Finally, a truly Popular bailout! | FT Alphaville

Finally, a truly Popular bailout!

Cyprus is apparently preparing a bailout for its second biggest bank which could come in at near 10 per cent of GDP.

This is from the Cypriot press (poorly Google-translated – sorry – and now apparently removed and replaced by a much blander article; although Reuters looks like it saw the same thing so we are not going mad):

[N]ightmare scenario for the Popular Bank and the Cyprus economy is described in a document of the Ministry of Finance, is a proposal to the Cabinet to authorize the Minister of Finance of Vassos Shiarly to sign a commitment to taking responsibility for state support of the Popular Bank.

The proposal was included for discussion and approval of the agenda Thursday session of the Cabinet, which was postponed. As the document [stated], “State intervention, if necessary, will be a last choice,” and having “exhausted all possible options to raise capital through the markets.”

And that could get very unpleasant:

However, under present circumstances, and “if they fail recapitalization efforts through markets” in progress, says the paper, [that] “would mean taking a first step, potential liability by the State an amount up € 2.5 billion which would cover all the activities for strengthening the capital adequacy of the bank. ”

This should be done under strict conditions, such as the appointment of Board members from government restrictions on compensation of senior officers, removal of bonus etc.

“Additives”, as noted, “should be implemented comprehensive restructuring plan that includes closing branches, reconstruction activities of the institution, declining employment and a significant reduction in staff salaries.”

And from Reuters:

State intervention in the bank – Cyprus’s second largest – could be triggered by concerns that auditors Pricewaterhouse Coopers (PWC) could express reservations on the bank continuing to function as a viable economic entity, the authoritative daily Phileleftheros said…

Authorities were not immediately available for comment. On Monday, Shiarly told reporters that up to 1.5 billion euros may be required by one Cypriot bank, which he did not name, to recapitalise.

Phileleftheros said Cyprus theoretically could issue a bond to plug the gap, on the proviso it was not downgraded to junk by Fitch, the only remaining ratings agency which has not cut Cyprus to that category.

“Should that happen the answer would be that Cyprus officially apply to the support mechanism,» the report cited by Phileleftheros said. «Theoretically, bank capitalisation could also be with a bilateral loan of the government with a third country.”

Popular, which was previously known as Marfin Popular, posted a record 2011 full-year net loss of 2.5 billion euros on Feb. 29. It needs to raise more than 1.0 billion euros to recapitalise to a core tier 1 level of 9 percent by the end of June.

As FT Alphaville has already noted, Cyprus is in serious danger with Exotix’s Gabriel Sterne pointing out that Cypriot bank assets are equal to 835 per cent of GDP.

And the over-riding concern, says Sterne, are the Cypriot banks’ operations in Greece, which are equal to 130 per cent of Cypriot GDP, and not doing particularly well.

Sterne did a quick back of the envelope calculation: if non-performing loans equal 30 per cent of total assets, and 50  per cent of NPLs go south, then the losses would be equal to 30 per cent of GDP. Not pretty.

As we have reported already:

The multi-billion euro question for Cyprus is who will pick up the bill for any losses on Cypriot banks operations in Greece; will it be the Greek or Cypriot government. The politics, economics and legal arguments make this a terribly delicate case. The main factors are as follows:•

The Greek branches are funded largely through Greek deposits. The implications are illustrated by taking an extreme example. If (in the unlikely event) a Cypriot bank declared insolvency with no government intervention, Greek depositors would probably need to be bailed out by the Greek government. In this case Cyprus saves itself a huge increase in debt.

So there is a strong incentive for Greece to show some willingness to contribute to the rescue to forestall such a scenario, though we are not clear from where the money would come from, and if programmed Greek recapitalisation funds are available.

• We think the Icelandic precedent, however, shows, however, that it could be difficult, if not illegal, for Cypriot parent banks to cut loose their Greek branches and responsibility for their depositors, unless they also impose similar losses on Cypriot depositors. Having nationalised the insolvent Icelandic banks, the state-owned banks imposed much harsher treatment towards British and Dutch depositors in Icelandic foreign operations than they did domestic depositors, leading to legal challenges by the UK and Netherlands. In the case of Cyprus and Greece, any attempt by the Cypriot government to bailout its own depositors while imposing losses on Greek depositors would create an ugly legal quagmire.

• The political ties between Greece and Cyprus are so close that we think the incentives to reach some burden-sharing agreement are huge. Cypriot newspaper Politis reported that Finance Minister Vassos Shiarly and Central Bank Governor Athanasios Orphanides met with ECB President Mario Draghi on 17 April to promote a plan to help the Cypriot branches of Greek banks.

It looks like Popular Bank might be the first test in a story that has the potential to get really ugly.

And, as Sterne is quick to note, Cyprus is a prime candidate for a bit of tender PSI. Its “PSI-able” share of debt is over 80 per cent compared to Portugal’s 35 per cent (and shrinking).

But hey, when has recapitalising a relatively enormous banking system ever gone wrong?

Related links:
When PSI is futile (but then again, Cyprus) – FT Alphaville
Cyprus may need to bailout Popular – Reuters