The world has turned upside down

THE GREEK mathematician Archimedes once said “Give me a place to stand and with a lever I will move the whole world”.

But Archimedes failed to add “…and with enough leverage I can turn the world upside down”. Thus, we find ourselves in the precarious situation where tiny Greece is causing a crisis in the Eurozone and a flight to safety by investors and depositors alike.

This is an outline of what lies ahead:

Greek economy – Things in Greece are a real mess. One side is asking voters to vote for it promising that when they come to power they will cut salaries and pensions. The other side is saying that they don’t care what the previous government agreed; they will simply not adhere to it even if that means going bankrupt. With 22% unemployment and a reduction in earnings of close to 40%, what would you choose?

Cypriot economy – The country makes its living from tourism and financial services, with banking being six to eight times the country’s GDP. Thus, there are systemic risks given the size of domestically owned banks and their exposure to Greece. The (recently nationalised) Cyprus Popular Bank is the most exposed to Greek debt, with 49% of its total loans, followed by Bank of Cyprus at 34% and Hellenic Bank at 17%.

Let’s put it in a different, crude, way:

Cyprus GDP: €15bn
Cyprus banking system: €15bn x 8 = €120bn
Exposure to Greek debt: Assume 30% x €120bn = €36bn
Greek non-recoverable debt: Assume (at best) 30% x €36bn = €10.8bn

Note: The total amount of Greek government bonds held by all Cyprus-based banks was circa €6bn, of which they lost circa €4.5bn

Cypriot real estate – Residential and commercial real estate remains overpriced, even though in the coastal districts of Paphos and Famagusta residential prices have fallen by 30-40%. Residential prices remain out of kilter with their long-term price to income multiple, whilst commercial property is suffering from higher vacancy rates resulting in lower rents, and from higher initial yields.

We expect residential and commercial prices in Nicosia and Limassol to fall by another 15-20% within the year. This will be compounded by the increase in the unemployment rate and the drop in earnings of government and banking sector workers, expected to materialise over the near-term. Land is the most overpriced property type across Cyprus and the one which we expect to suffer the most over the medium term.

From peak (2008) to trough (probably 2013/2014) we expect property prices to fall by 40% (residential Nicosia), 50% (holiday homes), and 60-80% (land on city fringe and countryside).

“Without Greece, Cyprus would have been fine” – Some have said it so often, that they have actually started believing it.

The Cyprus Central Bank defines non performing loans as those that are in arrears for over 90 days, and where the outstanding interest and loan amount is not covered by the collateral. The default rate currently ranges at around 12-15% of bank loans. Under the more widely used definition of non performing loans as those that are in arrears for over 90 days, the default rate currently ranges around 25-30%.

Let’s see what the numbers tell us:

Housing loans to local residents: €12.5bn
Housing loans to overseas residents: €2.6bn
Total housing loans: €15.1bn
Non-recoverable debt: Assume (at best) 10% = €1.5bn

Other loans to local residents: €10.9bn
Other loans to overseas residents: €0.9bn
Total other loans: €11.8bn
Non-recoverable debt: Assume (at best) 20% = €2.4bn

Total non-recoverable debt: €3.9bn

This amount excludes all loans to developers, companies, Cyprus government bonds, etc. Adding those makes things look much, much, much messier.

Cypriot banks – We envisage that banks will effectively become loan-workout companies, with considerable hands-on property management activities. The various outstanding loans will need to be regularly reviewed and restructured, and foreclosure and other proceedings will need to be initiated. At the same time the actual physical assets will have to be maintained and managed by their new owners (the banks). As a result banks will need to “invert” their front/ back office structure; they will transform themselves from companies having a large client-facing network which is geared for lending, to one with a smaller count of client-facing personnel and a large hands-on back office.

What do we do? – One of the wisest things we read said that “loans are a way of bringing the future into the present, with interest being the penalty for doing so”. Well, the penalty is high and the future isn’t as great as we thought it would be.

• If you don’t have cash flow problems, then put a plan in place in case you have in the future; 90% of businesses fail because of cash flow, not because they are not profitable.

• If you have cash flow problems, then get professional advice immediately. Talk to your accountant, try to extend your credit terms, and give debtors a chaser.

• If you have taken out a loan, then now is the time to seek advice on what your rights are and how to restructure it.

• If you are the bank that gave the loan, then you need to recognise what the future holds, make a plan and have a system in place of how to deal with your loan and property portfolios, and be flexible with your clients if there is any chance of increasing your recovery rate.