Banks face capital threat
The continuous downward revisions in earnings estimates have hit hard heavyweight Greek bank shares in the last three years, pulling the Athens Stock Exchange sharply lower with them. Even though many analysts expected bank share pressures to subside, there seems to be no letup as deteriorating world economic and market conditions take their toll, raising new questions about Greek banks’ strategy to rely on high lending growth rates to boost core earnings. Indeed, figures show the Athens general stock index has come down 33.27 percent since the beginning of the year to close at 1729.45 points on Friday, while the bank subindex has recorded losses of 41.04 percent in the same period. OTE shares have fallen 38.69 percent year-to-date, losing 22.62 percent since August 29, the announcement day of first-half financial results. Based on MSCI data, the MSCI-Greece stock index, widely used for benchmarking purposes by foreign institutional portfolios, was down 36.57 percent year-to-date as of Friday, ranking sixth from the bottom among developed stock markets. Sweden, Finland, Germany, Ireland and France performed even worse, recording losses of 49.36 percent, 47.81 percent, 47.57 percent, 40.35 percent and 39.11 percent respectively. If the collapse of the heavyweight Hellenic Telecommunications Organization (OTE) share paved the way for the drop in the Athens general stock index below the psychological 2,000-point level in September, it was the dismal performance of the Greek bank shares last week which set off the Athens bourse’s most protracted decline in the last few years. The Greek bank subindex fell some 7.5 percent last week alone. Even though the large Greek banks have been out of favor with brokers, analysts and local and foreign institutional investors for a long time, the aggressive liquidation of their shares last week caught some off guard. Others thought the sell-off was justified, based on economic fundamentals. The sharp drop in most Greek banks’ estimated earnings this year, coupled with the collapse of major European bank shares, rendered the P/Es (price-to-earnings), P/BV (price-to-book value) and ROE (return-on-equity) of Greek banks dearer compared to the European banking sector averages. Some of them even said in off-the-record conversations that last week’s sell-off did not close the valuation gap with the rest of Europe and they foresee more pressure ahead unless other European bank shares recover. Although the majority of analysts seem to share the view that at least three out of five large local banks – namely Alpha Bank, Commercial Bank, EFG Eurobank Ergasias, National Bank and Piraeus Bank – will report higher earnings per share next year, they are concerned about the ability of some large banks to continue to expand into promising retail banking in the face of shrinking profits and their limited capital base. It is known that most Greek large banks, with the exception of EFG Eurobank Ergasias, relied heavily on trading gains from their bond and stock portfolios to boost their profits in the runup to Greece’s EMU membership in the late 1990s. The last convergence gains and a world bull market in government bonds produced hefty gains in 2000-2001, helping local banks partially offset the shrinking trading gains from stocks and capital losses from holdings in closed-end funds, insurance companies and others. The protracted stock market decline and the limited gains from government bonds have hit revenues hard this year. This, coupled with limited progress in containing administrative expenses caused by expansion into retail banking, have compressed the three large banks’ earnings by 50 to 70 percent in the first half of 2002. On the other hand, the push into retail banking – mainly mortgage and consumer loans – has soothed the pain and enhanced banks’ operating profits so far. Nevertheless, analysts are concerned that the negative impact from the prevailing adverse capital market conditions on the large Greek banks’ balance sheets has yet to fully materialize. They say banks will be forced at the end of the year to take a significant charge for capital losses stemming from their stock portfolios and other company holdings. This will reduce their equity capital at a time when their loan books are experiencing double-digit growth, necessitating fresh capital injections in some cases. Although the magnitude of capital losses differs from bank to bank, the same analysts point out that at least one large bank will record large enough capital losses to materially affect its capital base and capital adequacy ratio at end-2002. They say most large banks appear to be well capitalized to accommodate such a charge but some, like Alpha Bank, will have to take measures to boost their capital base. Alpha Bank, which follows a capital-demanding strategy of aggressive expansion into the competitive corporate loan market as well as the mortgage market, has relied on Tier II capital, taking out a 75-million-euro subordinated loan at Euribor, plus 90 basis points last month, to boost its equity capital and raise its capital adequacy ratio to an estimated 9.6 percent against a required 8 percent. This is so because adverse stock market conditions make a share capital increase (Tier I capital) a difficult exercise. Falling profits and a genuine desire to distribute dividends to shareholders do not help, either. Moreover, analysts say Tier II capital is more expensive than Tier I capital. Banks relying on it will have to take into account their own cost of borrowing when they price their loans, making themselves less competitive. They contend that high loan growth rates cannot be supported by Tier II alone and at some point banks will have to resort to a share capital increase to boost their capital base even if that has to be done at a deep discount to market share prices, something that markets are not fond of. Top bankers and analysts alike also seem to be worried about potential hidden «liabilities» in some banks’ balance sheets to be revealed when IAS (International Accounting Standards) are introduced next year. However, Alpha and EFG Eurobank Ergasias already produce results under IAS while National Bank of Greece also files under US GAAP. So, there should be very few surprises, if any, from them. At the same time, there may be some positive surprises from their real-estate holdings, which will have to be marked to market, producing hefty capital gains in the case of National Bank. There are reasons for analysts, bankers and others to be concerned about issues such as the recapitalization of some banks in the context of high loan growth rates, declining profits and gradually tighter capital bases. Nothing can address those concerns more convincingly than the banks’ quest for higher profitability. Their fate is in their own hands.
