The Cyprus tourism industry has performed well over the past three years, with its recovery running in parallel to that of western economies and the opening up of the Russian market. A paradox lies however in that only 45% of loans to the sector are classified as performing.
Tourism constitutes one of the driving forces of the Cyprus economy and is one of the key sectors expected to carry the island out of the current crisis. There is a paradox however when one considers its current state and expected future.
The contribution of tourism to the economy of Cyprus followed a downward trend over the last decade, with a decline in tourism revenue as a percentage of GDP from 21% in 2001 to circa 15% in Q2 2013. Also, the contribution of hotels and restaurants to GDP declined from 10% in 2001 to circa 7% in Q2 2013.
As at March 2014 loans to the tourism industry constituted 7.2% of the exposure of all banks (c €2.3 billion out of €31.3b outstanding to legal entities), of which 55% were classified as non-performing. Although 45% of loans were performing, 14% of the total had previously been restructured. How come this sector is faced with so many problems when tourist arrivals have been performing well over the past three years?
The decrease in the contribution of tourism and of hotels and restaurants to GDP in percentage terms can be partly explained by the out-performance of other constituents of the economy. As other sectors of the economy grew faster than the tourism sector from 2001-2011, the sector’s contribution to the economy increased in absolute but decreased in relative terms. The out-performance of the other sectors however, does not explain why only 31% of loans granted are performing and have not been restructured.
The reasons behind the lack of correlation between tourist arrivals and the financial performance of the industry likely lay in three areas:
(1) many hotel owners and operators are significantly overleveraged as they have used their assets as collateral in order to expand their operations,
(2) the stock of hotels is quite dated which means that owners are incurring significant costs in maintaining their assets or discounting prices to attract tourists without carrying out any works, and
(3) operating expenses have risen over the past few years mainly as a result of higher electricity costs.
With reference to lending, it is important to note that most loans were granted as a percentage of the asset value of the hotel rather than on the operator’s ability to repay the loan. Property valuers artificially inflated prices by appraising hotels on a replacement cost basis rather than by using a discounted cash flow. With property prices booming during 2004-2008 land values skyrocketed; valuers used the value of the land and added to it the cost of construction of a hotel, without taking into consideration the income and expenses of an operating hotel. Banks used these values to provide the loans, without reviewing the buyer’s ability to repay.
Most hotels in Cyprus tend to be family owned and run, with various family members taking on managerial roles. This tends to increase operating expenses, as the business is not run in a way so as to maximise profit but to serve the family’s needs. This means that maintenance schedules are not followed, which in turn results in the physical condition of the hotel deteriorating. With most hotels having been built during the 1980s they are now approaching the end of their life cycle. Thus, owners either need to invest in them (with what funds?) or to accept advance payments on bookings (as has been happening over the past couple of years, especially from operators from Russia).
An African saying says that “A tree that does not know how to dance will be taught by the wind”. The Cyprus tourism industry has to modernise in order to survive and it is unlikely that most operators will be able to do so, given that they run their establishments as fiefdoms rather than as businesses. Another saying says that “The gathering of the eagles is not by mistake”; the recent sales of two of Limassol’s iconic hotels, Le Meridien and Amathus, are not accidental. The winds of change are upon the Cyprus tourism industry…