquidity to the BoC in line with applicable rules.
5. BoC will be recapitalized through a deposit/equity conversion of uninsured deposits with full contribution of equity shareholders and bond holders.
6. The conversion will be such that a capital ratio of 9 % is secured by the end of the program.
7. All insured depositors in all banks will be fully protected in accordance with the relevant EU legislation.
8. The program money (up to 10 billion Euros) will not be used to recapitalize Laiki and Bank of Cyprus.
So Laiki ( PopularBank of Cyprus ) is no more. Share, bond and unsecured depositors are wiped out and that money, €4,2bn in total, is transferred to a ‘bad’ bank in order to resolve Laiki’s debts. The secured depositors are moved to the Bank of Cyprus, along with the €9bn dollar loan through the ELA. The unsecured depositors, debt and equity holders in the Bank of Cyprus are yet to be informed exactly what their hair cut is, but given the BoC will need to be restructured to a capital ratio of 9% the haircut is believe to be well over 20%. Dmitry Rybolovlev will be most unimpressed.
The Bank of Cyprus is then expected to be restructured and downsized over the coming months, but none of the €10bn in Troika bailout funding will be used in the bank re-capitalisation. Although Cyprus is a tiny nation and in real terms the values are quite small, it shouldn’t be under-estimated how significant this operation is. Together Laiki and BoC have a balance sheet in excess of 200% of the countries GDP and this restructuring will have serious flow-on effects to the Cypriot economy, not withstanding the further austerity demands from the Troika.
As we’ve seen in Spain there are significant downside risks associated with bank de-leveraging, including both the demand and supply of credit along with associated asset price falls. Cypriot banks, not just the big two, have large exposure to domestic housing market which is expected to see significant losses over the next 12-24 months. On top of that the financial crisis is expected to put further strain on the domestic economy through rising unemployment and loss of business activity.
Again, as we’ve seen in Spain, the flow-on effects of this process create a rise in bad debts through the entire banking system, not just the troubled banks, and you can expected to see this start to de-stabilise other regional banks over the coming months, even without the issue of deposit outflows. On that topic, as I discussed earlier in the week, the Cypriot government is yet to enforce the capital control bill that was passed last Friday.
In short, even with the bailout in place and the ECB again providing liquidity support, there is still a significant chance of Cyprus requiring additional funding in the future and the risk the sovereign default remains high.
This little episode has also created some political strain for Cyprus outside the EU. Russians, who reportedly have nearly €20bn in Cypriot banks, are going to see significant losses from this bank restructure and the chances of retaliation from Moscow in some form or another against the EU are not out of the question. Secondly Turkey has made it very clear that it considers itself a part owner in Cyprus’ gas reserves which puts any further plans to leverage those national resources in the firing line of Ankara. Certainly these two players are something to watch as this unfolds further.
In news outside of Cyprus, S&P just took another swipe at Bankia with a downgrade to BB-, claiming its re-capitalisation plans aren’t going as well as expected even after a massive transfer of bad debts to Sareb, Spain’s own “bad bank”. In related news the Spanish Budget Ministry will publish budget figures for February tomorrow showing the Spanish governments revenue shortfalls. I’ll attempt to cover the announcements tomorrow.