Cyprus: The Land That Money Forgot
|Oct 30th, 2013 | Filed under: Alpha Strategies, Emerging markets, Today's Post | By: dfriedenberg||
We were invited to Cyprus recently to assist several companies in the restructuring of their bank debt. Our introduction to Cyprus was aptly named Cyprus Airways, where we found ourselves in Aphrodite class en route. Imagine our dismay when the stewards who served us bore little resemblance to Aphrodite. We asked management if we could ride in Miley Cyrus class on the way back as compensation. We were told that Miley Cyrus class was an oxymoron.
Cyprus, you may recall, was recently required by the European Union to have Bank of Cyprus “haircut” its depositors by all but 100,000 Euros of their deposits. The good news, if such there was, was that the disappeared deposits would reappear in the form of reconstituted equity in the new Bank of Cyprus. It wouldn’t be worth as much as the deposits, not even half as much, and the disappearance of that much wealth was a body blow to the local economy.
One salient point was made in a Forbes article in May shortly after the barber was finished. Nathan Lewis observed that crony capitalism came into play, as governments and counterparty banking institutions who could (should?) have known better were allowed to jump in line ahead of the depositors, who had no reason to know better.
That was actually not the most fascinating point in the article. We were reminded that things changed in another country in 2005 when that country’s banking laws revised the seniority list. Since 2005, derivatives liabilities have been the most senior asset class in a bankruptcy. The country in question? The United States. Anyone who knows the quantity of derivatives liabilities in bank portfolios will appreciate how unlikely it is that value would extend beyond the senior class. Your American bank might turn your deposits into toast, and you wouldn’t even get the free toaster.
But we digress. No doubt you prefer to know about Cyprus.
Perhaps the best symbolism for the state of Cyprus is the website www.cyprusdebt.com, which billed itself as the online info-portal for the Cyprus economy. They’ve posted no updates this year. We’re hoping this means the site is defunct, and that this isn’t a tacit representation of the lack of business activity.
During our visit, we met the owners of several businesses in Cyprus. They had all managed to accumulate a slug of Cyprus real estate. They all owned real estate currently valued, even with the market collapse, at or greater than their annual business revenues. They all had businesses that deserved to exist. From what we could see, the difference between businesses worth saving and “zombie” businesses were, apart from low margins, debt at 100% of real estate holdings. In the case of the latter, financial triage dictated that the owner should offer to turn over the entire mess to the banks, reasoning that the banks would want to run the business less than they wanted to leave it with the owners at a discounted debt load.
One of our hosts had the endearing habit of running through just turned red lights and honking as a way of telling waiting traffic that the light must be mistaken. He was just as intent on growing his business, taking practical steps to overcome the hindrances of the bank. And he had a business that would survive, through his visible ingenuity, given even half a chance. He had lost one important customer, but had determined a reasonable way to regain the lost revenues. Besides that, his real estate debt was a small enough percentage of mark to market holdings that there was room for a new lender to take out existing debt, and there were positive triggers on some strategic pieces of real estate.
It seemed to us that this business and others could easily flourish if bank burdens were ameliorated, and the island’s economy, now at 17% unemployment could begin to heal. But it would be unlikely as long as the people of Cyprus have to put up with restrictions such as the one about which we learned on the flight out. Not only did bank depositors take a haircut; today, they can only withdraw small percentages of their money at the bank.
A Distressed Investor’s Dream?
There’s always been an inverse relationship between price and optimism. That’s why the best bargains can be found on the trash heap of investments, provided that there are triggers for a reversal. In a smallish economy like that of Cyprus, some addition of outside capital might have a more substantial effect than it would in larger countries, and could serve as a test case of the opportunities created by austerity. One could wonder how an emphasis on government debt pay down during recessionary times, which takes money out of circulation, is any different than the medieval habit of bleeding the sick in order to cure them.
Roughly $10 billon worth of debt was transferred from Laiki Bank, now the bad bank, to Bank of Cyprus, the good bank. The anecdotal stories we hear suggest that the good bank is trying to make up for the previous era by managing corporate money flows so stringently that money flows with tortoise-like speed. One should never underestimate the rigidity of a banker trying to keep his job.
We also hear anecdotally that while banks are desperately trying to meet their required capital ratios, they are also willing to take haircuts themselves if their clients can raise fresh capital to take out their banks.
To us, this suggests an investor opportunity to restructure varied corporate debt by doing the things that a deer in headlights (Cypriot banks, perhaps) might not be flexible enough to do. We surmise that the businesses that can escape the clutches of the banks early will be the ones with the capital flexibility to outperform going forward. In a world where many businessmen now spend absurd amounts of time pacifying their bankers, there’s a real monetary value to not having to do that. One investor familiar with the hedge funds trading discounted bank debt opined that there was a trade to be done, but Cyprus bank debt buyers and sellers were still far apart pricewise.
There are a few good things about Cyprus: location; natural gas discoveries offshore; plenty of resort property; Russians. While we couldn’t say whether Russians are a good thing or not, we did hear that Russian investors were showing significant interest in Cyprus. They’re closer to the situation, so it would make sense. There are plenty more structural features that point to investor hate of Cyprus turning back to love, than there would be in, say. Tierra del Fuego.
In Cyprus, maybe you can make your own luck.
Doug Friedenberg has a knack for taking esoteric financial topics and rendering them merely obscure. He is principal of www.jigsaw-capital.com, which arranges asset-based finance for small and mid-sized businesses.