Home > Articles > Cypriot Bank Exposure to the Greek Debt Crisis

Cypriot Bank Exposure to the Greek Debt Crisis

30 December 2011

 

Cyprus and its three main banks were downgraded in November 2011 by the three major credit ratings agencies, in no small part due to their exposure to the Greek debt crisis as well as the declining situation in Cyprus. This downgrade was followed by the publication of the banking sector’s January - September 2011 financial results, which revealed a write-down of nearly EUR 1.5 billion of Greek government bonds (GGB) by the Bank of Cyprus, Marfin Laiki and Hellenic Bank, as well as rising impairments due to non-performing loans (NPL) in the private sector.

The downgrade can be summarised as stemming from a declining macroeconomic and fiscal situation in Cyprus itself, as well as Cypriot exposure to Greece:

a.  Cypriot banks are exposed to Greek government bonds (GGB), which must be written down by approximately 50% of their value in line with the private sector involvement (PSI) agreement of October 26th, 2011.

b. Cypriot banks are exposed to non-performing Greek private sector loans (Greek NPL). According to Moody’s, up to 20% of all Greek private sector loans may be classified as non-performing in the next 18 months

c. Cypriot banks are also increasingly exposed to non-performing Cypriot private sector loans (Cypriot NPL), which have been hard-hit by the declining situation in the real Cypriot economy.

A further potential exposure is seen in the uncertainty surrounding the second Greek bail-out package, which is seen as essential to avoiding a hard default by Greece. A little-known fact of the first bail-out is that any country encountering economic difficulties, expressed in a higher bond yield, may opt out of further refinancing for Greece. With Italian and Spanish bond prices having breached 7% in December 2011, it is increasingly possible that neither these countries nor France will be in a position to raise money for Greece on the open market. This could yet lead to a potentially catastrophic situation.

This article explores the actual exposure of the Cypriot banking system to Greece, and reviews the next steps in the Greek and wider European debt crises.

Loans-to-Deposits

Total deposits (including foreign deposits) in the three main banks amounted to EUR 32.953 bln for the Bank of Cyprus, EUR 25.509 bln for Marfin Laiki and EUR 7.370 bln for Hellenic, or a total of EUR 62.023 billion. Cyprus has accumulated the largest share of deposits, at EUR 33.45 bln, or 191.6 % of gross domestic product (GDP), based on  the 2010 GDP of EUR 17.46 bln.[1]

Deposits, 9M 2011

Bank of Cyprus

Marfin Laiki(1)

Hellenic

Total

Cyprus

19.695

7.0

6.755

33.45

Greece

9.791

7.5

0.615

17.906

Other

3.467

7.2

0

10.667

Total

32.953

21.7

7.370

62.023

 

 

 

 

 

Assets (Loans) 9M 2011

Bank of Cyprus

Marfin Laiki

Hellenic

Total

Cyprus

14.719

10.9

4.687

30.306

Greece

10.158

12.1

0.970

23.228

Other

4.902

3.8

0

8.702

Total

29.779

26.8

5.657

62.236

 

 

 

 

 

Loan:Deposit Ratio, 9M 2011

Bank of Cyprus

Marfin Laiki

Hellenic

Total

Cyprus

75%

156%

69%

300%

Greece

104%

161%

158%

423%

Other (2)

141%

53%

 

 

Total

90%

124%

77%

291%

(1)    The Marfin Laiki data refer to 3rd Quarter 2011; Bank of Cyprus and Hellenic Bank data refer to consolidated 9 month 2011 data.

(2)    The “Other” category in Marfin Laiki bank refers to loans and deposits made to business segments, not regions. We cannot distribute this number accurately due to a lack of detail in the Marfin Laiki financial statement.

Against this, the three banks granted a total of EUR 62.236 billion in loans, of which again the greatest share was in Cyprus, at EUR 30.306 bln.

The global loan-to-deposit ratios of Bank of Cyprus and Hellenic are largely satisfactory. Marfin shows higher exposure, which is in part offset by its business mix. However, Marfin has EUR 7.2 billion on deposit from business customers and shipping: this may make for volatility in future operations should a loss of business confidence lead to capital flight.

Greek Government Bond (GGB) Impairment

The major factor affecting bank stability and operations in 2011 has been the impairment and write-down of Greek Government Bonds (GGB). Marfin Laiki has the largest nominal value of GGB on its books, at EUR 3.084 bln, followed by the Bank of Cyprus with EUR 2.088 bln. Hellenic had a relatively minor amount of EUR 110 mln

GGB, 9M 2011

Bank of Cyprus

Marfin Laiki

Hellenic

Total

GGB Nominal Value

2.088

3.084

0.110

5.282

GGB Impairment

-1.046

-0.216

-0.055

-1.317

Write-Down (Net of Revaluation)*

-50%

21%

-50%

-24.93%

* Caveats to Marfin Laiki: Write down as of QIII 2011, not including 50% PSI agreed on October 26th

 

 

 

 

Of the three banks, Bank of Cyprus and Hellenic Bank had proceeded with a 50% write-down of their GGB nominal value in the 9 month 2011 statements. This lead to a write-down of EUR 1.046 bln for BOC. Marfin Laiki wrote down 21% of its GGB stock in the third quarter, but at the time of its filing of 9 month data, had not proceeded with a full write-down to 50% in line with the October 26th Eurozone agreement on Greek PSI.

Of the three banks, it is assumed that BOC and Hellenic are therefore largely out of the woods as regards GGB write-downs, while Marfin will likely take the hit in December 2011.

Non-Performing Loans

The second major risk on the books of Cypriot banks are impaired and non-performing loans (NPL). The technical definition used to define an NPL is a loan which has not been serviced in 3 months, and which does not have adequate collateral to guarantee it. This definition is problematic, for reasons which will be discussed shortly.

Based on third-quarter, 9 month filings for 2011, the Bank of Cyprus claimed total impaired loans of EUR 1.038 bln, of which provisions had been made to write-down EUR 0.295 bln. Marfin Laiki classified EUR 1.077 bln as impaired, of which EUR 0.103 bln where written down. Hellenic Bank was more aggressive, with an NPL stock of EUR 0.679 bln, of which EUR 0.101 bln was written down.

NPL, 9M 2011

Bank of Cyprus

Marfin Laiki

Hellenic

NPL Stock*

-1.038

-1.077

-0.679

NPL Provisions (Write-down)

-0.295

-0.103

-0.101

NPL %

8.60%

8.7%

13.52%%

The risk which is difficult to quantify in this data deals with the actual criteria used to define specific loans as non-performing or not. Most loans have been guaranteed with collateral such as real estate, which is now worth a fraction of its former value, and which is impossible to liquidate in case of repossession or foreclosure. Furthermore, in both Greece and Cyprus, debtors are protected by law against some types of foreclosure. For instance, a family living in a home in Greece cannot be evicted, and the property cannot be foreclosed, if this is the family’s primary residence, and if the total debts are below EUR 100,000.

And finally, it is socially extremely difficult to Cypriot banks to foreclose in Cyprus. The small size of the country and extensive family ties make it extremely difficult to implement such measures.

For these reasons, the definition of NPL should not be taken at face value. Most external analysts, such as Moody’s or Blackrock, place the NPL rate in Greece and Cyprus at far higher rates, between 15-25%. If so, this presents an important risk factor, and is one of the main reasons behind the rating agency downgrade of the Cypriot banking system

EBA Stress Tests and Cypriot Bank Recapitalisation

In mid-2011, the European Banking Association (EBA) implemented a second stress test on the European banking system. In Cyprus, the stress test covered the Bank of Cyprus and Marfin Laiki. As a result of this stress test, the two banks agreed to recapitalise with the objective of reaching core tier 1 capital of 9% by 2012.

The Bank of Cyprus implemented a recapitalisation in 2011, bringing core tier 1 capital to EUR 2.9 billion (after the GGB write-down), for a ratio of 9.6%. Marfin Laiki has a core tier 1 rate of 8.2% before its full 50% GGB write-down, and has stated that it needs an estimated additional capital buffer of EUR 2.116 bln.

Core Tier 1 Capital, 9M 2011

Bank of Cyprus

Marfin Laiki

Hellenic

Core Tier 1, EUR bln

2.9

2.3

0.462

Core Tier 1, %*

9.60%

8.20%

10%

GGB Impairment : Core Tier 1

 

 

 

NPL Impairment : Core Tier 1

 

 

 

* based on quarterly reports, not primary calculation

 

 

 

The GGB and NPL impairments as a ratio of core tier 1 capital are indicative of the danger seen by credit rating agencies to the Cypriot banking system. While Bank of Cyprus has probably emerged from the GGB issue (depending on a second bail out, discussed below),  and while Hellenic does not have significant exposure, Marfin Laiki is exposed to both a further GGB write-down as well as to a rising NPL situation.

Risks in the Second Greek Bailout II

On October 26th, the Eurozone partners, the International Monetary Fund (IMF) and the European Central Bank  (ECB) agreed to a second bail-out package for Greece worth EUR 130 billion. This includes EUR 30 bln to facilitate the 50% PSI deal; EUR 30 bln to recapitalise Greek banks, and EUR 70 bln for Greek sovereign debt refinancing and deficit spending.

This deal is contingent on a number of factors, including:

a.  A completed private sector involvement (PSI) deal for a 50% voluntary write-down (haircut) on Greek government bonds. Negotiations remained deadlocked in early December 2011 as this article went to press.

b. An agreement in national parliaments: each Eurozone country supporting the second bail-out will have to pass a second agreement to extend capital guarantees to Greece and subsequently raising the money.

This second point is now in doubt. Given that Italian and Spanish bond rates have risen above 6% in early December 2011, it is difficult to see how these countries can borrow money at 6% and lend to Greece at roughly 3.5%. This is a value-destroying proposition quite apart from the financial crisis currently affecting the markets.

The Eurozone itself has major bond refinancing due in 2012. Bloomberg estimates that EUR 1.1 trillion in Eurozone bonds need to be refinanced in 2012. Der Spiegel provided an estimate that France, Italy and Spain alone face re-financing of EUR 425 billion between December 2011-April 2012 alone.

Country

Dec

Jan

Feb

Mar

Apr

Total

France

37.1

52.9

35.9

17.4

34.4

177.7

Italy

22.5

15.6

53.1

44.2

44.5

179.9

Spain

12.2

9.2

14.5

8.8

22.7

67.4

Total

71.8

77.7

103.5

70.4

101.6

425

Der Spiegel

It is therefore clear that even a 50% write-down of Greek government bonds may not be possible, given the European financial crisis which is rapidly emerging. While this author believes a solution will be found, the risk of a systemic financial default and panic have risen to unprecedented heights, last seen in the September 2008 collapse of Lehman Brothers.

Evident Risks and Risk Analysis

Cyprus finds itself in the eye of a short-term financial shock, which may be alleviated over the medium term (e.g. over 5-7 years) by natural resources discoveries.

In the short term, the government needs to undertake further austerity measures, and has also implemented revenue-generation measures which will negatively impact Cyprus’ status as an international business centre. The latter include the decision to raise value-added tax (VAT) as well as to levy a one-time fee of EUR 350 per company count among as disincentives, and may contribute to a consolidation of the number of international companies (registrations) in Cyprus.

In the medium term, Cyprus will benefit from natural gas and oil discovered in its Exclusive Economic Zone. However, these will take time to develop properly, and a route for monetisation via exports has still not been agreed.

The dangers to Cyprus have therefore risen significantly since the last risk analysis done by this author, in September 2011. The worsening European financial crisis, the Eurozone decision to force a 50% PSI on Greek sovereign debt in October, the rising non-performing loans, and the disappointing progress in the real economy make for a potentially dangerous development.

The only upside we see in the current situation is the relative small financial value at risk. Cyprus’ public debt is low at 61% of GDP, while its GDP itself is only EUR 17.5 bln. This means that even if Cyprus had to turn to the European Financial Stability Facility (EFSF) or the IMF for funding, the relatively low amounts needed mean that a bail-out would be easy to structure.

The same applies to Cypriot bank funding. Even assuming a worse-case scenario of a EUR 10 billion recapitalisation of the banking system to address a drastic NPL situation and the potential failure of the second Greek bailout, this amount would be relatively easy to access (in theory) from the European Central Bank, the IMF or the EFSF.

To conclude: although the situation is becoming more serious, Cyprus still retains a strong starting point, both in terms of macroeconomic fundamentals, as well as due to its service-based economy. The relative poor performance of Marfin Laiki in particular reflects its exposure to Greece and the massive economic slump occuring in that country.

Whether Cyprus will remain financially solvent will depend to a large extent on the ability of its government and wider political system to address structural weaknesses while retaining business competitiveness. While the first results are visible, it is clear that political fragmentation and divisiveness, as well as a stagnant party system and public sector, create significant barriers to further achievement. It is likely that these systemic weaknesses will continue into 2012, making Cyprus’ exposure to exogenous economic events even more pronounced.

 

(c) Philip Ammerman, 2011

Navigator Consulting Group

www.navigator-consulting.com



[1] The share of Cyprus deposits is in fact larger than what is reported here due to the fact that the “Other” category in the Marfin Laiki accounts refers to loans and deposits from international business customers and shipping companies.


Back to Articles