CYPRUS: MERGERS AND ACQUISITIONS WAVE LOOMS OVER

UNCLAS NICOSIA 001092

SIPDIS

SENSITIVE

SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON CY
SUBJECT: CYPRUS: MERGERS AND ACQUISITIONS WAVE LOOMS OVER
CYPRIOT BANKING SECTOR - BOC BID TO ACQUIRE EMPORIKI BANK IN
GREECE STIRS THE WATERS

(U) This cable is sensitive but unclassified. Please
protect accordingly. Not for internet distribution.


1. (SBU) Summary. Up until June 2006, the Cypriot financial
landscape could be described as rather bland and
predictable, although offering impressive gains over the
past two years to the few foreign investors who dared
venture in the island's shallow stock exchange. All of this
changed mid-June 2006 when the Bank of Cyprus (BOC),
Cyprus's largest bank, launched a bid to acquire Emporiki
Bank in Greece, partly in response to efforts by the Greek
Piraeus Bank to become the BOC's largest shareholder. With
the stock market crash of 1999-2001 well behind it, the
Cypriot financial system had been ripe for a wave of mergers
and acquisitions, which has finally hit in what seems, by
Cypriot standards, to be like a tsunami. Credit rating
agencies are generally apprehensive about the prospects of
success of the BOC's ambitious gamble. The stakes are high:
the BOC bid could either make or break Cyprus' leading
financial institution, with all the implications that would
have on the Cypriot economy and the country at large. End
Summary.

Background on BOC
--------------

2. (U) Founded in 1899, the Bank of Cyprus (BOC) group is
the leading Cypriot banking and financial services group.
The group also has a strong presence in Greece, currently
being sixth largest in terms of assets and growing rapidly,
particularly since 1999. The BOC group currently operates
275 branches, of which 147 operate in Cyprus, 111 in Greece,
six in the United Kingdom, ten in Australia and one in the
Channel Islands. The Bank of Cyprus also has representation
in the United States, Canada, South Africa, Russia and
Romania. The Bank of Cyprus Group employs 6,065 staff
worldwide. On December 31, 2005, the Group's Total Assets
reached CYP 12.8 billion (USD 27.5 billion) and the Group's
Shareholders' Funds were CYP 762 million (USD 1.6 billion).
The Bank of Cyprus shares are listed on both the Cyprus and
Athens Stock Exchanges. (Note: the average exchange rate
between the Cyprus Pound (CYP) and the USD since the
beginning of 2006 has been USD 2.15 to CP 1.00.)

BOC Bid to Acquire Emporiki Stirs Financial Waters
-------------- --------------

3. (U) On June 22, 2006 the BOC group launched a CYP 3.8
billion (USD 8.2 billion) cash-and-shares public offer to
acquire 100 percent of Emporiki bank - Greece's fourth
largest -- but ailing -- bank. The sale of Emporiki (11
percent owned by the Greek government and 10 percent by
Greek pension funds) is the highlight of the Greek
government's divestment agenda this year designed to help
pay down public debt.


4. (U) If the acquisition goes through, the combined
BOC/Emporiki group would become the second-largest financial
institution among Greek and Cypriot banking groups in terms
of deposits and loans. It would have a total market share
of 12 percent of deposits and 15 percent of loans in Greece,
and 32 percent of deposits and 27 percent of loans in
Cyprus.


5. (U) The BOC offer is conditional on acquiring a minimum
of 40 percent of Emporiki's shares. The BOC bid rivals a
Euro 3.1 billion (USD 3.9 bilion) all-cash bid by Credit
Agricole (France's largest retail bank). Emporiki
shareholders will be asked to decide between the two bids by
August 7, 2006.


6. (U) To finance the deal, the BOC proposes to double its
share capital from CP 300 million (USD 645 million) to CP
600 million (USD 1.3 billion) through the issue of 600
million new ordinary shares at a nominal value of CP 0.50
each. The proposal will be put to a vote at an emergency
general meeting of BOC shareholders on July 28, 2006.
Having secured the approval of the Greek Capital Markets
Commission, the BOC bid is now subject to the approval of
bank supervisory authorities and competition authorities in
both Greece and Cyprus.

Playing with the Big Boys
--------------

7. (SBU) The BOC announcement exploded like a bombshell


among Cypriot financial circles, causing a storm of
speculation as to its pros and cons, its motives, and other
related issues pertaining to the bigger picture of the
emerging mergers and acquisitions scene between Greek and
Cypriot banks. The debate is far from academic. The
success or failure of the BOC's ambitious endeavor could
literally make or break the BOC - Cyprus' leading financial
institution, with all the implications which that has for
the Cypriot financial sector in general.


8. (SBU) Acquiring Emporiki will not be an easy undertaking
for the BOC. The first problem is size. The market value
of the BOC is USD 5.05 billion -- barely more than
Emporiki's total capitalization of USD 4.55 billion. (By
contrast, size is not an issue for Credit Agricole, which
has a capitalization ten times that of BOC). The second
major problem, and this applies to both bidders, is
Emporiki's corporate mentality, which is characterized by
osteoporosis and very strong labor unions. The BOC's bid is
a calculated gamble by the BOC that it can tame Emporiki's
unions, and infuse the ailing Greek dinosaur with a youthful
enthusiasm and a reinvigorated sense of purpose.


9. (U) On the plus side, acquisition of Emporiki will give
the BOC a leg up in expanding into the Balkans - a move
deemed a long-term strategic objective and an imperative for
BOC senior management. Secondly, the bid will result in
economies of scale for the BOC in its Greek operations - by
far its most profitable and rapidly-expanding market.
Experts consider the two networks of branches of the BOC and
Emporiki in Greece to be complementary of one another - a
key component to the idea of achieving economies of scale.
Lastly, the BOC is considered as having a competitive
advantage over Credit Agricole in both understanding Greek
corporate culture and dealing with unruly unions. The BOC's
long experience in dealing with ETYK -- the notoriously
powerful banking union in Cyprus - will certainly come in
handy.


10. (U) Analysts note that merger waves are fairly common
during the post-correction phase of a stock market boom-and-
bust cycle. Cyprus is a typical example. The Cyprus Stock
Exchange (CSE) experienced a painful boom-and-bust cycle
from 1999 to 2001. The downward slide of the CSE finally
hit rock bottom towards the end of 2004, by which time the
index had lost 90 percent of its value from its hey day in
November 1999. Since then, the CSE has recorded a solid
recovery, with impressive gains in the last two years: 52
percent during 2005, and a further year-to-date gains of
around 54 percent so far in 2006.


11. (U) The CSE recovery in 2005 and 2006 was driven by the
return to profitability of the island's two largest banks:
the BOC and Laiki (Popular) Bank, currently accounting for
50 percent and 17 percent, respectively, of the CSEs overall
capitalization. Against this backdrop, it is no wonder that
the two leading local banks have become very attractive
acquisition targets for foreign investors, at the same time
as they themselves are trying to expand further into the
Greek market.

"Hostile" Interest from Piraeus
--------------

12. (SBU) In other words, it should not have been a
surprise for the BOC Board when another bank, Piraeus Bank
S.A. of Greece, suddenly started quietly snapping up large
numbers of BOC shares around mid-June, building up its
position initially to six percent and, by the end of June,
to more than eight percent. Instead, a perturbed BOC Board
described Piraeus Bank's actions as "hostile" and "not in
the best interest of BOC shareholders, as they lack
completeness and substantiated strategic intention." The
buying frenzy also prompted the Cypriot bank supervisory
authority, the Central Bank of Cyprus, to issue a stern
warning to Piraeus Bank, asking it to come clean with its
intentions, leading some to speculate that the Central Bank
was being xenophobic and was trying to protect one of
Cyprus's business icons from foreign influence.


13. (U) Piraeus Bank, which had initially attributed its
interest, innocently enough, to "investment" reasons,
eventually admitted that it had a "strategic interest" in
the BOC, and confirmed that it had its eyes fixed on


building up its stake in the BOC to 9.9 percent. The
Central Bank also reminded the Greek bank of its obligation
to obtain the Central Bank's prior authorization for the
acquisition (whether directly or indirectly) of any Cypriot
bank - a requirement founded on EU Directive 2000/12/EC.


14. (SBU) Some local commentators have suggested that BOC's
bid for Emporiki is a defensive measure designed to stave
off Piraeus's possible interest in gaining a controlling
stake in the BOC by making it too large for Pireaus Bank to
swallow. Some have gone so far to suggest that the bid for
Emporiki was rashly prepared as a desperate attempt by the
BOC Board of Directors to ensure their well-paid jobs would
not be put at risk. The BOC has denied these charges,
arguing that the takeover bid fits their strategic
objectives and has been planned for some time. If
successful, the BOC/Emporiki merger will catapult the new
group way ahead of Piraeus in terms of size and into the
Greek "Premier League of banks" -- competing head on with
the three leading Greek banks at present: Ethniki, Alpha,
and Eurobank.


15. (U) Having already snatched up 8.2 percent of BOC's
shares, Piraeus is currently the Cypriot bank's largest
single shareholder. Other major shareholders include the
Cyprus Church (8.0 percent); the BOC Provident Fund (6-7
percent); followed by various institutional investors,
investment and insurance firms, and pension funds and,
lastly, by thousands of smaller investors. Attention is now
focused on how the bigger BOC shareholders will respond to
the BOC management's proposal to acquire Emporiki. A
minimum of 75 percent of those present at the BOC EGM on
July 28 must approve the proposal for the Emporiki bid to go
through.

Marfin Shares the Spotlight
--------------

16. (U) With the plot thickening rather more quickly than
Cypriots are used to, the Central Bank of Cyprus also fired
a warning shot across the bow of Marfin Group. Marfin,
which is 31.5 percent owned by Dubai Financial, currently
has a 10 percent stake in Laiki and a 40.6 percent stake in
Greek Egnatia. On June 27, the Central Bank informed Marfin
that it was investigating "unconfirmed information" that
Marfin had colluded with Tosca Fund to buy the HSBC stake in
Laiki. When HSBC decided to sell its 21.6 percent stake in
Laiki early this year, Marfin Fund absorbed 10 percent of
the shares and Tosca Fund another 8.2 percent.


17. (U) Marfin does have a stated goal as well as
permission by the Central Bank to build up its share capital
of Laiki to 20 percent. The Central Bank, however, has
also warned Marfin that it has information suggesting that
Marfin has violated the law by systematically buying Laiki
Bank shares within 30 days of the release of Laiki's
quarterly financial results. Cypriot law prohibits company
insiders to buy or sell shares within this "closed" period.
Marfin denied any collusion with Tosca Fund and wondered why
the Central Bank had chosen to publicize this issue. Still,
Marfin decided to stop buying Laiki shares "as a sign of
respect to the regulatory authorities."


18. (U) In a parallel development in Greece, Marfin
announced on July 6 plans for a triple merger between three
smaller Greek banks -- Marfin Bank, Egnatia Bank, and
Laiki's operations in Greece. The plan, which is subject to
approval by the shareholders of all three banks and by the
Greek regulatory authorities, is scheduled to come into
effect December 31, 2006. The new entity that will emerge
from the merger of these three banks will have total assets
of around Euro 8.2 billion and 4 percent of total deposits,
140 branches, and 6,000 employees.

Foreign Rating Firms Ambivalent
--------------

19. (U) Saying that these are interesting times for the
Cypriot banking sector is a gross understatement. Foreign
rating agencies, not to mention local analysts and
investors, have been ambivalent about the BOC bid on
Emporiki, contributing to the maelstrom of conflicting
information.


20. (U) Moody's was first to raise the alarm, cautioning


that the BOC's D+ financial strength rating could be subject
to downward pressure, resulting in possible negative
implications on capitalization levels and the likely
challenges from the integration of the two institutions.
Moody's did not change the BOC's deposits or senior debt
ratings but it did put Emporiki's corresponding ratings on
review for a possible upgrade.


21. (U) Similarly, Fitch put BOC's A- credit rating on
negative watch on account of concerns that the BOC's plans
for Emporiki might undermine the BOC's financial strength.
Eurobank Securities also cautioned that the BOC/Emporiki
deal would tend to dilute BOC profits per share and would
alter substantially the BOC's investment profile.


22. (U) By contrast, UBS has maintained its Buy 1 rating on
the BOC stock, retaining its bullish target price range for
the stock at CP 7.20 (from the current level of CP 4.14).
UBS sees merits in the BOC's bid to acquire Emporiki and
believes the acquisition will expedite the BOC's strategy of
achieving scale in its most important market (Greece). UBS
also remained very positive on other Cypriot banks.


23. (U) Deutsche Bank (DB) was also supportive of the BOC
bid, maintaining its price target of CP 5.60 on BOC shares
with a "buy" recommendation. It also described the BOC bid
as more attractive than that of Credit Agricole. However
DB, expressed concern that the bid would tend to reduce the
BOC's Tier 1 capital.


24. (SBU) Comment. A cynic might describe the BOC bid on
Emporiki as similar to a boa constrictor trying to swallow
an antelope of roughly the same size. The potential payoffs
are obvious but the inherent risks are also considerable --
worst case scenario is that the boa constrictor collapses
from indigestion. Only the future will tell whether the BOC
has bitten off more than it can chew. But first, the BOC
bid must receive the approval of both Greek and Cypriot
authorities as well as that of most BOC shareholders, before
Emporiki shareholders can have their say. End Comment.

SCHLICHER