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.