PAREX BANK: NO SMOKING GUN, CALLS FOR FURTHER

C O N F I D E N T I A L SECTION 01 OF 02 RIGA 000413

SIPDIS

E.O. 12958: DECL: 08/06/2019
TAGS: EFIN PGOV ECON PINR LG
SUBJECT: PAREX BANK: NO SMOKING GUN, CALLS FOR FURTHER
INVESTIGATION (C-TN9-01445)

REF: A. A) STATE 68184

B. B) 08 RIGA 723

C. C) 08 RIGA 701

D. D) 08 RIGA 690

Classified By: Charge d'Affaires Bruce Rogers for Reasons 1.4 b & d.


1. (C) Summary: This cable provides an update on the
condition and future direction of Parex Bank and responds to
questions from Ref A. The deal to nationalize Parex Bank and
the circumstances surrounding its collapse continue to spark
controversy in Latvia, including calls by the GOL for a
formal investigation of the deal as well as Parex's
activities prior to its collapse. Audits of Parex Bank
indicate that it may have understated losses in its reports
prior to the bank's takeover by the GOL. Former shareholders
made some moves immediately before being removed that they
clearly continue to profit from. There are no indications
yet of patterns of further suspicious activity prior to the
collapse on the part of Parex or its customers. However,
there are still many unanswered questions about the bank and
the takeover. Public officials are primarily focused on
investigating the decisions made by the previous government
rather than investigating the bank's activities or planning
for any future problems in the banking sector. For their
part, Parex has plans to split into two entities and rebrand
to make themselves more attractive to prospective buyers. End
Summary.


2. (U) In late 2008, Parex Bank faced a severe liquidity
problem, forcing a government takeover. In November, the GOL
purchased a 51% share in Parex for two lats (US $4),in order
to avoid a bank collapse and the associated and unaffordable
payouts of government-insured deposits. Subsequently, as the
negotiations for an IMF bailout package began, the GOL
completed a full nationalization of the bank, removing the
prior shareholders, Valery Kargins and Viktor Krasovickis,
from the board. Accusations that the bailout was more in the
interests of the previous shareholders than of the Latvian
public persist. (Refs B, C, and D.)

What Audits Have Uncovered - so far
--------------


3. (SBU) Independent audits have not uncovered any problems
in Parex's books that directly indicate fraud, malfeasance,
or alarming patterns of customer activity. That said, there
is much that remains unclear, and illicit activity may yet be
uncovered. There are some unexplained losses and
discrepancies between audits and annual reports, and the
situation remains murky even for close observers. (The U.S.
Treasury sent an expert advisor to assist with the audit
process, but she came out of the process with more questions
than answers.) There were certainly problems with Parex's
business model that closer supervision may have prevented,
although this is far from unique to Parex or Latvia.


4. (SBU) There were external audits before and after the
government takeover. Ernst and Young conducted a regular
audit just prior to the government takeover, and Price
Waterhouse Coopers (PwC) conducted another just after. There
is no proof of irregularities in these audits, but there are
reasons for closer investigation. Ernst and Young had
conducted the previous seven audits of Parex, and though
rotation of auditors may have been advisable, this did not
violate any formal accounting standards. PwC conducted
audits just after the takeover and indicated that as of
November, 2008, loan losses at Parex were understated by 71M
LVL (US $142M).


5. (C) Like many banks, Parex was highly exposed to the real
estate market and used short-term measures to finance
long-term assets. The outflow of deposits Parex experienced
included both Latvian and non-resident deposits and was
common to several banks in Latvia. However, Parex also
relied heavily on a small number of major non-resident
depositors, and the bank had unusually high operations costs.
Roberts Stugis, Parex CFO and a bank employee since its
inception, claimed these high operations costs were due to
loyalty to employees and a sense of complacency about the
bank's success that led to inadequate cost controls. Outside
observers, such as State Auditor Inguna Sudraba, suggest that
Kargins and Krasovickis were paying for substantial private
expenses with bank money, and would call their "loyalty" to
employees simple cronyism.

Calls for Investigation
--------------


6. (C) Finance Minister Einars Repse has called for an
investigation on the takeover, which briefly but noticeably

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sent deposits fleeing again. For her part, Sudraba is
working to develop enough evidence to call for a criminal
investigation. This may be pushing the traditional role of a
State Auditor's office, but she is one of the few public
figures in Latvia with enough public trust to do it. Sudraba
argues that it is clear from the publicly available facts
that the government was acting to protect the interests of
previous shareholders, not to protect the interests of the
public.


7. (C) Accusations directed at Kargins and Krasovickis do not
allege a lack of cooperation with a government takeover, but
rather their enthusiastic willingness to work on a deal that
was highly beneficial to them - selling a bank with huge
liabilities for two lats was a sweet deal. Questions remain
about their liability for the bank's debts. While they
transferred many assets to friends or family before the
takeover, they continue to earn an estimated 200,000 LVL (US
$400,000) each month on interest from their accounts at
Parex, for which interest rates were increased just before
their departure. Sudraba sees this as their "golden
parachute" deal as they left the bank. Stugis, their former
employee at Parex, argues that while they are certainly
living comfortably, they are so tainted by the Parex scandal
that they cannot undertake any other business ventures.

Future Plans for Parex
--------------


8. (SBU) Parex does plan to change its business model
significantly. They intend to split their two lines of
business - retail banking and wealth management. They hope
that each part on its own will attract an investor, since
there has been little interest in the combined package.
Stugis said that there was interest in purchasing portions of
the bank before the takeover, but Kargins and Krasovickis
were only interested in selling it all as one package - a
package they over-valued compared to offers they received.
In the meantime, EBRD has agreed to take over a 25% stake in
the bank, which may help confidence. Kaspars Abolins, the
State Treasurer and a Parex board member, indicated that a
re-branding to shed the Parex name was coming soon. Debate
about whether it is better for the GOL to unload Parex soon
or wait and try to get a better price later is a popular
topic lately, with the proponents of waiting currently
holding the upper hand.


9. (U) Parex is still looking for a buyer for LP Anlage und
Privatbank, which is self-funding and is not a major factor
in Parex's overall finances. Latvijas Krajbanka remains one
potential buyer. The exclusive agreement giving Krajbanka
the option to buy Anlage has expired and has not been renewed.


10. (C) Irena Krumane, head of the Financial and Capital
Markets Committee, reports that no other banks appear to be
troubled, although all are reporting significant losses.
Close Parex competitor Rietumu Bank is perhaps the only bank
in Latvia that reported a profit in their most recent report.
Parex chief Nils Melngailis argues that this was evidence of
Parex's honesty, in that it has been reporting its losses for
months now. Melngailis is a U.S. citizen and former director
of the Latvian national phone company, Latelekom, and has
long been a trusted contact of the Embassy. Regulators are
careful not to say anything too harsh about current Parex
management, but they are clearly concerned - probably more
about their capabilities as managers rather than their
honesty. Other members of the management team are holdovers
from before the takeover, and may hold continued loyalty to
the previous owners.


11. (C) Comment: It is no surprise that Kargins and
Krasovickis made out very well in the takeover. Calls for
further investigation of Parex make good political theater,
but their usefulness may be limited. It seems unlikely that
any serious investigation of any ethical or legal violations
will take place. On the other hand, the eccentric but
economically savvy Finance Minister managed to drive down the
value of the (now GOL-owned) bank with what seem like
politically motivated calls for an investigation just as the
government is trying to sell. The State Auditor remains the
only potential honest broker, but her office appears
outmatched in terms of financial sophistication and her
office was never intended to conduct this kind of
investigation.
ROGERS