MeritKapital Diversifies to Latvia - a Concurrent View on Cyprus

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CySEC has approved MeritKapital to operate a branch in Riga, Latvia.

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There have been some encouraging developments that draw a stable economic outlook for Cyprus. However, the apportionment of capital and efforts across other geographical markets, such as Latvia, forms a stepping stone towards a prudent risk management.

Coming close to the year end, we are pleased to announce CySEC's approval for MeritKapital to operate a branch in Riga.

The Cypriot banking bailout terms are a reminder of the business need to diversify revenue streams and exposure tied to the local economic environment. Latvia had its own banking crisis in ‘08, upon which it received a bailout from the IMF and the EU of 7.5bn (€). It has since recovered economically, aided by the growth of the regional economy and its adherence to the imposed austerity measures. With an estimated GDP figure of 22.3bn(€), it will adopt the euro on the 1st of January '14 and is forecasted the fastest GDP growth in the Eurozone of 4.1% for '14.

The outlook of the Cyprus economy could also be deemed to be on slow recovery.

First, S&P has recently upgraded it by a notch to B- and sovereign debt yields have decreased substantially.

Second, cultural and economic similarities make current macro figures from Greece a relevant case study to forecast the trends in Cyprus;

  •     an upgrade of the government debt by S&P to B with a stable outlook
  •     a significant drop in sovereign yields
  •     expectations that the primary budget surplus will be maintained this year
  •     debt to GDP levels that are forecasted to decrease to 156.9% in '14 l
  •     GDP growth that is expected to turn positive to 1.8% in 2015

The small Cypriot economy with a GDP of around 17.7bn(€), should prove versatile to the imposed austerity measures which seemed effective in Greece.

Third, the financial services sector of Cyprus, excluding the banks with imposed capital controls, contributes decently towards total GDP. This pool is predominantly comprised of the banks which operate without capital controls, professional services firms, investment firms and FX companies. Additionally, tourism revenues are significant where the CTO figures estimate a 13% input to total GDP for '12, excluding multiplier effects in other sectors of the economy.

On the professional services front, which deals with international clients, an independent survey on a selected group of the larger market players notes a 10-20% slowdown in sales for ‘13 but exhibits a steady core client portfolio. This is largely since Cyprus remains amongst the most optimal EU tax jurisdictions and because the strong client vs. service provider relationship is not easily transferable.

In regards to the FX and investment firms, they continue to prosper driven by an international client pool and a capital base with immaterial impact from the bailout terms.

Finally, the latest statistics from the tourism industry for January to November '13 noted a slight decrease in arrivals of 2.5% but total revenue recorded a growth of 8%. The latter transpires from an increase in British and Russian visitors.

Fourth, there are noteworthy 'OTC' transactions that have contributed liquidity to the market. MeritKapital’s sale of the first 'bailed in' Bank of Cyprus (BOC) deposit to a large US hedge fund and recent M&A activity, whereby 'bailed in' deposits are swapped for outstanding debts of the targeted investment within the same bank, are notable examples. MeritKapital is in advanced discussions for numerous other 'deposit' deals. An increase in all such OTC transactions and further innovative solutions should ease the ensuing credit crunch.

Last, the natural gas reserves off Cyprus’s southern shore are vital for the island's economic recovery. The “Aphrodite” gas field is estimated to contain around 4 trillion feet of cubic gas (TcF), the majority of which could be exported. However, the construction of an offshore LNG plant and added transportation costs would only make economic sense at 5 (TcF). If some agreement is reached for this LNG plant to liquefy the excess gas of neighboring Israeli fields, then the project would begin to make financial sense. A recent statement of US-based Noble Energy disclosed that the same gas field may, based on exploratory drilling, also hold between 1.2-1.4 billion barrels of oil. An encouraging development, as the time and cost to drill and extract oil is much less than that of natural gas.

Nevertheless serious challenges remain. Despite improving operating income ratios, the viability of BOC continues to be uncertain. Nonperforming loans (NPLs) have increased to 47% in Q3 from 38% in Q2. As a comparison, the Greek-based banks have average NPLs of 30-35%, and provisions per NPL reduced to 37% in Q3 from 42% in Q2. This demonstrates that Greek banks have already restructured their loans, repossessed assets and are subsequently managing them. The NPL figures for BOC still considerably lag behind these parameters.

Second, the credit squeeze that results from the capital controls and the banks' risk averse lending appetite is jeopardizing the viability of healthy businesses and sapping new business growth.

Third, the lack of foreclosure laws prevents a correction in real estate prices to ignite activity in the industry. Although the Troika encourages imminent legislative amendments the problem remains outstanding.

Last, Iceland underwent a similar banking crisis in '08, whereby an oversized banking sector and excessive risk taking led to the collapse of the island's three main banks. As in Cyprus, the Icelandic banks lured foreign deposits with attractive yields and then flexibly lended to foreign borrowers. With the collapse of Lehman and a freeze in the credit markets, the noted banks collapsed. Iceland has since been imposed capital controls which prevent the exchange of the local currency; their respective lifting date remains undetermined. Its economy has just turned to growth of 3% this year and could borrow from the open markets only in '11. Moreover, its businesses are suffering as FDI is discouraged by the capital controls.

Professor Mandelbrot advised to “diversify as broadly as you can – far more than the experts tell you to”. There have been some encouraging developments that draw a stable economic outlook for Cyprus. However, the apportionment of capital and efforts across other geographical markets, such as Latvia, forms a stepping stone towards a prudent risk management.

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Persella Ioannides
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