Cyprus: Too small to matter?

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Cyprus: Too small to matter?

We now know what the European establishment agreed at the weekend with the Cypriot government in return for €10 billion of emergency assistance. Bank depositors with more than €100,000 on deposit are now fair game across the eurozone as are all creditors, even senior bondholders.

By Mark Mcfarland (CIO WEEKLY REVIEW)

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Published: Sun 31 Mar 2013, 10:06 PM

Last updated: Sat 4 Apr 2015, 9:14 AM

Markets have shrugged off Cyprus as too small to matter but the implication of pushing taxpayers down the list of those called upon for bailout funding is that capital is even more likely to seek and move quickly towards safe-haven assets in times of distress.

And there will be! Without fiscal and banking unions in place, Europe has become more potentially volatile this March. It pays to watch the unfolding events on the island and the relationship between Moscow, Nicosia, Ankara and Brussels. This isn’t over. You can see that in equity market returns over the last five days. While global commodities are higher, MSCI Europe and its Eastern Europe equivalent are lower than this time last week.

In terms of differences between the plan of March 15 and now, there are two. The first is that bank depositors will no longer be subject to a levy on their assets as the banks have been separated into two groups, those that need official restructuring and those that do not. Only depositors with money in banks facing planned restructuring are at risk of losses. The second implication is that there will be a sharing of pain between all remaining stakeholders, including senior bondholders. That creditors are no longer ring-fenced is good although it will make future Euro-scares even more volatile as bondholders could reasonably expect to be repaid during the recent crises in mainland Europe. The third difference is that capital controls have been imposed on the country’s banking system, thus creating the conditions that Cypriots would experience if the country did leave the eurozone, but without the pressure-relieving luxury of currency devaluation. This is tough love indeed.

The details of Europe’s latest plan are complex, but important for investors as they have emerged in drips over the last few days with much gossip rather than fact. The second-largest bank in Cyprus, Laiki, is officially bust. Deposits in excess of €100,000 will be transferred to a bad bank that will be run down over time. Quite what the haircut on these deposits will be depends on how bad the growth outlook becomes. The average recovery rate in banking crises over the last 15 years has tended to be 30-50 per cent if memory serves me right but there is talk of 60-70 per cent in the market.

The imposition of capital controls must surely take the estimate of losses above 40 per cent of face value. Also, the closure of Laiki will destroy all stakeholder interests, including those of bondholders, with one exception. Those depositors with less than €100,000 on account will have their funds transferred to Bank of Cyprus and their positions 100 per cent guaranteed under the EU’s deposit insurance legislation.

Only the sovereign will be eligible for Europe’s €10 billion of emergency funding and Bank of Cyprus will have to raise its capital ratio to nine per cent to be able to re-open. The €9 billion of ECB emergency funding to Laiki, that brought accusations of secret bailouts last year, will be transferred to Bank of Cyprus.

In the Eurogroup’s own words, ‘The Bank of Cyprus will be recapitalised through a conversion of uninsured deposits (above €100,000) to equity and with the full contribution of equity shareholders and bondholders’. Quite what the value of that equity will be is difficult to divine. Then there is the issue of administrative measures as they are being called.

The writer is chief investment strategist at Private Banking, Emirates NBD. Views expressed by the author are his own and do not reflect the newspaper’s policy

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