LATVIA: POLITCAL, ECONOMIC AND TECHNICAL COMPLICATIONS

UNCLAS SECTION 01 OF 02 RIGA 000526

SENSITIVE
SIPDIS

E.O. 12958:N/A
TAGS: EFIN ECON ECIN PGOV PREL SW LG
SUBJECT: LATVIA: POLITCAL, ECONOMIC AND TECHNICAL COMPLICATIONS
REMAIN OBSTACLES TO PAREX BANK SALE

REF: A. RIGA 516, B. RIGA 484, C. STOCKHOLM 632, D. RIGA 413

RIGA 00000526 001.2 OF 002



1. (SBU) Summary: Political, economic and technical barriers may
impede the quick restructuring and sale of Parex Bank, which is a
key to Latvia's economic recovery. Latvia's other state-owned bank,
Land and Mortgage Bank, is facing a deteriorating loan portfolio and
may need additional government capital infusions. End summary.

Background
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2. (U) Parex Bank collapsed in November 2008 following a run on its
deposits in the wake of the global financial crisis. The government
took a majority share of the bank in a deal that has been the
subject of widespread scrutiny in the press and a recent State
Auditor's Office report. The State Prosecutor's Office announced a
criminal investigation on October 16 into the government's initial
handling of the takeover. The collapse of Parex precipitated
Latvia's approach to the IMF/EC for assistance. As a precondition
for IMF/EC assistance, the government was forced to take complete
control over the bank. Following a series of audits and extensive
review of the bank's balance sheet the EBRD recently took a 25
percent stake in Parex.

Restructuring and Sale
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3. (SBU) Parex's management will present a draft restructuring plan
to the Cabinet on October 27-28 and is hoping to secure the European
Commission's sign-off on the same plan by November 15. In a meeting
with Ambassador Garber, Parex Chairman Nils Melngailis outlined an
ambitious plan to sell Parex's restructured components (a commercial
bank and a non-core, non-performing asset fund) within 6-9 months.
Melngailis hopes to limit the government's liability exposure to LVL
400 million (USD 800 million),down from the current level of LVL
1.2 billion (USD 2.5 billion),which includes equity, deposits, and
sovereign credit guarantees on syndicated loans. This scenario
would see up to LVL 800 million (USD 1.6 billion) returned to the
Latvian treasury, substantially improving the 2010 budget outlook if
completed along Melngailis' expedited timeline.


4. (SBU) Given the domestic and international economic climate and
continuing uncertainty about ongoing investigations or potential
litigation by former shareholders, there appears to be very limited
commercial appetite for Parex, either as a whole entity or for its
restructured components. In contrast to Bank of Latvia Governor
Ilmars Rimsevics (see reftel A),Irena Krumane, head of the Latvian
financial regulatory authority (FCMC),the PM's office and
Melngailis all believe that the bank cannot be sold as a single
entity. Melngailis said that a number of third country banks are
looking at Parex as a gateway into the European banking market, but
noted that none of these banks are Russian as many have speculated.
However, he admitted that the ongoing investigations have already
scared away a couple of investors. Melngailis said there is,
nonetheless, some interest in the non-performing asset fund.
Specifically, Parex is hoping that the IFC will come in as the
anchor investor in the fund, which was valued by Melngailis at
roughly LVL 1 billion (USD 2 billion). Ultimately, Latvia's ability
to recoup its remaining exposure to the fund will depend on asset
price fluctuations over the next 5-7 years.

Land and Mortgage Bank: a Second Parex?
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5. (SBU) The FCMC told us that Latvia's other state-owned bank, the
Land and Mortgage Bank (LMB),may also soon run into serious
difficulties. Melngailis independently confirmed that LMB's problems
are much worse than currently reflected on its balance sheet.
According to the FCMC, without capital injections, by mid-2010 the
bank's capital adequacy ratio will be deficient. As a result, the
government is considering a restructuring for LMB. Parex and the
PM's office are both considering the potential of combining the bad
assets from LMB (LVL 1.5 billion/USD 3 billion) into the
non-performing asset fund created for Parex. However, the FCMC said
it would not support such a move, citing transparency and
complications involving the ERBD's investment in Parex.

Sale Key to Recovery
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6. (SBU) The successful restructuring and sale of Parex remains a
key to Latvia's economic recovery. The sale of Parex would
immediately improve the country's credit rating and ameliorate the
2010 budget outlook. Failure would put additional pressure on the
already strained budget as the bank will likely need additional
capital injections and the government is still on the hook for its
syndicated loan guarantees. According to the FCMC, Parex is too
weak to pay any share of the roughly LVL 200 million (USD 400
million) installment due in February, but Melngailis believes Parex
could pay LVL 100 million (USD 200 million).

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Political Maneuvering Could Delay or Derail Progress
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7. (SBU) The PM's office expressed concern that some political
parties may seek to delay action on Parex's restructuring out of
fear that the current government could claim credit and strengthen
their electoral prospects. While there is widespread political
agreement that the sale is a key to Latvia's economic recovery, the
political instability of the current coalition, coupled with the
ongoing criminal investigations and the highly charged political
debate over how the takeover was handled, may all combine to delay
or derail any deal. Such a scenario would also act as a drag on any
incipient economic recovery.

GARBER