PIMCO report on Cyprus Banking system : Obsolete
by George Hatjoullis
The PIMCO report on Cyprus banks is available courtesy of FTAlpahville, http://on.ft.com/ZaI4n0. It is obsolete. It is easy to conclude this by simply skipping to page 84 and looking at table 64 and table 65, the macroeconomic assumptions upon which the report is based. These scenarios date back to 30 June 2012. Indeed one need only look at one number; the cumulative loss of real GDP over the period 2012 and 2015 is assumed to be -7.3%, in the adverse scenario. The actual cumulative loss of GDP, given all that has occurred so far, is likely to be more like -25%, and this number may be conservative. Moreover, the report assumes that, again in the worst case, unemployment will rise by only 2.5% over this period. I think the authors had a touch of the Cyprus sun. Once again the unemployment rate is almost certain to at least double, so increase by 14% to 28%, and once again this is a conservative assumption.
On the basis of this optimistic set of worst case assumptions, the authors conclude that the Cyprus banking system will need 8.867 billion euro of capital. The analysis is primarily driven by expected loan losses by 2015. It is clear from the macroeconomic assumption that the expected loan losses are most likely wildly overoptimistic and the true capital requirement of the banking system is well north of 8.867 billion. The haircut on uninsured depositors does not seem to be enough. How will any shortfall be met?
On page 35, figure 25 displays the assumed Emergency Liquidity Assistance provided to the Cyprus banking system by 2015. The ELA falls away dramatically. Now this is a truly brave assumption. In part it reflects equally optimistic assumptions about deposit flows into the system. Recall that the Cyprus banking system is largely funded by deposits. On page 31, Figure 18 shows that, even under the worst case scenario, Russian cumulative deposit inflows are assumed positive (LoL) by 2015. Even more amazing charts are to be found on page 30, notably figure 16. Cyprus non-resident cumulative deposit outflows are assumed to be only approximately 4.5% by 2015. This figure may be accurate but only because a) this group have had their deposits confiscated to fund the capital short fall and/or b) the capital controls will not permit the outflow and remain in place until 2015.
All numbers relating to the economy of the Republic of Cyprus are subject to a reality check. There is no basis in reality to the conclusions of this report. I hope it was paid for by the troika and not the RoC. In the immortal words of Alan Bleasdale‘s Yosser Hughes in Boys from the Blackstuff , ‘gizza job, i can do that’.
The big question mark for the RoC is what happens when the inadequacy of the current funding package for banks becomes apparent? This is why I have argued for an orderly exit from the eurozone. It is better than risking a disorderly exit. The troika may relent and ease the terms of the ‘rescue’ package if the RoC make progress in the many reforms. However, the conclusion of all my previous posts must be that they may not relent and Cyprus is doomed to misery and pain until the gas reserves pay off. Or should that be if they pay off?
Postscript: The importance of the macroeconomic assumptions is apparently not evident to some. Ironically PIMCO provide an insight themselves when noting:
The relative inattention paid at origination to borrowers’ ability to service their loans has resulted in a sharp response to deteriorating economic conditions in the form of heightened serious delinquency ratios. Indeed, the marginal response of loan performance to changes in economic conditions appears much greater in Cyprus than in many other economies. This attention to collateral and relative inattention to debt service capacity helps to explain why non-performing loan ratios in Cyprus are so elevated despite recent economic performance that has been more robust than that seen in more economically distressed European countries. pp. 10-11.