1. Europe Cyprus
4 December 2012
Macro
Data Flash (Euroland) Economics
Research Team
Cyprus bailout - nearing a deal Peter Sidorov
Global Markets Research
Economist
(+44) 0 20754-70132
peter.sidorov@db.com
On Monday (3 December) the Eurogroup welcomed the steps that
Cyprus has taken towards agreeing on an adjustment programme. This
came after earlier in the day the FT leaked the draft MoU between
Cyprus and the Troika.
While a deal is yet to be finalised, the loan programme could total more
than EUR 17bn until the end of 2015. At close to 100% of GDP, this
would be larger in relative size than previous bailouts – Irish, Portuguese
and first Greek programmes - which were around 50% of GDP.
The draft MoU pencils in up to EUR 10bn for bank recapitalisation.
Banks’ capital needs should become clearer following the interim results
of the Cypriot banks’ due diligence, which are expected this Friday (7
December). The euro area finance ministers will then discuss the Cyprus
bailout at the special Eurogroup meeting on 13 December. Should a deal
be approved at the meeting, Cyprus could receive the first tranche in
late January.
Drawn-out negotiations
Monday (3 December) saw a busy day in the news for Cyprus with the FT leaking
the draft MoU between Cyprus and the Troika and the euro area finance ministers
discussing the assistance programme for the country. These latest developments
come as the negotiations on the Cyprus bailout, after months of slow progress,
have moved towards a deal in the last two weeks.
It has now been over five months since the Cypriot government asked for financial
assistance from the Eurogroup and the IMF in late June after being faced with
having to fund EUR 1.8bn in bank recapitalisation costs for the country’s second
largest lender. Following the request, the Troika replied with its draft proposals in
late July. Cyprus had been somewhat slow in formulating their response. In early
October the Cypriot President Demetris Christofias went so far as to say that he
would not sign a bailout under the terms offered, particularly objecting to
privatization of profitable state-owned enterprises (SOEs) and the abolition the
inflation cost of living adjustment of public wages.
Cypriot officials submitted counterproposals to the Troika’s draft proposals in late
October, with the Troika returning to the island on 8 November. On Friday 30
November as the Cypriot Ministry of Finance presented the details of the 2013
budget and the 2013-15 financial framework, which incorporated the fiscal
measures envisaged in the draft MoU.
The size of the bailout
While the leaked draft MoU does not spell out the size of bailout, this could in
Economics
our view total over EUR 17bn, close to 100% of GDP (EUR 17.8bn in 2011)
based on the draft MoU and our estimates:
Deutsche Bank AG/London
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 072/04/2012.
2. 4 December 2012 Data Flash (Euroland)
Up to EUR 10bn (56% of GDP) for bank recapitalisation is
pencilled in under the draft MoU. This would include the EUR 1.8bn
recapitalisation of Cyprus Popular Bank, which was done through the
issuance of a 1-year zero coupon bond to the bank. The cost of bank
bailout would bring the country’s debt ratio well above 100% - the
debt ratio is expected by the government to reach 76% of GDP
before any bank bailout costs (86% if we include the existing EUR
1.8bn recapitalisation above). The likely size of the bank capital needs
should become clearer with the preliminary Cypriot banks’ due
diligence results due this Friday (7 December) according to the draft
MoU.
We estimate that around EUR 5.6bn may be required to
refinance government debt through to the end of 2015. This
includes EUR 820m of bills outstanding as of mid-November, and a
further EUR 2.3bn of redemptions in 2013 and EUR 2.5bn in 2014-15.
Financing the budget deficit during the programme could
require between EUR 1.5bn-2bn based on our back of the
envelope estimate 1 . The draft MoU only presents an overall fiscal
deficit target for 2012 (at EUR 1.04bn, 5.8% of GDP), with primary
balance targets for 2013-15. This is likely as the interest expense
figure will be sensitive to the final size if the bank recapitalisation.
The interest rate on the loans is also still to be agreed.
If the assistance package were to total EUR 17bn (96% of GDP), it would be much
larger, as a proportion of GDP, than the Irish (EUR 85bn, 53% of GDP), Portuguese
(EUR 78bn, 45%) and the first Greek (EUR 110bn, 48% of GDP) programmes.
Details so far, and what is missing
In addition to the bank recapitalisation of up to EUR 10bn, with the size to be
finalised following the due diligence results, the draft agreement envisages
widespread changes to the regulation and supervision of banks. This includes
stricter classification of non-performing loans, reduction of the timeline for seizure
of collateral on NPLs, bringing the cooperative banks under the supervision of the
central bank and setting up an asset management company (AMC) to segregate
NPLs and non-core assets i.e. a bad bank.
The one aspect of bank reform that does not appear to be to be explicitly
addressed in the draft MoU is mitigation of the risks posed to Cypriot banks
by exposure to Greece going forward. The Greek loan book is arguably the
biggest risk facing the Cypriot banking sector – the country’s three largest banks
had Greek loan portfolios, net of provisions, totalling EUR 18.9bn (equivalent to
106% of Cyprus GDP) as of 30 September 2012. A credible recapitalisation
requires a strategy to reduce the risks posed by this exposure in the event of a
further deterioration of the banks’ Greek operations. The draft MoU does state that
‘an AMC or other vehicles will be able to acquire loans and other claims, including
foreign exposure from credit institutions in Cyprus that have received or will
1
This estimate based on the cumulative EUR 540m primary surplus over 2013-15 agreed in the draft
MoU), our estimate of the fiscal deficit for Q4 2012 that is yet to be funded (c. EUR 300m) and an
estimate of future interest expense based on estimated debt levels before further bank bailout costs,
estimated at c. EUR 15bn by the end of 2012, multiplied by the current average interest rate paid by
Cyprus (4.5%). The estimate of interest rate expense is uncertain - the level of debt post bank bailout will
be higher but the average interest rate will decrease as existing funding is replaced by the programme
loans - the Finance Minister Vassos Shiarly has suggested that an interest rate of 2.5% on the bailout
loans is being discussed.
Page 2 Deutsche Bank AG/London
3. 4 December 2012 Data Flash (Euroland)
receive state aid’. This suggests that a spinoff of banks’ Greek operations into a
bad bank could be on the cards. However, we await more details as to how the
risks posed by the Greek loan books will be mitigated.
On the fiscal side, close to EUR 1.3bn (7.25pp of GDP) of fiscal consolidation
measures is planned by end-2015, with 0.25pp of GDP adjustment in the
remainder of 2012, 2.75pp in 2013, 1.75pp in 2014, 1.5pp in 2015 and 1pp in
2016. This would bring Cyprus to a 4% primary surplus in 2016. Around 5.5pp
of GDP worth of measures have been set out in the 2013-15 medium term
financial framework, with another 2pp yet to be determined.
The draft MoU does not spell out the overall fiscal targets, only those for the
primary fiscal balance, and is relatively silent on debt sustainability. This is likely
due to the uncertainty over the size of the banking recapitalisation, to which the
public debt and interest expenditure figures will be sensitive.
Ensuring debt sustainability will be a crucial element for a finalised deal. The draft
MoU suggests that privatisations may be used to plug any gap, although no details
are provided – ‘If necessary to restore debt sustainability, the Cyprus authorities
will consider a privatisation programme for state-owned and semi-public
companies’. Debt sustainability considerations may also be important in
determining the interest rate on the bailout loans.
That said, in the long-run it is Cyprus’s gas reserves that will likely be key to
addressing the country’s high debt in the long-run. The plan is to establish a
resource fund which would manage revenues from gas exploration, although
these are expected no earlier than 2018, according to previous reports.
Next steps
The preliminary bank due diligence results, expected this Friday (7 December), will
be crucial to determining the size of programme. Should the size of a bank bailout
put debt sustainability in doubt, finalising a deal could become challenging as
additional contentious measures such as privatisation of SOEs and the use of gas
revenues, may be required.
The fiscal side of the bailout has now been agreed with the measures presented
last Friday by the Finance Ministry. The government is expected to submit a
number of bills relating to the MoU to parliament, with the aim of approving them
in time for the 13 December Eurogroup meeting. Were this meeting to approve
the Cyprus package, the country could receive the first bailout cash in late January
2013 after necessary euro area parliamentary approvals and the final results of the
bank due diligence, which are expected in mid-January.
Deutsche Bank AG/London Page 3
4. 4 December 2012 Data Flash (Euroland)
Appendix 1
Important Disclosures
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Analyst Certification
The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition, the
undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in
this report. Peter Sidorov
Page 4 Deutsche Bank AG/London
5. 4 December 2012 Data Flash (Euroland)
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