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Bondholders in crosshairs as Merkel travels to Cyprus

 

Bondholders are in the crosshairs as conservative European leaders gather in Cyprus amid talks over a bailout that may be as big as the nation’s entire economy.

German Chancellor Angela Merkel said this week Cyprus won’t get “special” treatment as it negotiates the rescue it requested in June. She, Ireland’s Enda Kenny and other leaders of the European People’s Party descend on the city of Limassol to discuss the next European Union budget as they back Nicos Anastasiades, head of the DISY opposition, as successor to Communist President Demetris Christofias in February elections.

Aid for the third-smallest euro nation will test policy makers’ commitments to hold the 17-member currency bloc together and avoid more sovereign-debt writedowns after they called Greece’s restructuring a one-off. The workarounds may put most of the burden on bank bondholders and possibly depositors.

Shared losses will be essential to win approval from German lawmakers, even at the cost of sending financial markets “a very bad message,” said Guntram Wolff of Bruegel, a Brussels- based research organization. “It will be impossible to get funding from the Bundestag to bail out depositors of Cypriot banks.”

Greek restructuring
 
With European markets rallying on speculation the worst of Europe’s debt crisis has passed, Cyprus has been bogged down in negotiations over its bailout, the fifth in the euro area since 2010. Cypriot banks lost more than 4 billion euros in Greece’s debt restructuring.

Cyprus may need as much as 17.5 billion euros to pay its bills and recapitalize Cypriot banks, Finance Minister Vassos Shiarly said in November. The amount is still under discussion. The government says it has enough cash to last through March.

European and Economic Affairs Commissioner Olli Rehn told the German newspaper Handelsblatt in an interview published on Thursday that “a haircut is not an option for us,” when asked about the prospect of debt relief for Cyprus. On Friday, Rehn said Cyprus needs to reform its financial oversight and follow through on commitments to fight money laundering, an issue that has caused concern in Germany.

“I expect that we can conclude the work and the Eurogroup can take decisions in due course so we can ensure financial stability in Cyprus,” Rehn said in Brussels.

Debt load
 
Moody’s Investors Service, citing the government’s projected debt load from recapitalizing the banking system, cut Cyprus’s credit rating three steps to Caa3 on Thursday.

Standard & Poor’s said Dec. 21 it sees the risk of a sovereign default as “considerable and rising.” Cyprus’s public debt will be 97 percent of gross domestic product this year and 103 percent in 2014, the European Commission forecasts. S&P expects it to rise “well above 100 percent” in the bailout aimed at shoring up the country’s banks.

A way around a sovereign write-off was pioneered in Spain, which won a financial-sector rescue after agreeing to tighter controls and EU-backed burden sharing. The aid imposed losses on junior debtholders, including depositors who bought preferred shares that were marketed as safe investments.

Other options include restructuring Cypriot government debt, modeled on the Greek “private-sector involvement” that euro-area leaders promised would not be repeated. Shiarly has said a debt swap in Cyprus would roil markets in vain because it would only hurt banks that are already in need of aid.

‘Tiny PSI’

“Even a bank-focused bailout would cripple the sovereign given the small size of the economy while an EU taxpayer- financed rescue of Russian oligarch-funded Cypriot banks would prove extremely controversial,” said Nicholas Spiro of Spiro Sovereign Strategy in London. “All this strengthens the case for a ’tiny PSI’, one which eurozone policy makers would hope would slip under radar.”

European policy makers have struggled with the prospect of a writeoff of Cyprus’s debt, stuck between their pledge that Greece was a one-off and an International Monetary Fund push for sustainable finances.

It’s “foreseeable” that Cyprus’s debt level after a bailout to aid its banks will be so high that “it is no longer sustainable,” European Central Bank Executive Board member Joerg Asmussen said on Germany’s ARD television Dec. 21. The same day, Luxembourg Prime Minister Jean-Claude Juncker said, “we made an exception for a private-sector debt writedown in Greece, we didn’t say Greek-speaking countries.”

The policy tangle means a euro exit can’t be ruled out, said Marc Chandler, chief currency strategist at Brown Brothers Harriman in New York. While European Union President Herman Van Rompuy said this week that the euro’s “existential crisis is over,” Chandler said the bloc is still not out of the woods.

“While last year we argued against the widespread view of a Greek exit, we are not as sanguine about Cyprus,” Chandler said in a note to clients. “We suspect the risks of a Cyprus exit are greater than currently appreciated.”

[Bloomberg]

 

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