By Joseph E Sarachek
LET’S say you’re in the back room of the talks that took place over the weekend between the Central Bank of Cyprus (CBC), the finance ministry and the troika (the European Central bank, the European Commission, the International Monetary Fund ) relating to the current banking crisis in Cyprus, and most specifically the haircut to be taken by Bank of Cyprus depositors. You can imagine the conversation went something like this:
Panicos Demetriades, CBC Governor: “We need to make sure that the 47.5% haircut on depositors’ accounts provides the Bank of Cyprus with enough liquidity to last for three years at which time we hope that our natural gas reserves will turn the economy around.”
Harris Georgiades, Minister of Finance: “But we have hotels, food manufacturers and shipping companies that need immediate access to cash; what’s the lowest haircut we can give them and when can we release the balance of their funds?”
Christos Sorotos, CEO of Bank of Cyprus: “Look, I’ve got eleven non-performing loans that amount to almost €1 billion, I have no idea what the underlying assets are worth, maybe twenty-five cents on the dollars, I have €5 billion in capital that left Cyprus in June, I need all the capital I can get and I’m sorry if Russian depositors aren’t happy about losing their deposits but I can’t let them take cash out of the bank now.”
Mario Draghi, President of the European Central Bank: “We understand that you want to give people access to their cash but we aren’t going to give you any more than €10 billion to solve your banking crisis and if you spend it all now like one of your neighboring countries did with our loan, you will be taken over by European Union authorities; why don’t you start privatising some of your country’s assets and recapitalise your banking system?”
The Central Bank said in a statement released jointly with the finance ministry that 12% of the outstanding balance in depositor funds which were frozen under the bail-in arrangement would be unblocked. The remaining frozen funds would be equally divided and placed in 6-, 9- and 12-month time deposits with the bank retaining the right to renew the arrangement once more. Interest paid on the time deposits would be higher than the going rates.
This would make sense because if depositors were given immediate access to their accounts, there would certainly be a run on the banks and the June statistics would appear paltry in comparison.
There is a solution to the banking crisis. There is an active secondary market in most distressed assets, including bank deposits, but Cyprus officials and the troika are resisting giving investors access to it. Some very large international funds have expressed an interest in these depositors account except the CBC will not allow for the conveyance of accounts. The reason they say is because they want to preclude transfer of funds outside of the country. There may be another reason; they don’t want foreigners to control the equity in the Bank of Cyprus.
Current market bids for Bank of Cyprus depositors’ accounts are in the low 40’s, or about a 20% discount to the value of the expected cash to be distributed. The value of the future equity in the Bank of Cyprus appears to be negligible.
The current discussion is that BoC will be broken into two banks, a good bank operating a retail business and a bad bank holding the non-performing loan portfolio. The reality is the equity in the good bank will be low because without cash to make new loans it is not a compelling investment thesis. Equally disconcerting is that the value in the bad bank is low because nobody knows the worth of the non-performing loan portfolio. History tells us that the underlying real estate collateral will require new capital to turn it around, and that’s something BoC doesn’t have. So, the likely result is that the bad bank will have to sell collateral at fire sale prices. The bottom line is Cyprus should allow for the free transfer of depositors interests because it is in the best interest of depositors and the free market.
By allowing for an active secondary market in depositors accounts, the market will value the portfolios of Bank of Cyprus and depositors will receive a flow of funds. Those dollars can be used to fuel the local economy by allowing people to buy goods and services, and meet their obligations.
The secondary market in distressed assets is well-established. In the recent global bankruptcy and receiverships of MF Global, where there were over 26,000 customers, many account holders seeking liquidity quickly sold out and utilised those proceeds for a variety of things, including reinvesting in the futures marketplace opportunities. Although there are reasons that the troika may have for controlling the ownership composition of the Cyprus banks, the reality is the underlying value of each institutions loan portfolio will be the driving force in determining value. Accordingly, it is for this reason, restrictions on secondary trading of accounts should be lifted and the market should be permitted to provide liquidity.
Joseph E. Sarachek is Managing Director-Special Situations and Bankruptcy Opportunities at the US-based CRT Special Investments LLC