NPLs hold key to banks’ balance sheets

The restructuring of the Greek banking sector has been completed, resulting in better capitalized credit institutions and the most concentrated sector in the eurozone. But the country’s banks still have work to do to clean up their balance sheets. The new stress tests to be completed by year-end and the ongoing review of distressed credit operations will show whether the identified capital needs over the next few years can be satisfied without any of them having to resort to a new share capital increase. Although local bankers are optimistic, others are more cautious about the outcome. At this point, keeping fingers crossed may be better.

The Greek banking landscape has changed dramatically in less than two years with some 12 non-core banks having been resolved or acquired by bigger, so-called systemic credit institutions. Post-recapitalization, the local banking sector is dominated by four core banks, namely Piraeus, Alpha, National and Eurobank, which account for more than 90 percent of total deposits and loans in the country. Attica Bank, a small, non-core credit institution, was the only one that managed to raise the necessary capital from other sources to retain its independence.

The four core banks received a total of 25.5 billion euros from the HFSF (Hellenic Financial Stability Fund) in the form of EFSF bonds, and private investors put an additional 3.1 billion in Piraeus, National and Alpha to satisfy the identified cumulative capital requirement of 28.6 billion for the four banks. The assessed capital requirement of each bank by the authorities took place in the first quarter of 2012 and reflected the losses from their bond portfolios due to the Private Sector Involvement (PSI) deal, the results of the diagnostic tests on their loan books conducted by BlackRock, and some other risks.

Upon completion of the recapitalization, all four core banks ended up with core capital adequacy ratios of 9 percent or higher. Piraeus and Alpha are more adequately capitalized, benefiting from recent acquisitions. Among the four pillar banks, Eurobank stayed in state hands while the other three core banks managed to raise more than 10 percent of their capital share increases from the private sector and remain under private management control.

Nevertheless, the deterioration in the credit quality of their loan books on the heels of the deeper recession since the assessment of the capital needs took place in February-March 2012 and the possible changes in Greece’s macroeconomic outlook looking ahead are calling for a reassessment. This may be affected by the review of the provisioning policies applied to loans in arrears for more than 90 days, the restructured loans and the review of the banks’ distress credit operations.

There is no doubt the key to cleaning up the banks’ balance sheets is nonperforming loans (NPLs). There appears to be a strong relationship between NPL formation and the changes in the unemployment rate and therefore the course of the economy over the years. The banking system’s ratio of nonperforming loans to total loans is seen above 31 percent at the end of June 2013 from 24.5 percent in the fourth quarter of 2012. However, analysts have observed a deceleration in the formation of NPLs in the last few quarters which is consistent with the slower pace of GDP contraction and smaller rise in the unemployment rate. Still, the NPL ratio is projected to rise further and peak at some point next year due to the lagging effect. In addition to decelerating new NPL flows, Greek banks will have to cope with the large existing stock.

Bankers are hopeful internal capital generation in the next five years or so on strong pre-provision profits as the economy recovers, the disposal of non-core and other assets and existing capital buffers will suffice to cover any new capital needs identified by the new stress tests on loans. They think the new tests will put their capital needs between 5 and 7 billion euros. If they are right, they will not have to resort to fresh share capital increases.

However, others are more cautious. In addition to concerns about low GDP growth rates and a jobless recovery going forward, they caution against a major change in the provisioning policy with regard to restructured loans. These loans, estimated in excess of 70 billion euros, have been restructured to help companies and individuals paying interest and principal during a tough economic period. They also say negative surprises from problematic loans parked abroad cannot be ruled out but they question whether it is possible to track them.  

Another issue may be the percentage of provisions set aside by banks on existing NPLs, the so-called coverage ratio. If the authorities decide the value of collateral, such as property, should be lower than estimated and the banks will have to take bigger provisions now, the capital needs will rise markedly. This is a tough, perhaps political decision, because the value of the collateral should go up in the future assuming the Greek economy recovers in 2014 and grows at a satisfactory pace afterward as projected in the adjustment program.

All in all, caution may be warranted before the review of distressed credit operations is completed, other procedures on collateral recovery and debt enforcement are designed and provisioning policy is determined before any conclusions on the banks’ capital needs are drawn. The capital buffer of approximately 9 billion euros at the HFSF is there to be used if necessary but no one would like the situation to reach that point.

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