Cyprus real estate: Is PAMELA coming for a visit?

THE CYPRUS government is slowly, but surely, following the footsteps of the five other countries before it, preparing itself to sign the bailout agreement with the “Troika” comprised of the EU, the ECB, and the IMF.

The choreography has been pretty much the same as that of the other countries, but this dance partner has been particularly ‘bad’ as it keeps changing its mind if it wants to dance or not. Whilst it has been obvious for many months that this day was coming, the government and politicians in general, have been postponing the decision as no one wants to carry the political cost of agreeing to it. Looking at the election results of incumbent governments who have agreed to a bailout, it is clear that they are making the right choice; but only for them and for no one else.

The draft of the agreement is titled “The Economic Adjustment Program for Cyprus“, but a way to think about it is losing weight in order to fit into a tight pair of jeans. You spent the last while consuming copious amount of resources using borrowed money lent to you by various banks and COOPs, and now it’s time to pay it back. This can only be achieved by a combination of diet, i.e. cutting back on salaries and social welfare programmes and increasing taxes, and exercise, i.e. economic growth as a result of more efficient procedures and a better functioning and more equalitarian marketplace. Whilst you may end up looking good in them, the pain of getting there is already evident in the social unrest and anti-austerity demonstrations in Portugal, Spain and Greece.

Over the next few months, government sector salaries will be reduced, VAT and property taxes will increase, and new taxes will be levied on consumer goods like petrol, alcohol and tobacco.

The resulting effect, through the multiplier effect, will be significantly higher as consumption expenditure decreases. The banking sector will be quick to follow suit, as will some other private sector companies jumping onto the bandwagon. Non-performing loans are likely to rise further, as the impact of a decrease in disposable income hurts businesses and puts additional financial strain on household budgets. This may end up becoming a self-fulfilling and self-fuelling negative feedback loop, increasing the economic strain further.

The big change in the banking and property industries will come through the creation of the Cyprus Asset Management Company (CAMC). This company, similar to the Irish National Asset Management Agency (NAMA), will have as its purpose to resolve the problem of banks and COOPs having so many bad assets and to reduce the financial sector’s exposure to non-performing and non-core assets. The company will ‘acquire’ loans from the various credit institutions which have received or will receive aid from the government, and will attempt to maximise the recovery of “value” (money) from the various assets having a medium to long-term perspective.

The role of this state-run organisation will be to asset manage the various loans (and their collateral) and progressively begin disposing of these assets in order for the government to recover some of the money it provided as aid to the credit institutions.

If things to come follow a similar path to Ireland, then the first to be affected will be property developers and construction companies, followed by real estate investors, and lastly people who owe money on their permanent residence. The aim will be to keep the social impact of this “value recovery” to a minimum, but at the same time show that action is been taken to “put things right”.

The CAMC’s challenge will be to increase the value of the assets by applying technical skills, in-depth market knowledge, additional investment, plus risk acceptance, and all for an expected higher price down the road. It involves tough decisions – some of which will be unpopular or ‘wrong’ or ‘questionable’ in hindsight or through the media lens.

The CAMC could end up stuck with many assets which will not sell at a price that is deemed “acceptable”. Thus, the only choice will be to hold them and to try to add value during this period. This takes time and skilled resources and incurs significant risks. However, by taking the active workout route the CAMC could be rewarded by an eventual higher price or in the worst case, simply preserve value.

Given how the Cyprus government has performed to date, we do not think that Pamela will be coming to visit any time soon. PAMELA stands for “Proper Asset Management of Estates, Loans and other Assets”, and somehow proper management and Cyprus seem not to be able to go hand-in-hand. We can only hope that we are wrong in our assessment, as the CAMC will soon form a significant player in Cyprus’ property market and its involvement will span all sectors and sub-markets for quite a number of years. If the government uses the CAMC to minimise the impact of the financial crisis on society, then the Troika would have achieved its goal.

If however, it is left to grow into a bureaucratic and arteriosclerotic behemoth, then the Cypriot government is now planting the seeds of yet another “white elephant” which will create market distortions and hamper growth and private initiatives.