June 02, 2014

Angelos Gregoriades: Alternatives to Bank Financing

Following the announcement that the European Bank for Reconstruction and Development (EBRD) would start investing in Cyprus, for a limited period, in a bid to help the country overcome challenges that have emerged as a consequence of the severe economic downturn, Gold News asked Angelos Gregoriades – President of the Cyprus Investment Funds Association (CIFA) – just what prospects this development poses for the economy, how Cyprus may expand its financing base, and how CIFA will position itself in supporting the economy’s recovery.

The EBRD and Cyprus’ economy:

The agreement with EBRD is a positive development for the Cyprus real economy. On the one hand it will provide financing to the businesses and on the other hand it will enhance confidence and efficiency in the local businesses. According to the EBRD announcement, they will be engaged in the financial sector, the restructuring of the small– to medium-sized enterprises (SMEs) and the privatisation plan.

The EBRD has very similar procedures to equity funds. Before deciding its investment strategy, all available information is analysed by professionals. They request detailed business plans and all the relevant supporting documentation. They assess the assumptions made and the potential of the investment.

Additionally, once the investment is made, the performance is monitored within specific time intervals and, where the progress is not in accordance to business plans, corrective measures are taken. These actions secure the investment, the viability and the profitability of the project while enhancing efficiencies. They also add expertise from abroad.

Collective Investment Schemes – an alternative to bank financing:

In a similar way, collective investment schemes can provide an alternative to bank financing, especially during this period where the financial institutions cannot finance new projects and the real economy. Such schemes provide security to the investor since they are licensed and monitored by the Cyprus Securities Exchange Commission (CySEC), while it gives the opportunity to the investors to diversify their risk. 

Actually, such a scheme was used in acquiring a highly reputable entity during the privatisation procedure in Greece. Additionally, we believe that Collective Investment Schemes are an appropriate vehicle for commercially developing governmental property. Such action is also required by the Memorandum of Understanding and it will give the ability to the Government to improve its financial performance.

CIFA’s proposal – the Cyprus Economic Growth Fund:

CIFA has proposed the creation of the Cyprus Economic Growth Fund, which will be administered by high caliber professionals that will analyse investment proposal and monitor their implementation. This fund can attract foreign investors who believe in the ‘Cyprus Recovery Story’ but who do not want to invest in a specific project while it can also be financed through European funds.  

Rescuing the real estate sector:

Furthermore, the recent credit crunch and economic decline have had detrimental effects on the Cyprus real estate market resulting in developers facing difficulties in repaying their loans. The exposure of local banks in problematic loans made to developers and construction companies is said to exceed €7.1 billion, of which €4.7 billion are non-performing according to recent press reports.

A possible solution for attracting investors in this sector is to set up real estate vehicles taking the form of Alternative Fund to be operated by property developers and the Banks. These structures provide full flexibility to the Bank and the potential investor since one fund can be registered for each project or several types of properties (e.g. commercial and housing) may be included in the fund providing diversification of risk.

How Alternative Funds can work in practice:

For example, the Fund will be set up for a limited duration, and the management shares will be held by the developer and the bank. The properties that are charged as a security to the loans may be contributed to the Fund by the developer in exchange for Investor Shares and in turn the developer will transfer to the bank the relevant number of Investor Shares coinciding with the outstanding principle of the loan. The Fund will aim to raise capital from external investors for the development, repositioning or rehabilitation of the property as the case may be. The Fund’s portfolio may include all types of real estate assets (i.e. from commercial real estate to single family housing).

The developer as an operator of the fund will provide the necessary expertise as well as due diligence and financing to construction, design, leasing and sales. The exit strategy in the long-term will be to sell the property once the market recovers and the sale price yields favourable returns, while short-term will be to benefit from any rental revenue applicable. The developer will also have a right to repurchase the property within a period of two years from the day the property is contributed to the Fund. 

Exit from the Fund for the bank as an investor may be achieved in the form of either i) a transfer of part or all of the Investor Shares held to a third party or ii) the redemption of all or part of the Investor Shares in accordance with the terms of the constitutional documents of the Fund and based on the Net Asset Value per Investor Share in the event where the property is sold with a profit.

Special incentives will be provided in order for this structure to work, in an attempt to reduce the volume of the non-performing loans. No taxes or transfer fees shall be paid when the financial institutions are transferring repossessed assets to such schemes, unless the shares or the property is sold to a third person.

The collective investment schemes provide flexibility and the vehicle of obtaining finance towards the target of economic growth. They also provide the tool for restructuring distressed loan and enhancing the liquidity of financial institutions.