Rising loan delinquencies and declining public confidence will require banks to recapitalize. Based on their Texas ratios, they are already bankrupt, according to U.S. economist Steve Hanke.
By Robert Stowe England
July 11, 2015
With or without a new bailout package for Greece, it will take more than a green light by the European Central Bank to raise the Bank of Greece’s ceiling for Emergency Liquidity Assistance to undo the damage done from the capital controls imposed Greek banks on June 29. Indeed, their financial condition was already deteriorating over the course of the last six months, as customers withdrew more than €40 billion in deposits. When the banks re-open, there’s worry the exodus of deposits could resume.
With hope rising for a new bailout package for Greece, it will take more than a fres flow of funds from the European Central Bank to the Bank of Greece and out to the Greek economy to undo the damage done by shutting down the banking system for two weeks except for small daily withdrawals for 60 euros. Greece’s banks have been weakened by the shutdown and public confidence on the banking system, already declining, has fallen sharply lower.
Buffeted by a rising tide of bad loans on a thin capital base, Greece’s largest banks are sailing toward bankruptcy, according to Steve Hanke, professor of applied economics at Johns Hopkins University in Baltimore and director of the Troubled Currencies Project at the Washington, D.C.-based Cato Institute, which monitors currencies that are in trouble. “The banks are on tenterhooks. They have almost no good collateral to even go the European Central Bank to get more liquidity and they are probably insolvent,” Hanke says.
Non-performing loans on Greece’s banking system reached €78 billion at the end of the first quarter of 2015, representing 35 percent of bank portfolios, according to the Bank of Greece, up from 34 percent at the end of 2014. Nearly half of all consumer credit was in arrears, while 35 percent of business loans and 30 percent of mortgages were delinquent. Banks have reserved €50 billion to cover losses on the troubled loans.
The four largest Greek banks – the National Bank of Greece, Piraeus Bank, Eurobank Ergasias, and Alpha Bank – hold €346.4 billion or 87 percent of €397.8 billion assets in the Greece’s banking system. “They have huge dominance,” says Hanke. Given their central role to the economy, Hanke argues, the Big Four will have to be recapitalized to salvage the Greek economy, which declined 0.4 percent in the first quarter is expect to decline the rest of the year.
Hanke’s gloomy analysis is based in part on the fact the Texas Ratio scores for Greek banks have risen to a level that in the past has predicted bank failure. The Texas Ratio was devised during the U.S. savings and loan crisis of the 1980s by RBS Capital bank analyst Gerard Cassidy to identify banks and thrifts likely to fail and helped identify which bank and thrifts were like to fail in New England during the 1990s.
At year-end 2014, the Texas ratio for Greece’s four largest banks was at or above 100 percent. Any measure above 100 means that the book value of all bad loans and foreclosed real estate is greater than the bank’s entire tangible equity plus loan loss reserves. “If you have a ratio over 100 percent, there is a high probability the bank will end up being insolvent if those nonperforming loans ultimately have to be written off,” explains Hanke. The National Bank of Greece has the best Texas ratio at 98.7 percent. The other three are higher: Eurobank Ergasias, 124.7 percent; Alpha Bank, 129.4 percent; and Piraeus, 195.1 percent.
The Texas ratio, while very useful, can still mask weaknesses, according to Hanke. For example, a dominant share of Greek bank equity is made of up a tax deferred assets. Hanke calls such deferred tax assets “phantom capital” because they are only useful to offset future earnings and offer no real capital buffer in a time of crisis when banks are unprofitable. At the Big Four banks tax deferred assets range from a low of 38 percent of tangible equity capital at the National Bank of Greece to high of 61 percent at Eurobank Ergasias. Taking out tax deferred assets from the capital, adjusted Texas ratios give a grimmer but more accurate snapshot of the Big Four, according to Hanke. For example, the adjusted Texas ratio rises to 122 percent for National Bank of Greece. It rises to 265.5 percent at Piraeus Bank.
Hanke points to the steady decline in money supply as a key culprit in the deteriorating outlook for Greek banks. According to the Bank of Greece, the nation’s central bank, the M3 measure of money supply fell 16 percent year-over-year in May, falling from €193.6 billion in May 2014 to €161.9 billion in May 2015. Worries about the Greek banks are also draining away deposits. Even thought depositors added funds to the banking system most of last year, since last fall deposits at Greek banks have plunged 22 percent or €39.9 billion, falling from €178.5 billion in October 2014 to $138.6 billion by the end of May, according to the Bank of Greece.
To boost falling capital ratios, banks are also scaling back the size of their loan portfolios by not making new loans and refusing to roll over some loans when they come due. As a result, loan portfolios at Greek banks shrank from €235.5 billion in January 2015, a recent peak, to €229.6 billion in May. “There is no money and credit being produced in the banking system,” Hanke says. “That means the depression they are going to have in Greece is going to be massive when compared to what it’s been in the past.”
With deposits falling, Greek banks are growing more vulnerable to restrictions on how much emergency liquidity assistance the European Central Bank will allow the Bank of Greece to provide to Greek banks to compensate for loss of deposits at banks. “Greek banks are now almost as reliant on funds from the Eurosystem . . . as they are on the customer deposits,” Moody’s Investors Service stated in a comment by analysts Alpona Banerji, Nondas Nicolaides and Colin Ellis on June 22.
Greece’s banks were shut down June 29 for six days to prevent their collapse a day ahead of Greece’s default on a €1.6 billion debt payment to the International Monetary Fund with withdrawals limited to €60 a day. On July 6 the capital controls on the bank were extended through July 9. Also on July 6, the day after Greek voters soundly defeated the European Union’s austerity proposals in a referendum, the Governing Council of the ECB held steady its €89 billion cap on emergency liquidity assistance but also tightened the screws by requiring the Bank of Greece to apply haircuts to the collateral from banks for the funds the central bank advances under the emergency program.
Resolving the Greek crisis will necessarily also mean finding a way to bolster confidence in the banks by boosting their capital levels. The banks last year raised €8.3 billion in private capital but now need additional capital injections to bolster their balance sheets. Without the capital, the banks will continue to shrink their balance sheet to compensate for rising levels of non-performing loans and falling deposits, starving the Greek economy of money, its economic lifeblood, according to Hanke.
While in the past the banks could have gone to the financial markets to raise real equity capital, the window of opportunity may be closing. “That’s just not going to happen because the price of shares in the banks is way below book value,” Hanke says. More shares would just completely dilute the value of existing shares, he argues. A second option, going to the Greek government for capital injections, is “improbable,” says Hanke, because the government has no money to do the recapitalization. A third option would be to have the European Union recapitalize the bank and, in effect, take ownership of the Greek banks – but that may be politically impossible, he adds.
One viable option, say Hanke, would be for the Greek government to privatize some of its considerable holdings of land and buildings to raise the cash to capitalize and nationalize the banks, a more politically palatable resolution. “That should be their top priority because without the banks functioning you have an engine shut down that normally supplies 87 percent of the money in the system,” says Hanke.