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Summary

  • Top-4 banks Alpha, Eurobank, National and Piraeus successfully completed the third phase of a new era for the Greek banking sector.
  • Capital ratios strengthened following capital increases of $11.3 billion in the past two months.
  • Reliance on Eurosystem funding has narrowed by 29% year to date – Two banks tapped debt markets.
  • No major surprises from Q1 results – NPLs keep rising.
  • Under a base case scenario for the economy with political stability intact, profitability would rebound as of next year with a positive impact on valuation.

The core Greek banks reported first quarter (Q1) results in the last three days of May. The release of the results was the last act in a series of important developments for the Greek banking market over the past two months. These developments constitute the third phase of the new era for Greek banks, which started two years ago.

The first phase involved consolidation in the sector, with significant M&A activity in the 12-month period starting in July 2012, which resulted in the transformation of the domestic banking landscape. At the end of that part, four banks -- Alpha (OTCPK:ALBKY), Eurobank (OTCPK:EGFEY), National (NYSE:NBG) and Piraeus (OTCPK:BPIRY) -- acquired the bulk of medium and small banks and now control around 95 percent of the sector's assets.

The second phase was marked by the first round of recapitalization. Alpha, National and Piraeus raised €21.7 billion ($29.5 billion) in fresh capital, of which €3.1 billion ($4.2 billion) or 14 percent stemmed from private investors. The remainder was covered by the Hellenic Financial Stability Fund (HFSF). Eurobank's capital needs of €5.84 billion ($7.94 billion) were fully covered by the HFSF.

At the end of that phase, HFSF became the dominant shareholder, although with restricted voting rights, controlling an 81 percent stake in Piraeus and 84 percent in Alpha and National. HFSF's stake in Eurobank was 95.2 percent with full voting rights.

The third phase was initiated in early March this year when the Bank of Greece disclosed local lenders' capital needs by the Bank of Greece. The capital shortfall for the top four banks was estimated at €5.8 billion ($7.89 billion) under the binding baseline scenario and at €8.8 billion ($11.97 billion) under the adverse scenario.

Strengthened capital ratios

The four banks subsequently proceeded with capital increases. They successfully raised a total of €8.31 billion ($11.3 billion) -- Alpha €1.2 billion ($1.63 billion), Eurobank €2.86 billion ($3.89 billion), National €2.5 billion ($3.4 billion) and Piraeus €1.75 billion ($2.38 billion) -- from private (primarily international) investors. That amount was 2.7 times higher than the €3.1 billion ($4.2 billion) raised by private investors last year.

Since the HFSF did not participate in those equity raisings, its stake in the four banks was diluted to 35.4 percent (now with restricted voting rights) in Eurobank, 57.2 percent in National, 67.3 percent in Piraeus and 69.9 percent in Alpha.

Following the capital increases, the pro-forma Q1 fully-loaded Basel III Common Equity Tier I (CETI) ratio (applicable in 2024) significantly improved to 12 percent for Alpha, 11.6 percent for National, 11 percent for Piraeus and 9.8 percent for Eurobank.

Under current capital standards, CETI stood at 17.7 percent for Eurobank and National, at 15.6 for Alpha (excluding preference shares) and at 14.4 percent for Piraeus (also excluding preference shares). The difference to Basel III fully loaded figures is largely attributed to the elimination of the deferred tax asset mostly related to the PSI losses.

Higher capital increases by Alpha and Piraeus banks, well above the capital needs of €262 million ($356 million) and €425 million ($578 million), respectively determined by the BoG, enabled the two banks to pay back their state preference shares.

These shares, worth €940 million ($1.28 billion) for Alpha and €750 million ($1.02 billion) for Piraeus, were issued in May 2009 as state aid under the law 3723/2008. At the time, the Greek state issued a special bond (maturing on May 21, 2014), which was its contribution in kind for the preference shares it received from the banks.

National has indicated its plans to redeem its preference shares worth €1.35 billion ($1.84 billion) "when appropriate," while Eurobank noted it is "in no rush" to purchase its preference shares worth €950 million ($1.29 billion).

The next challenge on the capital front for Greek banks is the outcome of the ECB stress tests, which is due to be disclosed in the autumn. The recent capital increases minimize the risk of additional capital needs, particularly for Alpha and Piraeus.

In addition, ECB stress tests will also determine whether the remaining HFSF backstop facility of €11.4 billion ($15.5 billion) will remain untouched, allowing it to potentially be used to reduce public debt or cover the government's funding needs.

Diversifying funding sources

The second important development this year was the issue of senior unsecured bonds by Piraeus and National placed with institutional investors for the first time over the past four years. Piraeus' transaction was a 3-year note of €500 million ($680 million) with a coupon of 5 percent on March 18. One month later, National issued a 5-year note of €750 million ($1.02 billion) with a coupon of 4.375 percent.

Since the beginning of the year, and particularly after the completion of capital increases, Greek banks have materially reduced their Eurosystem funding with all banks currently having zero exposure in Emergency Liquidity Assistance (ELA) funding. More specifically, their current ECB funding stands at €51.6 billion ($70.2 billion), implying a narrowing by €21.3 billion (29 percent) on the end-2013 figure of €72.9 billion ($99.1 billion). Since deposits have shown outflows of €1.93 billion ($2.62 billion) by the end of April, it seems the ECB funding has been replaced by interbank lending.

The bulk of the ECB funding collaterals of €49 billion ($66.6 billion) at year-end 2013 were in the form of uncovered government-guaranteed bank bonds that will not be eligible for ECB funding purposes as of March 2015. Greek banks have already started replacing these collaterals by assessing other funding sources, which would involve tapping debt markets, securitizations and covered bonds on top of higher interbank lending that has been evident so far.

No Q1 surprises

The Q1 results did not unveil any major surprises, showing a quarter on quarter (QoQ) moderate pressure on net interest income (NII), ongoing deleveraging, deposit re-pricing, further cost containment and a double-digit QoQ drop in loan provisions. Most of these trends are broadly expected to be maintained for the remaining of the year.

Excluding National, which showed Q1 net profit of €181 million ($246 million), the other three banks posted net losses ranging from €94.1 million ($128 million) for Alpha to €246 million ($334.6 million) for Piraeus. This is broadly a function of pre-provision income (operating income minus operating expenses) still falling short of loan provisions, albeit the latter is on a declining trend.

A detailed analysis of Greek banks' Q1 results can be found here:

Alpha

Eurobank

National

Piraeus

NPLs rising

The asset quality showed the non-performing loan (NPL) ratio rising to 37.9 percent for Piraeus, 33.3 percent for Alpha, 30.9 percent for Eurobank and 23 percent for National. The latter has benefited from its Turkish subsidiary (Finansbank) having an NPL ratio of just 6 percent. However, the NPL ratio for National's Greek operations stood at 28.4 percent, still well below its peers.

The highest quarterly NPL increase was posted by Eurobank, which saw a rise of 1.5 percentage points (pp), followed by Piraeus at 1.3 pp, Alpha at 0.6 pp and National 0.5 pp (1 pp for Greece).

The NPL dynamics are also directly related to the cumulative provisions (relative to loans) for each individual bank. As expected, for banks with a high NPL ratio, the loan loss reserves (LLRs) to loans ratio is at the high end.

The respective ratio in Q1 stood at 19.2 percent for Piraeus, at 18.6 percent for Alpha, and at 15.5 percent for Eurobank, with National at the low end, at 12.9 percent. Overall, the four banks had accumulated LLRs of €43 billion ($58.5 billion), corresponding to 16.6 percent of the total loan book at €259 billion ($352.7 billion).

Alpha and National enjoy the highest NPL coverage (LLRs over NPLs) at 56 percent, with Eurobank and Piraeus at the low end, at 50.3 and 50.7 percent, respectively.

Outlook

Going forward, the evolution and resolution of NPLs is the key qualitative metric for banks' loan portfolio, with banks' current estimates pointing to a peak of the NPL ratio close to the end of the year, easing thereafter in line with the anticipated bottoming out and rebound of the Greek economy.

Setting asset quality aside, we would expect deleveraging to continue for a couple of quarters and positive credit growth to resume as of Q4 2014 or Q1 2015. Deposit re-pricing, particularly regarding lower time deposit rates, will be the key driver for a rebound in the NII within the year.

On the cost front, synergies stemming from the recent acquisitions will continue to drive expenses down. The implementation of voluntary retirement schemes will also result in further cost containment, which is expected to continue showing a double-digit drop in the coming quarters.

Although these positive trends are expected to further improve the pre-provision income throughout the year, the level of loan impairments is still high (albeit exhibiting a double-digit decline) and will continue to erode profitability this year. Current consensus estimates point to a loss-making year for all banks except National, while a recovery of bottom-line profitability is expected as of 2015.

Valuation

Greek banks currently have a combined market value of €35.1 billion ($47.7 billion), corresponding to 45.7 percent of the Greek market capitalization. HFSF's share in banks has a market value of €21 billion ($28.6 billion), implying unrealized capital losses of €4.4 billion ($6 billion) on its "investment" last year. This primarily reflects unrealized losses of €3.7 billion ($5 billion) from Eurobank and €3.4 billion ($4.62 billion) from National, while unrealized gains from HFSF's participation in Alpha and Piraeus currently stand at €2.2 billion ($3 billion) and €400 million ($544 million), respectively.

The banks' stock performance shows Alpha's share has soared 57 percent compared to the issue price of last year's capital increase. Piraeus shares saw a modest increase of 6 percent, while Eurobank and National shares have retreated 73 and 39 percent, respectively.

Those who have invested in this year's capital increases in the past couple of months will see a different picture: Eurobank and National shares' have risen 32 and 19 percent respectively, while for Alpha and Piraeus, the respective gains stand at a moderate 6 percent.

Following the injection of €8.3 billion ($11.3 billion) of fresh capital in the past two months, the combined shareholders' common equity of Greek banks stood at €32 billion ($43.5 billion) in Q1, with tangible equity at €29.5 billion ($40.1 billion). Current prices indicate Greek banks are trading 1.1x their Q1 book value and 1.2x their Q1 tangible book value.

Under the base case scenario for the economy and assuming political stability remains intact, the anticipated recovery of profitability from next year will also have a positive impact on Greek banks' valuation over the medium term.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Source: How Greek Banks Moved Into A New Era

Additional disclosure: Investors should be mindful of the risks of transacting in illiquid securities such as ALBKY, EGFEY, NBG and BPIRY. Their primary listing in Athens, ALPHA GA, EUROB GA, ETE GA, TPEIR GA, offers substantially better liquidity. I am long Greek banks with limited exposure.