Push to increase bank capital ratios reflects possibility of modest haircut

The prospect of early general elections spooked the market in Greek government bonds and stocks, reversing recent gains but did not scare another large local lender, Piraeus Bank, from going ahead with a sizable rights issue to the tune of 800 million euros. This was yet another sign that Greek banks are bracing for the tougher economic times ahead and preparing for a possible restructuring of public debt as the European Union prepares a new permanent system to handle sovereign debt crises after 2013 where private bondholders will share part of the pain in the form of a bond haircut in a debt restructuring. Following the example of National Bank of Greece, the country’s largest commercial bank, Piraeus Bank announced its intention last Friday to seek shareholder approval for a 800-million-euro rights issue, underwritten by four large international banks, namely Barclays Capital, Credit Suisse, Goldman Sachs and Morgan Stanley. There is little doubt that the surging yield spreads of Greek bonds over the German equivalent on the prospect of early general elections raised by Prime Minister George Papandreou last Monday night made it tougher for the Greek bank. It should be noted that the 10-year Greek bond yields 10.6 percent at present, that is, 814 basis points over the similar German bund, compared to some 9.3 percent about 10 days ago. Nevertheless, it is a positive sign that Piraeus Bank has decided to go ahead with a rights issue and also to seek approval for up to 250 million euros for a convertible bond issue that is not expected to be tapped for at least six months, following the completion of the rights issue. The country’s fourth largest lender wants to boost its capital adequacy ratios in anticipation of a challenging economic environment marked by a further rise of loans in arrears. Analysts expect nonperforming loans as a percentage of total loans to reach 12 percent and a peak of even higher next year in Greece from an estimated 9.0 percent at the end of June and 7.7 percent at the end of 2009. National Bank recently completed a share capital increase of 1.8 billion euros and aims to sell a 20 percent stake in its Turkish subsidiary Finansbank in the first quarter of 2011 to further boost its equity capital. Executives from both Greek banks have communicated to the market that their capital-enhancing exercise is not related to M&A deals but aims at strengthening their capital adequacy ratios and help them obtain greater access on the interbank market. It is well-known that local banks depend a lot on cheap European Central Bank (ECB) liquidity to fund their assets and would like to gradually disengage and reduce their dependency by tapping the interbank market, where one banks lends to the other for larger sums, even though this is a much more expensive exercise at this point. Although no Greek banker that we know of would like to admit it in public, boosting a bank’s equity capital is also a precautionary move aimed at shielding it from a haircut on the value of Greek government bonds in the future. It is estimated that Greek banks own more than 50 billion euros’ worth of Greek government bonds and most have been placed in the held-to-maturity portfolio. This means they do not have to mark to market their bonds on a daily basis, which would have had an impact on their profit-and-loss statement or their equity capital. Moreover, Greek banks appear to have become more leveraged to local securities at the same time that other European Union banks and institutions are able to unload them onto the ECB, the International Monetary Fund and the other eurozone countries. If this trend persists, local banks will be more sensitive to developments in the Greek bond market in 2012-2013 than other EU and foreign banks. This is not good news at a time when Germany is pushing hard for the creation of a permanent mechanism to deal with future sovereign crises where private bondholders will also share the pain in the form of a haircut. Of course, all bankers hope that Greece will be able to fund its borrowing needs on the markets by that time and there will be no need for the country to enter the permanent mechanism. However, no one can be sure, especially when the existence of this mechanism itself may scare banks and others away from lending to weak countries, such as Greece, forcing them to sign on to continuing to fund their needs. In this regard, local banks’ push to strengthen their capital adequacy ratios is a prudent move because it also takes into account the possibility of having to take a modest haircut in Greek government bonds in the next couple of years if German Chancellor Angela Merkel has her way with the new permanent mechanism.