Greek Deal Won't Save the Country's Banks

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Greece at Crossroads as Europe Braced For Worst

Greek banks, which received two capital infusions in the past two years, may need a third one as a recession drives up losses from bad loans.

The four biggest lenders, accounting for 91 percent of the country’s banking assets, could see their 12 billion euros ($14 billion) of tangible core capital wiped out by mounting provisions as overdue and restructured loans default. Even if Greece reaches an agreement with European creditors to free up additional money, its next bailout will need to include a new round of funding for the ailing banks.

Bad loans rose last quarter as the economy slipped back into recession and Greeks delayed payments waiting for the new government to pardon debt. With the recovery stalled, the four banks -- National Bank of Greece SA, Piraeus Bank SA, Alpha Bank AE and Eurobank Ergasias SA -- could require 16 billion euros in additional provisions to cover losses if half of the 59 billion euros of overdue and restructured loans on their books sour.

“We had expected nonperforming loans to peak in the first quarter, but we now expect this sometime in 2016, subject to some kind of economic stability,” said Nondas Nicolaides, an analyst at Moody’s Investors Service in Limassol, Cyprus. “There’s a high risk that restructured loans and others showing signs of trouble will slip back into default. It’s a possibility the banks might need another round of capital injections.”

Spokesmen for National Bank, Piraeus and Eurobank declined to comment. A spokeswoman for Alpha didn’t return calls.

Tax Assets

Even after two previous capital infusions, including a bailout by the European Union and the International Monetary Fund, Greek banks are thinly capitalized. More than half their capital is made up of deferred tax assets, or DTAs, credits for losses that can be used to reduce taxes when the banks return to profitability. The credits only have value if the government, which is almost broke, can convert them to cash.

Global rules implemented after the 2008 financial crisis are phasing out the use of DTAs as capital because they don’t help absorb losses. Some European countries including Greece converted them to government guarantees of future credits. The European Central Bank is skeptical of their use and may ask banks to increase equity to lower their reliance on such capital. The 12 billion-euro figure for tangible capital at the four Greek banks excludes DTAs.

Reversing Outflows

Analysts and investors have focused more in recent months on liquidity -- how banks are funded -- than on solvency. Lenders have lost more than 20 percent of their deposits since November, according to Greek central bank data and JPMorgan Chase & Co. estimates. The firms have relied on almost 120 billion euros of funding from the ECB and Greece’s central bank to replace the deposits and are close to running out of collateral to pledge.

Bank executives expressed optimism during first-quarter earnings calls that the outflows would reverse once the government reaches an agreement with its creditors. While that would resolve the liquidity issue, it would do little for longer-term solvency. With an agreement in place, the banks could switch back to ECB funding, which is cheaper than loans from the Greek central bank. Still, those savings pale in comparison to potential losses from souring loans.

Euro-area finance ministers were converging in Brussels Thursday in an attempt to restart negotiations. International Monetary Fund chief Christine Lagarde said Greece won’t be given a grace period if it fails to make a payment of about 1.5 billion euros to the fund on June 30.

Shares of the four Athens-based banks have gyrated in recent months depending on how close or far an agreement between Greece and Europe looks. They rose on Thursday after falling earlier this week. Since December, they’ve lost about half their value.

Restructured Loans

The four banks had an aggregate 59 billion euros of restructured and overdue loans that they didn’t consider impaired at the end of 2014. Banks typically restructure loans by modifying payment schedules or lowering interest rates to help struggling borrowers continue paying. Those borrowers remain at a heightened risk of going back into default, with the failure rate often depending on how long it takes their country’s growth to resume.

In India, where the economy is booming, more than 40 percent of restructured loans have turned bad in the past four years. In Greece, where gross domestic product has shrunk more than 25 percent in six years, the rate will probably be higher.

Greek banks provision for an average of 55 percent of the value of soured loans based on the assumption the firms will be able to recover the rest. That means they’ll need to set aside an additional 16 billion euros if half of the restructured loans and those less than 90 days overdue fall into default.

Capital Controls

As Greece and its creditors head for a showdown, the specter of the country’s exit from the euro or the imposition of capital controls is rising. The latter would try to halt the deposit flight from the banking system by restricting cash withdrawals and money transfers abroad. Such controls could hurt the economy more as importers face difficulty paying suppliers and consumers without full access to their savings cut spending. That could further sap borrowers’ ability to pay and speed up the rise in bad loans.

The four banks reported at the end of the year that they had collateral worth about 60 percent of their total loan books, without breaking down how much of that was for soured debt. Countries that have tried to clean up their banks after an economic or financial crisis have sold bad-loan portfolios for as little as 10 percent of face value. When banks repeatedly restructure bad loans, they usually end up delaying the day of reckoning as well as economic recovery because they can’t make fresh loans to worthy companies in need.

That suggests the recovery rates banks assume are probably unrealistic. Housing prices in Greece, which have declined about 40 percent since 2008, would fall further if banks tried to foreclose and sell the property, according to Nondas at Moody’s.

“The real recoverability of the bad debt is probably not so realistic,” said Jonas Floriani, a London-based analyst who follows Greek banks for Keefe, Bruyette & Woods. “The time it takes to recover, the legal issues, all those would reduce the final value they can receive.”

(An earlier version of this story corrected the location of the analyst quoted in the fourth paragraph.)

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