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Living in denial doesn’t mean forgetting to live

Cypriots are still going round drinking coffee, having dinner with friends, and booking holidays, having a hard time appreciating what has happened – and what will happen in the months ahead.

CYPRUS is now famous! The first country in which depositors got “bailed-in” to save a disproportionate and inefficient banking system. It’s almost as good as being known as the kid with the most acne in high school.

So, where are we now and where are we going?

Regarding the economy, it is clear that both the deposit “haircut” and the prolonged capital restrictions have created a toxic combination that is going to have a significant impact on the real economy; much greater than originally envisaged in the Memorandum that Cyprus has agreed in order to obtain access to the much needed funding from the Troika. Whilst the Memorandum refers to a contraction in GDP of circa 8.7% in 2013, the reality is that this is likely to be close to double that (if not more).

There are four reasons that will cause the economy to shrink significantly in 2013 (and 2014).

Firstly, Cyprus’ banking system was eight times its GDP and it has now “lost” circa 1.5 times its GDP from the sale of the Cyprus’ banks operations in Greece.

Secondly, the prolonged capital restrictions have caused a massive loss of credibility to the banks’ international business operations (their most profitable segment) and strained relationships between companies and their suppliers/clients.

Thirdly, the reduction in the inflow of capital to Cyprus has/will cause a significant impact on the economy via the multiplier effect.

And finally, even during this past month companies have already started laying off staff and cutting salaries by 15-30%.

We expect that the deterioration in the economy will accelerate over the next six to nine months, peaking in the last quarter as the seasonal unemployment caused by the end of the tourist season adds an additional burden to the overstretched public finances. 2014 is likely to be an even harder year, as companies and households are faced with a lower level of savings (since they will draw some down over the second half of 2013) and there will be a complete lack of financing from banks.

As banks are at the centre of the Cyprus economy, a quick comment is warranted on the (forced) merger between Bank of Cyprus and Laiki Bank.

The two banks had a combined market share of circa 50% and merging them will create a behemoth which will dominate the local banking industry. However, the new Bank of Cyprus will not be a ‘bank’; at best it can be described as an asset management company with banking operations attached to it. With Laiki Bank having one of the highest non-performing loan (NPL) portfolios and Bank of Cyprus already having its own set of problems before the “haircut”, the merger of the two entities will create an organisation whose main job over the medium term will be to take control and manage the loans and assets that it already has. With the Greek operations gone and international business uncertain, the bank’s main focus will be asset management and damage limitation (effectively the new Bank of Cyprus will be the “Bad Bank” envisaged in the original MoU agreed in November 2012 – and whose reference is suspiciously omitted in this MoU). Given that the new Bank of Cyprus will control such a significant part of the Cyprus economy, it will effectively be the bellwether of the Cyprus economy.

The Cyprus consumer is already retrenching, but not as much as it should be doing. Cypriots tend to enjoy living in denial (this is also illustrated by the lack of action as the economy deteriorated), and this situation is the perfect time for them to do just that.

The human brain is unable to comprehend large things – if you lose €10 you can appreciate what this means/feels like because you know what that amount can buy; the same for €10,000 or €100,000. But what does €23bn mean? (the amount that Cyprus’ banks are expected to require). Thus, for now, Cypriots are still going round drinking coffee, having dinner with friends, and booking holidays, having a hard time appreciating what has happened (and what will happen). You do need to live in denial at times. It’s a kind of a weird, almost dream-like, state – makes you feel bit detached from everything going on around you.

And does property present a good investment opportunity at this point in time? Is it now the time to protect your savings by buying assets or buy property at distressed prices? No. The Cyprus government is in the process of raising the Immovable Property Tax (IPT) and it has already announced that its going to revise it further over the next six months.

Property is one of the easiest assets to tax, as there is a central registry of owners and assets (the Land Registry). Furthermore, in terms of pricing, generally speaking, property remains overvalued relative to income, more so now that income is going to decrease significantly over the medium term and there will be a lack of finance. Finally, until the situation in the banking sector settles down and Cypriots fully appreciate what has happened, banks will be unwilling to sell their assets at a significant discount to book value.

There are always opportunities in the marketplace, but these are likely to be income producing assets (ideally with an income derived from overseas, e.g. hotels, airports, etc), assets that require the owner to “sweat the asset” by maintaining and property managing it, and properties that require significant capital/ turnaround, e.g. refurbishment, half-finished developments.

An area where we see considerable scope is that of short-term business lending, where an investment company provides short term finance (three to five years duration) to operating companies who wish to finance their operations or carry out specific projects. At the end of the day, with banks being in a state of consolidation, the best way to make money is for you to “be the bank” and have no competition whilst doing it.

About the author

Pavlos Loizou MRICS is the Managing Partner at Leaf Research

Leaf Research is a real estate consulting firm, providing high quality real estate market research, strategic consultancy, valuation, and financial modelling.

Readers' comments

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  • Gavin Jones says:

    Evander Priam.

    The illustration I gave about “wishful thinking” was merely that: an illustration. It in no way belittles what happened to the inhabitants of Famagusta and others in the north who were displaced and had to spend time in refugee camps, one of whom was myself.

    Crookery and thuggery in whatever form has to be addressed and fought against, be it perpetrated by developers, lawyers, bankers, coupists or armies on the rampage in July and August 1974.

  • Arthur Dent says:

    If ever there was an emotional non-sequitur it is that from ‘Evander Priam’ who, with a pseudonym like that, obviously kids himself that he is carrying forth the Hellenic banner from the Graeco-Trojan wars several thousands of years ago!

    Two entirely different wrongs, separated by many years, do not make a right. This website is about the property market in Cyprus today and recently. Does theft of Greek Cypriot property by Turkey in 1974 somehow justify fraud and wrongdoing by Cypriot developers, lawyers and state offices against foreign property buyers in the 21st century?

  • Evander Priam says:

    Every site I visit to do with Cyprus, its the same commentators engaging in double speak.

    Gavin Jones is a Prime example,

    Lets disregard the law for Cypriot refugees and the resolution of the Cyprus problem. Its also their fault that they where dispossessed through armed robber as a result of the invasion.

    well its your fault you were dispossessed of your property by corrupt lawyers and banks. live with it like them and accept no solution or a political one that does not benefit you.

    fair?

  • Denton Mackrell says:

    @Johbee. None of the blog comments has criticised or insulted Cypriots for going out for a coffee or a meal.

    The comments as far as I can see relate to the financial mess, its sources and what comes next. Pavlos Loizou also does not appear to criticise or insult Cypriots for going out for a coffee or a meal, rather he comments on a culture of denial. No one suffering from the effects of any form of compulsive behaviour or dependency (such as living long-term on credit beyond the capacity to repay debts) can cure themselves unless they admit to themselves that (a) they have a harmful condition and (b) their behaviour will have to change. One can deny that the day of reckoning has arrived but such denial does not mean that it hasn’t.

  • @steve – the issue of wrongly registered properties is being addressed – see Revised property tax bill announced.

  • steve says:

    Property is one of the easiest assets to tax, as there is a central registry of owners and assets (the Land Registry).

    What about all the properties that are owned by Cypriots, built on land owned by Cypriots and get passed down over generations. These properties are not registered on a central register and will probably never be. These are the people who will never pay IPT either. It has worked fine for hundreds of years until the eurozone came along.

  • John Swift says:

    Just got back from a week in Paphos, many places closed, night-life virtually none existent, I know it was still April but we visit most years in late April and usually meet up with fellow musicians we know at their gigs in down-town bars.

    The Duckpond market was as busy as ever if not busier.

  • johbee says:

    Surprising that Cypriots are insulted and criticized for having a coffee or going out for a meal. These simple actions are what’s needed to stimulate the economy. Spending money in the local markets will ultimately create jobs and help improve the economy. What are we supposed to do? Sit in our homes with all the power off in the heat and cry?

  • Martyn says:

    Regular readers of comments in this Forum will know that over the last 3 years I have become increasingly a Prophet of Doom as far as the Cyprus banking sectors and general economy have been concerned. Watching on as the total Denial (that anything, really, was wrong) continued, I even predicted the total bailout of the Cyprus banks to be close on the now recognised €23bn. So when the Crunch came in March it was of no real surprise, perhaps only the original idea that all Savers (Depositors) would be robbed of their Savings/Deposits to help address the awful problems created – and largely ignored! – by the previous Government. At least the ‘small’ savers/depositors have been rescued. But the aftermath is already massive and will surely worsen considerably before any ‘revival’ gets underway,

    Pavlov Louizu’s excellent piece is acknowledged, not just for summarising what has happened but for trying to give a fair and honest assessment about what is likely to come next, and where any ‘tail-end’ risks and opportunities might appear. And for sure all property owners (with Title Deeds!) are going to be hit hard as the Cyprus government tries to revive revenues, keep ‘paying the bills’. This will perhaps be the ‘easiest’ tax to impose – but not necessarily to collect!

    I still just wonder if there is still a ‘Black Swan’ event not too far away. Collapse of the Eurozone, maybe, but still unlikely, too many vested interests, too many political reputations at stake; a restructuring of the€zone more likely with maybe Cyprus as part of a 2nd tier ‘Club Med’. Or possibly a catastrophic, initially, individual departure of RoC from the Euro and Ezone. Right now I sense anything, even the so far unthinkable, may just happen.

  • Frank says:

    Pavlos Loizou says: “Given that the new Bank of Cyprus will control such a significant part of the Cyprus economy, it will effectively be the bellwether of the Cyprus economy.”

    As ‘bellwether’ is derived from the word for a castrated ram (effectively unfit for purpose) who is leader of the sheep; we may have different ideas of contenders for that title (now retired, defiant and unapologetic).

  • Gavin Jones says:

    One can’t help but wish that more people in Cypriot public life were as circumspect as Mr. Loizou. Regrettably, spinning fairy tales and living on a diet of sure-fire certainties which invariably never get off the drawing board tend to be the norm. This mindset has always been a way of life on Aphrodite’s isle and has been a major contributory factor to its demise.

    This failure to see things as they are and instead resort to wishful thinking spills over into every aspect of life. I remember being in a leading Famagusta hotel on the night of 19th. July 1974 and listening to everyone scoffing at the idea that the Turks would DARE to invade. Hm.

    Hats off to you, Mr. Loizou, as your article is a timely acknowledgement of reality. However, I’m sure I don’t have to tell you that you’ll require half a dozen lifetimes – if not more – in order to convert sufficient numbers to your way of thinking…

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