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With our pants down

Turbulence brings change and with that change come opportunities to improve the Cyprus banking system and the Island’s economy. But is society ready for the difficult road ahead and is its leadership up to the required standard?

THIS article provides an outline of three topics: societal turbulence, the state of the Cyprus economy, and opportunities in the property market.

It is important to examine these topics in tandem, as one cannot scrutinize the property market without taking into consideration the state and outlook of the economy, which in turn is being affected by (and forms part of) the workings of society.

Economy

A crisis is when you cannot say “let’s just forget about the whole thing.” Whilst previous “mini crises” have been swept under the carpet, this one is not going away. The main reason is that banks (and coops) form such an integral part of the workings of the economy and of society, that there is an interlinked loop between the three. Thus, whilst other crises could be “isolated” and forgotten about, this one lingers on and on.

The problem isn’t just a deepening recession, however serious. We face a conjunction of three large events – the implosion of the debt-based finance-capitalism that developed over the past twenty years or so, a fracturing of the euro resulting from fatal flaws in its design, and the ongoing shift of economic power from the west to the fast-developing countries of the east and south. Interacting with each other, these crises have created a global crisis.

How do we solve the problem? There is no silver bullet. We need to start by accepting that the problem is here and that any problem cannot be solved by using the same level of thinking that created it. In other words, if you screwed it up, you can’t fix it. Is it logical to expect that the same politicians, bankers, consultants and bodies will solve the problems which they themselves helped create?

The solution to the problem is likely to unfold at the end of a “black swan” type event, i.e. a rare event that will in turn lead to catharsis, like a war or a revolution. Until this “rare event” occurs, we will continue to move from one failed solution to the next, and thus from one crisis to the next, as the system struggles to survive whilst imploding at the same time.

We apologise if we sound too philosophical about this, but we call it how we see it.

Cypriot society

A classic example of the system’s struggle for survival, is the recent announcement/letter of the Association of Cyprus Banks that they are “concerned” that the definition of non performing loans that the Troika may use in calculating the recapitalisation its members require, will lead to big(ger) losses for local banks.

The letter goes on to state that the Association should be invited to (I paraphrase) “explain to the Troika the nuances of the Cyprus banking system”. What does that mean? Well, that the same banks that are likely to require circa €8.0bn to €10.0bn to be recapitalised, want to send the same decision makers who caused the need for the recapitalisation to explain to those who will give them the money how to do their job. Nice.

In his introduction to first year students taking his finance module, Professor Robert Shiller, one of the leading researchers in real estate finance, gives a simple explanation of how finance works: “a bank lends you money and charges you interest for giving it to you. If you don’t pay the money back, it takes the collateral and sells it in order to get its money back. If it can’t get its money back then the system doesn’t work and the bank will run out of money.”

The Association of Cyprus Banks is worried about Troika’s definition of “non performing loans”. The definition used by the Cyprus Central Bank is that if a loan is not being serviced for more than 90 days, i.e. if interest is not being paid on the loan, and the collateral is valued at less than the loan, then the loan is deemed to be “non performing”. However, the international definition is that if a loan is not being serviced for more than 90 days, then the loan is deemed to be “non performing”. The argument of the Association is that a loan’s collateral can be sold and thus the money paid back to the bank (as per Professor Shiller’s definition).

However, in order for that to happen (1) property rights must be absolute, (2) the foreclosure process must be efficient, (3) the sale of the asset must be forthcoming. With 130,000 properties not having title deeds, a foreclose process lasting at least 6-10 years, and the entire banking system having no liquidity, how likely is that any collateral will be sold? Yeap, that’s the problem right there. The system made a rule that “obstructed” the true nature of non performing loans and now wants to maintain the definition in order to safeguard its survival. For the past three decades nobody spoke about this, because banks were (and are) the “sacred cow” of the economy. As the saying goes, “a good slogan can stop analysis for fifty years.”

Cypriot property market

This leads us to the third topic, of opportunities in the property market. It is important to note that the property market is not dead. There are circa 1,000 transactions concluding every month, with the property markets of Paphos and Famagusta beginning to show some early signs of recovery (albeit from a very low base).

Buyers are of course concerned about the state of the economy and of banks, but with prices at 30-50% off their 2008 peak and the sterling up against the euro by 20-30% since 2009, Cyprus property is becoming an attractive option especially for overseas buyers. The top end of the market is also performing quite well, with sales of “exclusive” houses and apartments continuing above trend.

We do not expect a rebound in transaction activity or prices, but a slow pick-up in activity and progressive stabilisation of prices in Paphos and Famagusta (we remain negative for the other districts; particularly Nicosia’s, whose labour force is dominated by bank and public sector workers). With more locals choosing to study in Cyprus and rent housing for longer, opportunities will arise in student housing and serviced/ managed apartments. We also note the rise of smaller companies setting up a physical presence in Cyprus, requiring serviced offices and good quality residential units for their staff.

The “game” now is less about volume and more about quality of product and service.

We look forward to the forthcoming changes in the workings of the banking industry and to the Cypriot economy as a whole. We remain concerned that society is not ready for the difficult path ahead, and that leadership will not be up to the required standard. The only thing to be certain about is that turbulence brings with it change and that with change come opportunities.

Pavlos Loizou MRICS

Lead Consultant, Leaf Research

Readers' comments

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  • andyp says:

    All very well and good but in my humble opinion absolutely nothing will change until we hit rock bottom and then a little bit more.

    Buyers need confidence, transparency and protection or at least recourse when it all goes wrong through no fault of their own. Will this ever happen? Probably not.

  • Geo says:

    “it is individuals who will be the most problematic for the banks to deal with (its much easier to deal with a company by putting it under administration/liquidation than to kick someone out of their home).”

    The banks do not want to deal with individuals, they are showing no interest in this line whatsoever. All the banks want is these loans paid off. They see no value in any of the properties mortgaged to them and will not take them back to mitigate their losses.
    This despite their careless lending policy.

  • Martyn says:

    Another excellent depth article.

    It has been blindingly obvious that Cyprus banks have been operating a long, long way beyond ‘good old fashioned banking practice’ in a number of ways, the most alarming of which has been the way they have been participating for many years in what amount to ‘double indemnity’ practices (aka as Schemes or another shorter word beginning with S) whereby they contrive to keep Purchasers of ‘Immovable Property’ liable for the builder/contractors debts that are secured on the land, evidenced by the large numbers of new and not-so-new properties that Purchasers have paid the Agreed Price for but still await Title Documents, many for years and, unless something is done to eradicate these practices, for some considerable time longer yet.

    Pavios Loziou is right to call for fundamental life and economy-changing Change, it will be essential to purging the bad practices of the past and setting up new and fair/durable ones for the future. This will of course mean considerably bigger ‘bailouts’ for many of the Cyprus banks, extend the country’s overall pain and ‘austerity’ well into the future. But it surely MUST happen.

    And with the Troika due to report soon, things may start to get interesting – and probably Expensive! -over the next month or two.
    Aid the G

  • Denton Mackrell says:

    @Nish. You are right but that will not arrive in significant amount for at least another 8-10 years (when production tax revenues kick in) and, to a lesser extent, slowly over the next 4-8 years of pre-production spin-off activity onshore.

    While most welcome, none of this ‘gas revenue’ should be factored into seeking to offset the current and short-to-medium term debt crisis of Cyprus.

    Even the government in recent days has scotched the notion of mortgaging the island’s gas ‘futures’ to massage the debt figures.

    The Troika certainly won’t be swayed by virtual revenues of the future.

  • Robert Briggs says:

    @Mr Pavlos Loizou, There is the matter of the Title Deeds + covert developer loans issues to be resolved.

  • Stuart says:

    @Pavlos. Jim and Denton both make very valid comments on your submission which I have to agree does not come across with much conviction in its conclusion.

    Of the circa 1,000 transactions concluding every month, how many are fully and legally secured by existing Title Deeds? Any fool can buy property without such entitlement and so exacerbate an already scandalous situation.

    The definition of NPL’s by the Cyprus banks is certain to cost them dearly. Not only is the collateral value less than the loan but there is little possibility of the collateral being sold to offset a potential loss.

    Even where there are still legitimate transactions taking place which are fully supported by title deeds, “One swallow doesn’t make a summer” comes to mind.

  • Nish says:

    The recent gas find should be a real potential boost for the Islands economy.

  • James L. Baron says:

    What a clean open and easy to understand article. Let us hope many politicians, bankers and especially law-makers read this article and put into practice what needs to be done. With the ultimate intention it need not take rocket science to solve the “title deeds” problem.

    But no doubt things will just trundle on – one step forward and two steps back. People say “a Country gets the Government it deserves” Period.

  • Pavlos Loizou says:

    @ Jim & Denton.

    Thank you very much for your comments.

    With reference to the property market, I agree that the worse is yet to come, i.e. repricing of property, foreclosures, bankruptcies, etc. As I qualify in the next paragraph “we do not expect a rebound in transaction activity or prices, but a slow pick-up in activity and progressive stabilisation of prices in Paphos and Famagusta (we remain negative for the other districts; particularly Nicosia’s, whose labour force is dominated by bank and public sector workers).” Prices in both of these districts have dropped by 30-50% – prices are unlikely to go down further by much (the pricing in these markets has happened already).

    I also note that developers are part of the problem (indeed a major part of the problem), but as the economic part of the crisis has now escalated, it is individuals who will be the most problematic for the banks to deal with (its much easier to deal with a company by putting it under administration/ liquidation than to kick someone out of their home).

    In line with what you both state, we also do not foresee any strong/ healthy pick up in property activity (see above also). At the same time however, the market is not dead – it is at the same level of transaction activity as in 2000/2001. Thus, whilst it may appear to be dead or that its all doom-and-gloom, we are really doing a “back to the future” in terms of transaction volume and prices.

    PS (1) I would note that a similar situation is what is happening in the UK property market. Transaction volume is circa 40-50% off its peak, with the exception of London. Indeed, if you take London out of the transaction and price indices, then prices across the UK have been going down for a while now and transaction volume is even more depressed. There is always activity and opportunities in any marketplace regardless of conditions. However, this is not the time for “average Joe” to invest.

    PS (2) Apologies for the grammar of “we”. I meant to say “we”, as in Leaf Research throughout.

  • Denton Mackrell says:

    @Pavlos Loizou. Thanks once again for another thoughtful piece. The first two sections (Economy and Cypriot Society) seem to square with what most observers and informed commentators have been saying for some time. The recent revelation about how the banks here have been defining NPLs for developers, while shocking,comes as no real surprise.

    However, I’m not convinced by your Cyprus Property Sector section, whose rationale seems rather disconnected from the previous two sections. There may well be some glimmers of hope, but the severity of the consequences of sections 1 and 2 are unlikely to see the sort of early recovery you imply in section 3. I note also that you switch from ‘we’ in section 1 meaning ‘all of us’ to ‘we’ in section 3 meaning Leaf Research (I assume that’s who you mean).

    I can’t foresee any real,solid recovery in the Cyprus Property Market for some years, in line with the Troika’s warning about how long the pain of debt recovery is likely to be for Cyprus.

  • Jim says:

    @Pavlos. I mostly agree with your submission up to the point of “Cypriot property market”.

    I see no evidence of any forthcoming turnaround in the property market. It’s pace of dying, may be slowing, but that is only because it’s almost dead anyway.

    Only a fool would buy property in Cyprus that has no title deed in place at point of sale. Until the government get their heads round that issue, there will be no chance of a recovery in sales.

    The austerity measures being forced on many EU countries & soon to be forced on Cyprus, will continue to depress the market.

    I am afraid wishful thinking will not produce any improvement.

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