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Monday, May 26, 2014

One Helluva Way To Increase Bank Equity!

The Annual Report shows that 2013 was an outstanding year for Piraeus Bank: it reported a net income of 2,5 BEUR which it retained to strengthen equity. Together with capital increases from the outside (HFSF, etc.), Piraeus could increase its equity by 10.9 BEUR as shown by the below table: (in MEUR)
 
Equity 01 Jan 13
-2,324

Net income 2013 2.546

Capital increases 8.321 +10.867



--------
Equity 31 Dec 13
+8.543

Relative to the equity at the beginning of the year, which was negative, the 2013 net income represented an infinitely high ROE. Relative to the increased equity at the end of the year, it was still an outstanding ROE of 30%! Equity at year-end represented 9% of total assets, which is not outstanding but still a lot better than at many other large banks.

How could Piraeus be so profitable in 2013? Because it recorded a one-time revenue of 3,8 BEUR. Without this one-time revenue, Piraeus would not have reported a net income for 2013 of 2,5 BEUR but a net loss of 1,3 BEUR, instead.

The one-time revenue of 3,8 BEUR stemmed from the acquisition of other banks which Piraeus could acquire by paying 3,8 BEUR less than those banks were worth according to their books (the technical term is 'negative goodwill').

(in MEUR)

Greek operations of Cypriot banks +3.414
(Bank of Cyprus; Cyprus Popular Bank; Hellenic Bank)
Geniki Bank SA
+4
ATEbank SA

+84
Millennium Bank SA
+308



---------
Total negative goodwill



+3,810

What stands out is the 3,4 BEUR one-time gain on the acquisition of the Greek operations of Cypriot banks. This means that Piraeus could buy assets (loans, etc.) for 3,4 BEUR less than what the books showed they were worth. Two scenarios unfold:

Scenario 1: those assets were indeed worth what the books showed and Piraeus could strike a bargain by paying 3,4 BEUR less for them. In that scenario, the 3,4 BEUR would have been a real revenue and it would have represented real increased equity for Piraeus. One wonders, however, why the sellers would simply give 3,4 BEUR of value away. The representative of the sellers could be sued by other creditors for damaging their interests.

Scenario 2: Piraeus paid a fair value for those assets because they were never worth what the books showed. In that scenario, to show the 3,4 BEUR as revenue (and equity) means showing something as revenue (and equity) which does not exist. The proper action would have been to make a loan loss provision of 3,4 BEUR to offset the ficticious one-time gain.

Time will tell. If Piraeus doesn't have to write-off any of the assets it bought, it struck an extraordinary bargain by acquiring those assets. If, however, those assets were really not worth more than what Piraeus paid for them, then the 3,4 BEUR of revenue and equity is nothing other than hot air which will evaporate as loans are written-off in the future.

The total of 3,8 BEUR which Piraeus recorded as revenue from negative goodwill is now part of Piraeus' total equity of 8,5 BEUR. In other words, 45% of the total which Piraeus reports as equity could possibly be nothing other than hot air. If one were to adjust the equity by that 'hot air', the equity/assets ratio would decline from an acceptable 9% to an unsatisfactory 5%, as shown below.


Annual
Adjusted

Report





Equity8.543
4.733
% of Assets9%
5%

The financial statements of Piraeus Bank are prepared according to IFRS and audited by PwC. Thus, one can assume that all accounting principles and rules have been observed in the preparation of these statements. It seems that it is possible to do both --- to fully comply with accounting rules on one hand and to create 3,8 BEUR ficticious equity out of nothing on the other.

The more conservative (if not more responsible) way would have been to book assets at the value which one paid for them, and to recognize any gains if and when they occur. That way, of course, Piraeus would have posted a loss for 2013 instead of a profit and it would report only a little more than half of the equity which it actually showed.

One helluva way to increase a bank's equity!

4 comments:

  1. Very interesting comments from you KK and Viennacapitalist.

    Before months in a parliamentary committee some members ask governor of GCB G Provopoulos about the negative goodwill (they perceive them as profits) that Piraeus had. The explanation (as i understood it ) was "that negative goodwill is not a profit and should considered as a part of loan loss reserve that Piraeus Bank probably will deal, the years to come".(It's accounting)

    What you asked in Viennacapitalist is important:

    1) Why didn't make simultuneous provision to the loan loss reserve?

    2) And how it came about 3.8 b € negative goodwill ?

    In the 3M/2013 page 4/25

    Negative goodwill due to the acquisition of assets and liabilities of Cypriot banks network in Greece was 3.413 b €

    In the same page, profit before provisions, impairment and income tax 3.542 b €.

    In FY 2013 page 54/248

    Total Net Income (with negative goodwill): 5.945 b
    Total Operating Expenses before provisions: 1.637 b
    Profit before Provisions, Impairment and Income Tax 4.308 b

    They state that, 4.308 b € was a profit before provisions etc

    According to this

    http://www.investinganswers.com/financial-dictionary/debt-bankruptcy/loan-loss-reserves-2790

    " Loan loss reserves are accounting entries banks make to cover estimated losses on loans due todefaults and nonpayment.

    If and when Bank XYZ decides to write ALL or a PORTION of a loan off, it will remove the loan from its asset balance and also remove the amount of the write-off from the loan loss reserve.
    The amount deducted from the loan loss reserve MAY BE TAX DEDUCTIBLE for Bank XYZ."

    http://www.ekathimerini.com/4dcgi/_w_articles_wsite2_1_14/01/2014_535885

    For Greek banks the full amount of available deferred tax assets (from 20% to 100%) will help them with their capital adequasy basis. Greek banks can offset deferred tax (5 b € ) from PSI+ in a period of 30 years.

    (Irrelevant, the following, but is there a possibility?)

    http://www.taxjustice.net/2014/05/22/seems-credit-suisses-fine-may-tax-deductible/


    In FY 2013, NOTE 48 page 141 / 248--- shareholders equity was 3,937 b €. Negative goodwill was 3,413 b € and 524 mil euros the cost of aquisition.

    According to this :

    http://in.mobile.reuters.com/article/bankingfinancial-SP/idINL3N0CQ3I320130403

    " Piraeus acquired assets with a value of 16.4-19.2 billion euros. It also took on 15 billion euros of deposits. At the mid-point of these two valuations, the Greek operations had a net asset value (NAV) of 2.8 billion euros. Piraeus’ purchase price of 524 million euros amounts to a pretty low 19 percent of that NAV.
    When Laiki’s directors saw the deal negotiated on their behalf, they concluded the Greek branches had to be recapitalised by about 2.8 billion euros before being sold, according to Reuters."

    The issue is how the acquirer of a bank oversight credit deterioration in order to determine the fair value of the loan portfolio, especially when there is uncertainty for future credit losses.
    When real cash flows differ from expected cash flows, the acquirer may need to adjust the loan discount accretion, the loss-share asset, and perhaps EVEN ESTABLISH A LOAN LOSS RESERVE when anticipated cash flows to be lower than initially expected.

    Also in Cyprus Mail news:"Court freezes Vgenopoulos assets"

    http://cyprus-mail.com/2014/05/23/court-freezes-vgenopoulos-assets/

    Very interesting--- in relation to TIME FACTS--- is the following link:

    http://www.fergusmurraysculpture.com/2013/05/21/another-day-another-another-3-4-billion-euros/

    "Michalis Sarris, ex-Laiki chair January to August 2012 told the parliament's Ethics Committee of “strange” loans worth around €4bn where the collateral, people and interest rates of those loans were 'strange'. He declined to provide further details over concerns that it could hurt potential court procedures."

    Also the title "Piraeus Bad Loan provisions"


    MS

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    Replies
    1. If Provopoulos said what you quoted above, he said exactly the right thing except he shouldn't have said 'in the years to come' but, instead, 'right away'. As of now, the negative goodwill is still part of net worth.

      On page 90 of the Annual Report, you will find all the numbers regarding the negative goodwill from the Cypriot operations: http://www.piraeusbankgroup.com/~/media/Com/Downloads/Investors/Annual-financial-report-2013en.pdf.

      Reuters seems to be the only media which got this story right.

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    2. I haven't found the exact words of G Provopoulos, so it's possible to have said "right away". My sense was that he was referring to the future.

      3 questions:

      1) Negative goodwill is recorded in income statement, but NOT ALL negative goodwill AT ONCE?
      2) After the aquisition of the banks - PB should test fair value of the acquired assets for impairment?
      3) So if let say PB, acquire and future losses, the negative goodwill is deferred and recognized on the income statement, when those future losses, occur?

      MS

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    3. As I said in the article, the ENTIRE 3,8 BEUR was recognized as income. Of course, assets have to be tested for impairment, be they acquired or not. The future losses will occur if and when the bank decides that the assets need to be written down. Below is a detailed analysis of Piraeus Bank:

      http://viennacapitalist.com/2014/04/17/greek-banks-what-are-david-einhorn-and-john-paulson-thinking-part-1/
      http://viennacapitalist.com/2014/04/22/greek-banks-what-are-david-einhorn-and-john-paulson-thinking-part-2/

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