Ben Aris in Berlin -
"The crisis is over." That was the conclusion of the so-called Sage of Omaha, Warren Buffett, on May 4, but for bankers like Nils Melngailis, the new chairman of Latvia's Parex Bank, this only means that life isn't impossible any more, just really, really hard.
Latvia has probably been the hardest hit of any country in the former Soviet Union by the international financial crisis. Danske Bank said in a note in April that, "while the global economy is showing tentative signs of improvement and some risk appetite has returned, Latvia's economic woes have simply got worse." The contraction in GDP this year is expected to be in double digits, while Prime Minister Valdis Dombrovskis predicts the country is facing a "deep and long recession."
"Only two years ago, Latvia was amongst the fastest growing countries in the world. An adjustment was inevitable - real estate prices in Riga were on a par with those in Tokyo, New York and London. A fall from on high is hard indeed and shows what can happen in small emerging markets," Melngailis tells bne during a flying visit to Berlin at the end of April.
Saving the banka
Melngailis took over what was once regarded as Latvia's best bank in December and has worked miracles to pull it back from the brink of collapse. Within months he had managed to persuade 61 creditors who had extended the bank a €775m syndicated loan to wait for up to three years to get their month back. He then restructured the bank and, by January, depositors were starting to return.
The bank seems to be out of the woods for the moment. It reported a LVL120m (€169m) loss in 2008 and made a loan-loss provision of LVL6.9m for the first quarter, but this is not enough to threaten the bank's capital, says Melngailis. Parex also has some €80m of bonds outstanding, but these aren't due until 2011, so Melngailis is confident the bank's business will be running better by then and he can meet these obligations without trouble. The challenge he faces now is to get the bank's business moving again. "There were 61 banks in the syndication and we needed 100% approval [to restructure the debt]. About a third of these banks were German and the first step to restructuring our bank was to restructure this loan," says Melngailis. "Now that is done, the next problem is to attract some liquidity to the market to get business moving again."
The second stage of the recovery plan was easier to manage, because the Latvian government had stepped in to rescue the floundering bank at the end of last year when it bought out the founders' 85% for a nominal LVL2. In April, the European Bank for Reconstruction and Development (EBRD) bought a 25%+1 share of this stake, thus giving the bank some very solid backing.
So with the big problems solved, the bank is now in limbo as it waits for the country to deal with its own issues. Melngailis was in town with Dombrovskis to meet with the International Monetary Fund (IMF), the German government (amongst Latvia's biggest investors and trade partners), as well as the heads of most of Germany's biggest banks.
The country's prospects going forward now depend entirely on if and when the Latvian government can cut a new deal with the IMF. Talks have got stuck over the size of the country's budget deficit: the IMF wants the government to cut the deficit to 5% of GDP, while the government is holding out for a bigger 7% deficit. Neither side is budging and analysts are wondering if a deal is possible at all. "Talks are tough, but the government says the end is in sight," says Melngailis, fresh out of a breakfast meeting. "The question under discussion is a trade-off: short-term cuts against investing in a slower but stronger recovery over the medium to long term. There remains a risk that if you cut too much, then there will be social unrest, which could set up back a decade or more."
The Latvian government is arguing that the extra 2 percentage points of spending now will cushion the blow and produce strong growth in as little as two years. On the other hand, the government is complaining that it has already cut 40% out of its spending and any more cuts won't actually save the government that much more money. "If you cut more, then although the budget in 2009 will be smaller, you will see the spending go up in 2010 and 2011 as these cuts will cause unemployment that will come back as government spending for social support next year and the year after," says Melngailis.
While the talks are difficult, the IMF has shown in a similar row with Ukraine that it is not prepared to abandon any country in the region. The Latvians seem confident that a deal will be done by the start of June. Assuming the second tranche of the IMF money is released, then many of the problems hanging over the small Baltic state could disappear, such as speculation over whether the country's currency peg will collapse. Indeed, Melngailis argues that the IMF money could spark a faster return to health than most of Latvia's neighbours in Central and Eastern Europe. "We don't need that much money to turn [the economy] around," he says, sitting in Parex's Berlin branch office, which was opened about two years ago, during better times. "A couple of billion euros would be more than enough to restart very significant development. Latvia's recovery cycles will be amongst the shortest, simply as we are amongst the smallest countries in Europe."
An IMF deal will prime the pump, but a really strong recovery won't kick off until the frozen credit markets start to thaw; the subject of Melngailis' other meetings in Berlin.
The return of bank's depositors in January means Parex can function again, but it still needs to fill big holes left in its balance sheet by the outflows in recent months: the bank had significant deposits from depositors in other CIS countries that need to be replaced, says Melngailis. To really get its business moving again, Parex and other banks need the foreign investors to come back to the market and lend. "We have come to restart the interbank relations," says Melngailis. "The interbank market was frozen about six months ago. Recovery depends on how soon liquidity returns to the market."
Germany plays an important role and German banks were the biggest single participants in the bank's syndicated loan, making up a third of the total. Many Germans have been watching the explosive growth of the CEE region in recent years and the profits earned there by the early movers - largely the Scandinavian and Austrian banks. But they were late into the game and balked at investing, as the prices had become so high. A few large German institutions are taking advantage of the crisis to finally make their move - Deutsche Bank announced it will move into Ukraine earlier this year and Commerzbank has also beefed up its presence in the region, to name two - but as Melngailis points out, "they have problems of their own to deal with at the moment."
There is also the issue of whether European banks can use their state aid money to support and expand their foreign operations. The Swedish government has explicitly stated that their banks can, which is good news for the Baltics, as these banks dominate the sector. However, the German government is still dithering and the issue has been made doubly sensitive by this year being an election year.
Parex finds itself in the same bind and will have to sit on its hands until the IMF and German banks are ready to move. "Our capital is state money and we have to turn inwards and be docile until we have paid this money back," says Melngailis.
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