By Dimitris Kontogiannis

In Greece, the cart is sometimes put before the horse with suboptimal results. This appears to be the case with the recapitalization of the banking sector, where local credit institutions are struggling to attract the minimum private capital required in the planned share capital increases to avoid nationalization. Apparently, things would have been much better both for the state and their shareholders if banks had restructured before recapitalization and not the other way around.

Greece has set aside public resources of 50 billion euros for the recapitalization process and resolution costs of the banking sector, with government and central bank officials saying the amount is sufficient to cover their current and expected capital needs until the end of 2014.

The 50-billion-euro figure includes the estimated capital needs of core and non-core banks, a capital buffer of 5 billion euros for unforeseen developments, the costs of potential future restructuring above the capital needs for non-core banks and the net impact of completed resolutions and recapitalizations. Banks suffered losses close to 38 billion euros from their participation in the biggest sovereign debt restructuring ever, known as PSI, while the projections for credit losses from their loan portfolios in Greece and abroad stood at about 47 billion euros.

According to a report released by the central bank last December, the total capital needs of the local banks on a consolidated basis for the 2012-14 period were estimated at 40.5 billion euros in May 2012. The capital needs of the so-called core banks, namely National Bank of Greece (NBG), Eurobank Ergasias, Alpha Bank and Piraeus Bank, were put at 27.5 billion euros. The capital requirement reflects the difference between the target capital adequacy ratio (Core Tier I) and the estimated ratio in 2014. National Bank’s capital needs were estimated at 9.8 billion euros, Piraeus Bank’s at 7.3 billion, Eurobank’s at 5.8 billion and Alpha’s at 4.6 billion.

At this point, the four core or systemic banks have received bridge recapitalization from the Hellenic Financial Stability Fund (HFSF) in light of the capital increases scheduled for the end of April. The share capital increases will be fully subscribed by the HFSF but banks can avoid nationalization if private investors take up at least 10 percent of the share capital increases. Otherwise, the HFSF will buy the common shares and have full voting rights.

Although the authorities appear confident the amount of 50 billion euros earmarked in the economic adjustment program is enough to cover all costs, some analysts are more skeptical, saying more money may be needed depending on the outlook of the economy. If the Greek economy turns around in a year or so and starts growing faster than projected in the macroeconomic assumptions underpinning the calculations, banks will likely need less capital than estimated. However, if the economy gets worse, banks will generate less internal capital than assumed and will have to take more provisions for bad loans, most likely resulting in higher capital needs.

This uncertainty about the future of the Greek economy, along with the terms of the recapitalization – investors know they will lose part of their money in banks with negative equity from the start – and the lack of a clear investment story helps explain why private investors do not appear to be enthusiastic about the coming share capital increases.

Obviously, it is hard to sell investors Greek banks as a growth story in such a traumatized home economy and convince them they will get their money back with a good return. It could have been easier to sell the restructuring story but the management teams have no track record. Moreover, the general impression outside Greece is of a country where any serious effort to cut operational costs big time, close down many branches and lay off a good portion of the work force will be met with stiff resistance and potentially withdrawn or watered down.

Things would have been quite different and private investors could have flocked back to the scheduled share capital increases if local banks were asked to do the tough part first, that is, restructure. As a senior banker with international experience put it recently, “Internationally, normally, you first restructure a bank and then recapitalize it to attract private investors.” This way, banks would have been in much better shape financially and the management teams would have earned the confidence of private investors to take part in the share capital increases, leaving no doubt banks would remain in private hands.

This way it would have been better for the state since the capital needs of the banks would have been smaller at the start, regardless of the performance of the Greek economy, if the restructurings were successful. Of course, one may argue nobody stopped the management of the banks from undertaking such a task in previous years. This is true, but the scope of the overhaul is so big, some say 20 to 40 percent of operating costs have to be cut from current levels, that some kind of official blessing had to be given, at least in state-controlled banks, to induce the willing management teams to proceed. The latter was never the case.

All in all, the recapitalization of the systemic banks may lead to the nationalization of a few and the breaking up of non-core banks into good and a bad entities if private investors continue to look at the share capital increases with skepticism. This could have been avoided if restructuring preceded the recapitalization process.