A Greece-Cyprus break-up is the best option for Popular Bank

I hope that it is not already too late to say this, but shareholders of the Cyprus Popular Bank/Laiki, formerly Marfin Popular Bank, should be praying that the bank gets EU and IMF permission to split it into a “good” Cypriot bank and a “bad” Greek bank, rather than going down the more wobbly route of state ownership.
There are several reasons to suspect that state ownership will only increase the risk of sweeping problems under the carpet, leading to another capital or government debt crisis down the line.

Business will pay for a debt/GDP ratio over 80%
First, at the level of principle, the debt for share idea is just a eurozone version of printing money. By issuing bonds in order to buy Laiki shares, the government will be “borrowing from Peter” (the bank) “to pay Paul” (the same bank).
The global financial crisis has taught us that there is no such thing as free money. The people who will pay the price for this money-printing will be Cypriot businesses. Buying Laiki with what could be as much as EUR 2.2 bln in debt (see below) will raise the government debt/GDP ratio to over 80% of GDP from 71.6% of GDP in 2011. Not only will this attract unwelcome attention from the rating agencies, it will also raise annual debt-servicing costs, which will push up the budget deficit and make it even more likely that the EU will wade in and force the government to cut back on spending or raise taxes.

Will the government be able to repay a EUR 2+ bln Laiki bond?
Another problem with the bond-for-share swap is that it assumes that the government, which does not even have the funds to repay around EUR 2.4 bln falling due in 2013 without a Chinese/Russian/EU bailout, will have the money to repay the EUR 2+ bln it borrowed from Laiki in several years’ time. This, in turn, assumes that the government will run the bank well enough to see the bank’s market capitalisation rise from less than EUR 350 mln today to several billion in a few years’ time, so that it can sell its majority stake and pay back the bond with the profit.
There are reasons to doubt that the government will achieve this. Whatever your political hue, it has to be said that the current government has not exactly proven itself to spot economic problems early on and deal with them. Only under pressure from the rating agencies we all love to hate did it finally realise that we had a serious fiscal problem and start doing something to address it.

Government could stick its head in the sand (again)
But as the statements from the outgoing Central Bank Governor, Athanasios Orphanides, attest, when it comes to the banks, the government still has a tendency to put party political interests above the wider economic interests of the country. Not consulting your central bank when the implications of the Greek debt write-off for your own banks were so severe was plain silly, even if Germany would never have agreed to Orphanides’ preference for direct European Central Bank (ECB) lending to banks.
Having stuck its head in the sand with the fiscal situation and the Greek debt write-off, the risk is that the government will do this again with Laiki, a bank which itself has not had the best record of disclosure in the past.
It’s not just the 1990s-style investor relations website–much more difficult to navigate than that of Bank of Cyprus–that makes the bank look like it has yet to understand the importance of making things clear for analysts. There are also other issues. Take the press release announcing the results for the third quarter of 2011. The first bullet point declared that the bank had made a net profit, whereas the last bullet point came clean and said that “after one-off extraordinary items, the Group registered a net loss of €86.0 million”.
Things have got a little better under the new chairman, Michalis Sarris. The bank took the iniative to invite a number of economists, including most of the members of the Financial Mirror economist panel, to hear the preliminary results on February 29.

Still need more transparency at Laiki
But there is still a tendency to hide problems. In its preliminary financial statement, Laiki (and, it has to be said, Bank of Cyprus) chose to assume that the Greek debt write-off would be only 60% of nominal value. Yet the international media at the time were already talking of a write-off of up to 75%. Laiki’s excuse was that it depended on the accounting treatment, which was not yet certain. This is true. But Hellenic Bank (with a lot less Greek debt in the first place) took a more precautionary line, writing off 70%.
Then came the audited results, where you will not find a single sentence telling you exactly what the current Tier 1 or Core Tier capital ratios or levels are. In June 2011 this was all made transparent. I am not an accountant, but if the EUR 2.47 bln authorised share capital as declared by the bank is the same thing as equity capital as defined by Basel, and if the minus EUR 3.1 bln reserves in the balance sheet are the same as disclosed reserves as defined by Basel, then it looks like the Core Tier 1 ratio is not even zero.
Based on the risk weighted assets inferred from the bank’s statements and presentation for June 2011 (which admittedly have probably changed since), it implies that Laiki might have to find around EUR 2.2 bln to meet the European Banking Authority (EBA) diktat of a Core Tier 1 capital ratio of 9%, or perhaps more, if its capital is actually negative.
Another worrying development is that ever since I innocently analysed the impact of a 50% haircut on the banks for this newspaper in April 2011, which apparently upset rather a lot of bankers, it has been harder and harder to replicate the data, as more and more pieces of information have disappeared from the investor presentations and the published accounts. (Even that Q3 “profit” press release is mysteriously missing from the website). Laiki is not the only one guilty of this, but it again points to a bank or an entire banking system that has yet to come to terms with its problems.

Another skeleton in the cupboard?
The reason why this could be serious is because of another possible skeleton lurking in Laiki’s cupboard, namely its loans to Marfin Investment Group (MIG), whose chairman is the former chairman of Marfin Popular Bank, Andreas Vgenopoulos. As of December 31, the group had given advances to Marfin Investment Group Holdings amounting to EUR 670 mln. These loans are collateralised with “real estate mortgages, blocked deposits, pledging of company shares (listed and not listed in stock exchanges), invoices and [believe or or not] company cars.” The shares of Marfin Investment Group Holdings have not been pledged as collateral for these loans. Another 102 million shares and 2 million bonds–of unstated value–have “been pledged in benefit of the Group as collateral for customer facilities”.
Now, EUR 670 mln does not sound like much when total advances to customers are EUR 24.8 bln. But this loan constitutes enough of a risk to warrant a special mention because it is a concentration of loans to “a single borrower or group or related borrowers” that exceed 10% of the bank’s regulatory capital.
Then there is the rest of the EUR 11.8 bln advances to customers in Greece. After specialist advice, Laiki has already taken a goodwill impairment for Greek loans of EUR 1.2 bln for the whole year.
This is a good start, and hopefully a sign of more self-honesty to come. But one worries whether this process will continue if the bank is owned by the government. We know from the row with the central bank that MIG’s chairman is supported by Akel. Add to that the rumours that Akel has already put its own technocrats in charge of the central bank even before the new Akel-friendly governor, Panicos Demetriades, takes over and you can see why I am worried that the MIG loan and perhaps other problems with the group’s Greek operations might not be dealt with properly if the bank is owned by the state.
You might retort that Akel’s days are numbered. But to pardon the pun, don’t bank on it. For reasons that would have nothing to do with our economic health, the Democratic Party (Diko) might well install another Akel president, even if it might not be Demetris Christofias.
This is why a break-up into a bad Greek bank and a humbler Cyprus-based bank is the better option. Precisely because it will mean strict oversight by the IMF and the European Central Bank (ECB), it will involve a proper clear-out of bad Greek assets.
By hiving off the bad bank, we can draw a line under the “Greek contagion” problem , protect ourselves better from a possible Greek euro exit and hopefully improve our credit ratings. Laiki will be able to concentrate on its more profitable Cypriot business. Net interest income from Cypriot operations in 2011 rose by 29.5% according to the preliminary financial statement, compared with 12.6% for the group as a whole, according to the final statement.
This will allow the bank to lend more to Cypriot business, supporting growth in the economy, which in turn will help property prices recover and ensure that we don’t have to deal with another potential asset problem, namely a bad property-based loan book if property prices keep going south.