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Investors re-engage as Bank of Cyprus comes out of the woods

Article - February 27, 2016

Cyprus’ largest bank, which sold one billion euros worth of seven-year bonds in April, now plans to raise a further 10 billion from 10-year bonds and float on the London Stock Exchange


Irish banker John Hourican had his work cut out for him travelling around the world to deliver essentially the same message to potential investors: “No, no. Cyprus is not Greece – nothing like it. In Cyprus, the government had the conviction to recover, and was willing to make hard and immediate choices. Cyprus had a fiscal legislative and reform agenda that was consistent with an actual desire to recover, rather than just talk about recovery.”

It’s a message that is beginning to resonate as a flat-lined financial system staggers back to life and foreign direct investment trickles back into the country. As the macro indicators revived, the Bank of Cyprus, where Mr Hourican has served as CEO for the past two years, became one of only two local lenders to pass EU-imposed stress tests. “I think the bank is coming very nicely out of the woods and is out of the danger zone,” Mr Hourican said at the time. “In Cyprus, people understand that prosperity is built on the foundations of austerity.”   

Signs of recovery were confirmed this past April, when investors acquired one billion euros worth of seven-year bonds, a placement equivalent to roughly half of the demand. It allowed the Bank of Cyprus to repay part of its allocation from the 10 billion euros (£8.06 billion) bailout from the European Commission, the IMF and the European Central Bank, and prompted the government to lift all remaining restrictions on capital leaving the country.

Plans now are to raise 10 billion euros in 10-year bonds, which is not bad for a county that Moody’s downgraded just four years earlier to two notches above junk.

Cyprus needs exposure on the international capital markets to attract major investment flows, and Mr Hourican expects that when housecleaning is completed in April 2016, the bank’s owners will seek a float on the London Stock Exchange. “It is obvious that this bank is big enough and investible enough for us to want to put it on a proper exchange,” he told the London financial press.

“The confidence was so badly interrupted that restoring it was going to be quite a challenge. I wasn’t sure we could, but it has been really pleasing to see people start to re-engage with the bank and recognise what we do”

The Bank of Cyprus was already the island’s largest when it was earmarked for restructuring by incorporating salvageable components of the Cyprus Popular Bank (also known as Laiki; in its time, the country’s second largest) as part of a recapitalisation process carried out under EU supervision. Operations in Romania, Russia, Greece and elsewhere were hived off the balance sheet and high net worth clients saw 47.5 percent of their uninsured deposits over 100,000 euros converted into equity in the bank. Mr Hourican raised another billion from investors, including billionaire investor Wilbur Ross, in order to reach the 15 percent common equity needed to pass the ECB stress test.

“We have been deleveraging our balance sheet by 6 percent of GDP every quarter, which is enormous,” says Mr Hourican. “That means doing all of the things you naturally do in a recession environment. We have combined the two largest banks on the island, and we have shared 35 percent of the cost, 25 percent of the staff, combined IT platforms, and taken 70 of the 200 branches. Basically, we have been busy, busy doing normal M&A corporate finance stuff, which, if you do it as a job, you get used to it, but it feels like a shock to any institution.”

The upshot is that the Bank of Cyprus announced after-tax profits of €60 million for the first six months of 2015. By way of explanation, Mr Hourican cites improving credit risk management and optimising risk weighted assets, deleveraging and reducing the number of problem loans. That last item is what damaged Cyprus’ banks arguably even more than their exposure to unredeemable Greek bonds.

Damaged may be too mild a term to characterise the results of the mountain of underperforming loans that some experts say will eventually have to be written off as irrecoverable. Obtaining credit was a simple matter. Cyprus is not that huge a place; everybody knows everybody, families develop ties to other families, merge and overlap. With a stock exchange serving mainly as a platform for short-term speculation, banks were providing the bulk of long-term financing and mortgage lending to families and companies, especially in the briefly booming construction sector. Loans were approved on the basis of collateral, rather than reasonably verifiable prospects of on-time repayment.

The result: on average, approximately half of all the outstanding loans in the portfolios of Cyprus’ banks are dead in the water. For the Bank of Cyprus, announcing its second quarter results, the figure is 53 percent of its gross lending, or 12.6 million euros.

Cypriot President Nicos Anastasiades is perfectly aware of the situation, and says it is in the process of being solved. “Banks have been restructured and recapitalised, most importantly through private capital, and are refocusing their operations with a prudent risk-based approach to lending. Banking institutions now continue to reduce their operational costs and improve their profitability, as well as strengthening their capital position.

“The House of Representatives have enacted the improved legal framework on foreclosures and insolvency, which is intended to address the issue of non-performing loans. The legislation, implemented in April, is a critical step aiming at reducing the high level of non-performing loans, which is essential to restoring growth and job creation in Cyprus.”

For the first time, under the new law, residential and other property valued at 250,000 euros or more will be subject to foreclosure if the owner defaults. A new regulatory framework allowing for the securitisation of debt is also part of the reform package that Mr Hourican says he welcomes, realising it will be painful for many. “It’s very important to create the moral hazard for a functioning banking system in a recovering economy, because we can’t provide credit to an economy that doesn’t have the legal basis on which we can recover in a rapid way.”

Mr Hourican’s mission to oversee the bank’s restructuring is nearing the end. “You need confidence in a leveraged environment, and if you don’t restore it, you will just die. That is what worried me most about the Bank of Cyprus – the confidence was so badly interrupted that restoring it was going to be quite a challenge. I wasn’t sure we could, but it has been really pleasing to see people start to re-engage with the bank and recognise what we do as good.”