27 February 2013

Graham Bishop: Italy and Cyprus

CONFIDENTIAL

·       Cyprus: was at a session recently with a senior Cypriot official:

o   Target is for an MOU by end March

o   Size of banks: there seemed agreement with an independent commentator that the banks’ balance sheets amounted to 7x GDP (The Commission’s 2012 `in-depth analysis’ put the figure at 814% of GDP. 100% of GDP is quite a disturbing difference on such a basic measure of potential risk.)

o   Greek PSI hit is €4.5 billon/25% of GDP – well known

o   Junior debt holders are €1.7 billion (so a full haircut will not make much difference)

o   Pimco has taken account of other loans in Greece but he responded to my question about loans to Russia and said not analysed!!

o   Russian deposits are about 7-14% of total deposits (so on my calculation, €9-17 bn)

o   Just back from Russia and he feels they will agree to lengthen maturity of their loan

·       GPB observations:

o   He seemed to agree with my assessment that the €10 billion capital need looked surprisingly small after deducting the Greek PSI effects and considering the potential magnitude of Russian problem and the problems of mortgages lacking title deeds. (The Commission 2012 in-depth study put the lack of title deeds at around 120-130,000 properties. (This seems to be equivalent to all transactions since 2004…))

o   Cyprus was the largest foreign direct investor in Russia - at 22% in 2011 = €10 billion for that year alone. It has been amongst the largest for several years and OECD reports the inflows to be $262 billion in 2007-11. At say 20%, that would give a cumulative Cypriot stock of an astonishing €40 billion

o   It is thought that a lot of the Russian inflows are via back-to-back deposits versus loans. But total loans by Cypriot banks to non-financial corporations are only €33 billion and local press reports say 40% of that is to local property companies. So it is just about plausible that say €17 billion (100% of GDP) of deposits has been lent back to Russia.

o   So if there were depositor haircuts, how much of the loans would be repaid???

o   At the other extreme, if the banks were allowed to fail  and the standard rights (under English law!) of set-off were applied???

o   Italian result: there could only have been one worse result – outright Berlusconi win! But got to wait to see how the rest of the cards fall

o   However, this raises the stakes on the Cyprus situation as it is clear that markets are trying to establish a system of precedents

o   (GPB thought: could there be a sharp enough distinction in the next few weeks between bad deposits in Cyprus and good deposits in Italy??? Difficult to be sure in advance)

One conclusion: the Italian election result may well have increased the chances of Cyprus getting a first round bailout to avoid any contagion to Italy at such a delicate time. So I am changing my view about the chances of Cyprus getting an initial bailout to more than 50:50. But as the `inspectors’ delve ever deeper, the barrels of worms could turn out to change the picture.

© Graham Bishop