Wednesday, September 3, 2014

ECB Stress Tests --- Piraeus Bank et. al.

Wonderful times are approaching for all those who have been worried about the stability of the financial system: by late October 2014, so I understand, the ECB will announce the results of their multi-month examination of the roughly 120 “too-big-to-fail-banks” in the Eurozone. When all is said and done, we will know – so we are lead to believe – which banks are zombies and need to be resolved in an orderly manner and which banks have capital insufficiencies which need to be replenished within a short period of time. All other banks, in all likelihood the great majority of them, will pass the stress test successfully. They can be considered as ‘safe’ going forward. No more worries to be had about the stability of the financial system of the Eurozone!

I predict that the most interesting section of the ECBs report will be the one outlining the ‘qualifications’, the ‘provisos’, the ‘subject-to’s’, etc. Obviously, the ECB will not make any outright statement as to which banks are definitely ‘safe’ for the simple reason that one can never make such an across-the-board judgment about any bank.

Particularly the 4 large Greek banks will be interesting cases to watch. They have all published their financials for the first 6 months of 2014 recently. The common denominator is that roughly one-third of their loans are non-performing. I would argue that any bank (or any group of banks) which has about one-third of its loans in the non-performing category cannot be objectively judged as to its financial stability. Period!

In its examination, the ECB has to start with official financial statements and question those wherever appropriate and/or necessary. An uninitiated outsider might wonder why official financial statements need to be questioned when they are audited by reputable auditing firms. The disappointing answer is that one can do a lot of things with numbers even within the strict rules of International Financial Reporting Standards. Here is a case in point involving Piraeus Bank.

Piraeus Bank reported total net revenue (before operating expenses) of 1,374 MEUR for the first 6 months of 2014. Included in that net revenue is a 144 MEUR ‘gain resulting from the replacement of one the two acquired loans of Marfin Investment Group (MIG) companies with a convertible bond inssued by MIG’. Now that really sounds impressive because it suggests that MIG was able to raise fresh money via a convertible bond to pay back bank loans which had already been written-down by the lending bank. Quite a feat!

Unless, of course, the lending bank receiving repayment of its previously written-down loans and the bank buying the new convertible bond are one and the same bank --- Piraeus Bank. Then, the above-mentioned 144 MEUR gain is nothing other than a gain manufactured by fancy business practices and fancy (though not incorrect) accounting.

I have described in previous articles why, in my opinion, MIG – the holding company of the Marfin Investment Group – is a classic case of a financial zombie (here and here). If the P+L statement of a bank is heavily influenced by gains from a fancy deal with a financial zombie, one wonders how many other fancy deals are recorded in the official financial statements of the 4 large Greek banks.

And one really wonders how the ECB will deal with such issues!

PS: these issues obviously apply to all banks and not only to the Greek ones.


  1. Let us hope that the ECB will read your text!

  2. Supposing the ECB follows a strict policy and the stress tests for Greek banks prove them all zombies. If that becomes the case, then what do you forsee that would come up next for the Country and its subjects?

  3. Of cause you cannot make an objective evaluation of banks with one-third of their loans non-performing, the stress test is mental masturbation. With Greek banks it is even worse, considering the tradition of giving economic amnesty to debtors of all sorts. Do I believe there is collateral for the loans? No.
    Now, I know that it is pure coincident that the 70 billion EUR non-performing loans correspond to the 70 billion EUR that disapeared from Greek bank accounts from 2009 to 2013.

  4. Ismtherenany indication that pireus underwrote the bulk of the convertible. Are there market prices?
    If the underwrote the new bond, absnt a market price, they nevertheless would have to write down the loan:according to ifrs a loan has to be booked at fair value at initiation...althoug most banks/auditors dont follow the rule

    1. Marfin's June 16 announcement said that all convertibles were bought by Piraeus for 252 MEUR and that the proceeds would be used for repayment of bank loans. They don't say bank loans due to Piraeus but that can safely be assumed. The August 28 announcement said that trading of the issue would now begin.

      The way I see this is: Piraeus disbursed 252 MEUR for the convertibles and received back 252 MEUR as repayyment of loans which had already been written-down and carried at 144 MEUR less than face value. Thus, they realized a gain of 144 MEUR through this pay-out take-back transaction. I am sure it is all in accordance with IFRS but IFRF allows a lot of crazy things. Here a gain of 144 MEUR was shown which is nothing but hot air.

    2. @MS
      This was most revealing; thank you! So the press had picked up this issue at the time and they must have been quite critical, otherwise Piraeus would not have considered it necessary to make a clarifying announcement. This is the key sentence:

      "Piraeus Bank has acquired for a consideration of €165 million loans, bonds and shares of aggregate value in excess of €325 million, making this a highly profitable transaction while at the same time reinforcing the financial health of MIG Group".

      75 MEUR is a loan to RKB, the Serbian borrower. RKB recorded a net loss of 20 MEUR in 2013. No need to worry because the loan is said to be 'overcollateralized with first mortagages'.

      250 MEUR are obligations of MIG, the holding company, of which 90 MEUR will be converted to equity.

      That combined package of 325 MEUR of overcollateralized loans to a money-destroying Serbian borrower and other claims against a de facto insolvent holding company was purchased for 165 MEUR. A great deal if you think the package is worth 325 MEUR, as Piraeus seems to suggest. Not so great a deal if the MIG group collapses in which case Piraeus could sell the real estate in Serbia and walk away free and clear from the holding company. No way that anything close to 165 MEUR could be realized in that scenario.

      It all boils down to the question of what kind of a risk the MIG Group is. The ECB will make that kind of an evaluation. Based on that, the ECB will determine what the appropriate value of Piraeus' loans to MIG are worth. That would be an interesting read if only if it were made public!

      My own assessment of the MIG I have made a little while ago and I link it below. In short: that group is dead in the water and being kept afloat by a bank which throws good money after bad in order to avoid that the whole thing blows up.

      Piraeus does its best to portray MIG as a winner. It certainly is no winner today. To proudly announce that one has taken a profit of 144 MEUR from a company which is dead in the water is what I would call 'aggressive communication'. Or plain stupid.

  5. I see, but this would not be in accordance with Ifrs as they would have to book the loan at fair value which in this case cannot be argued to be the principal, i.e. 100. as I said, auditors do not follow this rule as long as they can somehow argue convincingly. But in this case, since the amount is a) material and b) evidently not arms length, I think the auditors are walking on very thin ice. Funny the stock still trades above book...

  6. @Viennacapitalist
    Upfront: I don’t think that 144 MEUR are going to make or brake Piraeus. That was not my point. Instead, my point was/is that if Piraeus can happily report one such transaction without fearing any repercussions, how many other such transactions take place within Piraeus and, more importantly, within the Greek banking system?

    If this had been an arms-length transaction, it would have been a great success, namely: a de facto insolvent holding company, MIG, would have successfully raised 252 MEUR from third-party investors and would have used that money to repay a bank which had already written down its loans to MIG by 144 MEUR. Piraeus would have been able to dissolve 144 MEUR of its loan loss provisions, thus improving its net allocations to the loan loss provision. No one would have heard about it because, in order to find traces of the deal, one would have needed details of loan loss provision movements which not even IFRS requires to be published (IFRS requires the publication of additions to and dissolutions of the loan loss provisions but it does not require the publication of customer names and/or deals).

    Since this was an inside deal between Piraeus and MIG, one really has to wonder why they published the details. Piraeus would have had to publish its subscription of 252 MEUR of a MIG-convertible bond. MIG could have published that the funds would be used to repay bank debt in general. But no one would have needed to publish that it was exclusively Piraeus loans which were repaid and, much more importantly, that Piraeus took a 144 MEUR gain on the transaction. Maybe Piraeus thought they would come across as smart if they published to have taken a 144 MEUR gain on a de facto insolvent holding company. If that had been the case (which would have been the case if the convertible had been at arms-length), then it would have been a stroke of genius on the part of MIG (or great luck).

    The more likely explanation, in my mind, is that Piraeus knew of course that this was a shady way to record a profit and instead of keeping it secret and running the risk that someone would eventually find out about it and cause negative headlines, they escaped ahead and published it like it was the most natural transaction in the world.

    Mind you, the transaction was not bad per se, even as an inside deal between Piraeus and MIG. It is essentially a debt-equity swap without any increase to the overall Piraeus exposure to MIG. Piraeus may well be in a stronger position as a holder or equity and/or convertible bonds than as a lender. And above all --- Piraeus may be able to unload some of its convertible bonds to investors (I am sure that the retail arm of Piraeus already has a marketing strategy in place to convince innocent savers to buy those convertibles!). In that scenario, Piraeus would indeed reduce its own risk to MIG. As a market maker in those convertibles, Piraeus could make sure that the prices remain firm in order to avoid mark-to-market adjustments.

    What it really boils down to is the question how Piraeus goes about recording profits. In 2013, they recorded profits which included 3,8 BEUR on the income side as negative goodwill. In this particular deal, they recorded 144 MEUR as income whereas it is nothing other than up-writing the value of claims against MIG. My conclusion is that Piraeus does not have a lot of inhibitions to record profits which may not really be profits (because they don’t even make a secret out of it). And what if this lack of inhibitions to record revenues is accompanied by complete inhibition to show losses where losses occur?

    And, finally, what if all Greek banks operate the same way?

  7. Fully agrre Klaus, I was suspicious from the begininnig about Pireus accounting as outlined in my blog posts- I mean they had a substantial double digit percentage of their loan book 90 dpd WITHOUT having booked any provision against them. Od course greek banks are operating in a shaddy way, how can you have a crisisi of such proportions without any major bank failing? answer: agressive accounting ( with the consent of regulators and auditors who understand that once the house of cards unravels it is game over for them). This doesnt surprise me, what I dont get into my head is how reputable investors ( einhorn, paulson, klarman) hold this stock above book- i simply fail to understand....

    1. I have pondered that very same question over and over again. The only possible answer that I can come up with is that the Greek government has a splendid track record of solving the banks' problems in an extremely shareholder-friendly way (case in point the recent recaps). Presumably, Einhorn & Co. feel confident that the Greek government will continue to do that in the future.