The timely passage of a bill to strengthen the local insolvency law helped convince both the International Monetary Fund and sovereign bond investors that the Cyprus credit story should not be bracketed with that of Greece.

When Cyprus returned to the international capital markets at the end of April, it was able to demonstrate emphatically that it is not Greece. Morgan Stanley was a lead manager on the €1bn deal, and its team included one member who was well acquainted with the difference – the International Monetary Fund's (IMF's) former frontman in the eurozone crisis.

Cyprus – or at least the Greek part of the divided island – has umbilical social, linguistic and cultural ties with Greece. It was the very closeness of their connection that sucked Cyprus, belatedly, into the eurozone crisis.

With disastrous timing, the state had adopted the euro late in the day, at the start of 2008. In the run-up to this it had brought its budget and inflation under control. No sooner had it joined the eurozone, however, than it began to run up large current account imbalances as foreign money poured into the country. The funds came from Cypriot expatriates in the UK and elsewhere, from Russia, eastern Europe and the Middle East, and much of it found its way into the property market, fuelling a property boom.

The offshore banking industry began to dwarf the economy, with deposits more than six times nominal gross domestic product. The Cypriot banking sector was very concentrated, with the two largest banks – Bank of Cyprus and Laiki Bank – accounting for two-thirds of the market. They were heavy on Greek assets, including government bonds.

Bail-out needed

After 2009, economic growth tailed off. Then, as the eurozone crisis developed, Greek assets turned sour, property prices fell and non-performing loans began to escalate. The combination was enough to bring down the banking system.

"The government did not have very high debt, which was lucky, but the banking system was insolvent," says Reza Moghadam, Morgan Stanley vice-chairman, global capital markets for the Europe, Middle East and Africa (EMEA) region. "The government had to intervene, but a full bailout would have made it insolvent also."

Mr Moghadam was director of the European department at the IMF between November 2011 and July 2014. Cyprus was forced to accept a €10bn bailout programme early in 2013, including a controversial and significant levy on deposits. The Troika of the EU, IMF and European Central Bank (ECB) insisted on this, since deposits far outweighed the amount of bondholders' debt available to be written down.

The money was used to recapitalise Bank of Cyprus, which absorbed Laiki. In a first for a eurozone country, capital controls were introduced to stop money pouring out of the country; they have been removed very recently. The bailout programme called for various structural reforms and changes to the fiscal framework.

Committed to reform

It was at this point that the differences between Greece and Cyprus started to emerge. "Everyone expected a very difficult adjustment," recalls Mr Moghadam. "The Cypriots had fought very hard [against the programme terms]. But what was reassuring was that, the day after the agreement, they completely assumed ownership of the programme and said 'let's get on with the task of reforming the economy'."

For the government, that has been easier said than done, since it does not have a majority in the Cypriot parliament. It helps that those in power are those who negotiated the programme, unlike the situation in Greece. But to get measures approved, the government has to canvass the support of non-government parties, which has sometimes been a laborious process.

A case in point has been the new insolvency and foreclosure regime demanded by the country's lenders. A law allowing banks to foreclose on delinquent borrowers within two years, compared with the current average of 15 years, was passed in 2014. But it was then suspended while debate continued over the insolvency framework. The IMF held back €86m in bailout funds until the law was adopted.

Return to market

Last year, Cyprus was able to issue its first public bond since the crisis and bailout. In June 2014, it raised €750m with a five-year bond yielding 4.85%. It had hoped to return for more later in the year but found the market's enthusiasm had evaporated.

So this latest issue has been an important demonstration of the sovereign's renewed access to the international capital markets. It began last December with a non-deal roadshow organised by the four lead bankers – Barclays, HSBC, Morgan Stanley and Société Générale.

"This signalled an intent to issue in 2015, while not giving absolute clarity on timing," says Andrew Salvoni, a Morgan Stanley vice-president, global capital markets EMEA. "The aim was to get Cyprus in front of investors and explain why its situation was different from Greece."

While Cyprus is a smaller, less frequent issuer, it has quite a wide investor base, including both rates and credit buyers, hedge funds and emerging market funds. "The roadshow gave them time to get their credit work done," says Mr Salvoni.

The feedback was good, he says, although there was particular interest in exactly when the foreclosure law was likely to be passed. This was key in one very important respect. The ECB's quantitative easing programme excluded the bonds of two eurozone sovereigns – Greece and Cyprus. But Cypriot bonds would become eligible if the upcoming bailout review was positive, which depended in turn on the passage of the insolvency and foreclosure package.

Since January, Greece's new Syriza government has raised anxieties over Greek debt default and possible exit from the eurozone. The Cypriot government was particularly concerned that an accident in Greece could sweep Cyprus away with it. Time, it argued, was of the essence if the difference between the two sovereigns was to be highlighted. That required successful issuance, which required a foreclosure law.

Looking for peers

This argument finally prevailed and the foreclosure law was passed in mid-April. A benchmark offering was launched little more than a week later. This was the week after eurozone finance ministers held Greek debt talks in Riga, where Cyprus had been quoted as an example worth following. That provided a helpful tailwind, with Cypriot bonds rallying in response.

With existing benchmark issues maturing in 2019 and 2020, a seven-year maturity was chosen to build out the curve, and initial price thoughts were in the 'very low 4%' yield area. In pricing, there was not a lot to compare with. "In extrapolating the curve to 2022, the only sovereign curve that came close was Portugal," says Mr Salvoni. "It trades significantly tighter but pointed to fair value for Cyprus in the very high 3% range."

Cyprus was flexible on size, looking at a minimum of €500m with €1bn at the top of the range. By the end of that day, indications of interest totalled about €1bn. "That gave us some leeway on size and price," says Mr Salvoni.

The books were opened officially the following day with pricing in the 4.125% area and attracted orders of just under €2bn. The size was set at €1bn with a reoffer yield of 4%. The bonds traded 5 to 10 basis points tighter over the next few days. Indeed, in the market turmoil that followed shortly after, only Cypriot bonds traded tighter, as investors anticipated imminent ECB eligibility.

Signs of recovery

The non-performing loan ratio of Cypriot banks was 48% at the end of 2014 and remains a major challenge, impairing lending capacity and constraining large swathes of the economy. However, the economy grew 1.6% in the first quarter of 2015, expanding for the first time since it entered recession in mid-2011.

These are unmistakable signs of recovery. "Growth in the first quarter of 2015 was the highest in the eurozone," says Mr Moghadam. "Current account imbalances and fiscal imbalances have improved enormously. [Cyprus has] stabilised its debt, which is likely to be lower than projected in the programme."

Cyprus has now done two years of that three-year economic adjustment programme. "Ownership has been very high and outcomes have been better than projected – usually, they are worse," says Mr Moghadam. "That's because [Cyprus has] been very serious in implementing the programme, and because its economic structures and civil service are quite strong."

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