«BLUEPRINT SERIES 25 EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHS Dirk Schoenmaker and Nicolas Véron, editors Thomas Gehrig, Marcello Messori, ...»
The ECB acted throughout on the assumption that Greece would remain in the euro area, and thus continued to approve liquidity provision through the ELA even as the banks’ solvency ratios deteriorated together with the Greek economy. According to President Draghi, the ECB had to walk a tightrope between ensuring sufficient liquidity for Greek banks and putting euro-area financial stability at risk: “I don’t want to underplay the difficulty that the ECB and the Governing Council of the ECB had in the last few weeks about having to take decisions between making sure the payment system continued to work, liquidity provision, monetary policy and not to amass excessive risk for the euro system all at the same time”87. Whether Greek banks were 86 ECB press release (2015) ‘Eligibility of Greek bonds used as collateral in Eurosystem monetary policy operations’ 4 February, https://www.ecb.europa.eu/press/, pr/date/2015/html/pr150204.en.html.
87 ECB press release (2015) ‘Introductory statement to the press conference (with
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Mar-16 Source: Bank of Greece.
still solvent by mid-2015 is debatable. President Draghi confirmed the SSM assessment that they were solvent on a static basis, since they fulfilled the minimum requirements of common equity Tier 1 (CET1) capital of 4.5 percent and a total capital ratio of 8 percent. However, he implied that on a forward-looking basis Greek banks were “failing or
likely to fail”:
“However, [...given] the enormous influence that the quality of the government paper has on the solvency of the banks88, well, you Q&A)’ 16 July, https://www.ecb.europa.eu/press/pressconf/2015/html/is150716.
88 Draghi was referring not only to government paper in bank portfolios but also to DTAs and DTCs, which constituted over 50 percent of Greek banks’ Tier 1 capital.
In March 2015, SSM chair Nouy said she might need the European Parliament’s support to close loopholes in EU bank capital rules that provide countries leeway in the definition of capital, but so far the Commission has not ruled that legislative changes that permit DTAs to be transformed into DTCs in banks in Greece, Italy, Portugal and Spain constitute state aid. The EU Capital Requirements 106 | BRUEGEL BLUEPRINT question their solvency in prospective terms because you look at how things go, how the policy dialogue develops, and therefore how the quality of the government paper changes according to these developments [...] It’s on the basis of this prospective assessment that looks at the quality of the government paper, but also at the quality of the overall banks’ balance sheets after such a protracted recession, and therefore with a foreseeable increase in non-performing loans [...] an overall envelope of €25 billion, out of a programme of €86 billion, was earmarked for the Greek banking system”89.
Bank recapitalisation All parties (Greek government, ESM, IMF in its programme monitoring role, and the ECB) agreed that bank recapitalisation should be concluded before the BRRD’s bail-in rules became mandatory on 1 January 2016, to avoid haircutting uninsured deposits belonging to healthy Greek corporates, which would further set back the economic recovery. This aggressive timeline required the rapid conclusion of an asset quality review (AQR) and stress tests to assess capital requirements – a task the SSM addressed efficiently, by all accounts. However, requiring all four systemic banks to raise funds simultaneously, in a risk-off market environment ahead of the US Federal Reserve’s tightening cycle, and before the Greek government had implemented bank-related reforms including a strategy to deal with NPLs, could only be achieved at fire-sale prices: the recapitalisation was concluded at a price-to-book ratio in the range of 0.30-0.35 for all four banks.
Regulation (CRR) does not count DTAs as capital because they are contingent on future profits, but counts DTCs as capital because they constitute a claim on the sovereign regardless of whether the bank makes a profit or a loss. Insofar as they constitute a liability for the state, large DTCs go obviously against the objective of breaking the link between banks and sovereigns.
89 ECB press release (2015), ‘Introductory statement to the press conference (with Q&A)’ 16 July, https://www.ecb.europa.eu/press/pressconf/2015/html/is150716.
107 | EUROPEAN BANKING SUPERVISION: THE FIRST EIGHTEEN MONTHSEuropean banking supervision found that the four systemic banks needed a total €14.4 billion of additional capital, comprising €4.4 billion under the baseline stress test scenario and an additional €10 billion under the adverse scenario. The shortfalls included AQR adjustments of €9.2 billion, partly covered by existing capital buffers and baseline scenario profitability. “Covering the shortfalls by raising capital would then result in the creation of prudential buffers in the four Greek banks, which will facilitate their capacity to address potential adverse macroeconomic shocks,” the ECB said in a statement90, adding that a minimum of €4.4 billion, corresponding to the baseline shortfall, was expected to be covered by private investors. By implication, any bank that failed to attract private capital to cover the shortfall of the baseline scenario would be considered ‘failing or likely to fail’ and would thus be resolved.
As it turned out, Greek banks were able to raise as much as €9 billion from private investors. Senior and junior bond instruments contributed €2.8 billion either through a voluntary liability management exercise or through bail-in; €5.2 billion was raised from new equity investors; and €1 billion mainly from asset sales. The chosen book-building process, with no effective minimum price set, helped attract private capital as share prices fell to new lows ahead of the November 2015 offering, with the consequence that existing shareholders were effectively wiped out. The €25.5 billion initial stake acquired by the Hellenic Financial Stability Fund (HFSF, a national entity set up under the first Greek assistance programme) in May 2013, worth just €2.1 billion in September 2015, was further diluted to €750 million at the prices of the November 2015 offering (Figure 10).
Once this process was completed, residual capital requirements of €5.4 billion – largely resulting from adverse-scenario stress test results for two out of the four banks – were filled by the Greek state (via the 90 ECB banking supervision press release (2015) ‘ECB finds total capital shortfall of €14.4 billion for four significant Greek banks’ 31 October, https://www.bankingsupervision.europa.eu/press/pr/date/2015/html/sr151031.en.html.
108 | BRUEGEL BLUEPRINT HFSF) using ESM funding. Three-quarters of the capital contributed by the HFSF, or €4.1 billion, was in the form of contingent capital instruments (CoCos), and the remaining €1.3 billion as common equity. The use of CoCos helped minimise the state shareholding in the banks.
Figure 10: Market value of HFSF shares in the four systemic banks Source: Hellenic Financial Stability Fund.
The Greek state’s share was diluted to minority stakes in all four banks, as shown by Figure 11. The HFSF’s stake in Alpha and Eurobank fell to just 11.0 percent and 2.4 percent, respectively (from 66.3 percent and 35.4 percent), as these two banks managed to fully cover their capital requirements from private investors. The MoU specifically stated that “the recapitalisation framework will be developed with a view to preserving private management of recapitalised banks and to facilitating private strategic investments”. Maximising the capital raised from private investors was therefore a key objective, even if it implied massive dilution of existing shareholders.
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50% 40.4% 35.4% 40% 26.4% 30%
Source: Hellenic Financial Stability Fund.
As had been noted by President Draghi, uncertainty about the impact of capital controls and recession on NPLs, but also political uncertainty (snap elections on 20 September 2015 were called as soon as the MoU was signed), pointed to the need to err on the side of caution in deciding how much official funding to set aside for the recapitalisation. Although the recession in 2015 turned out to be more shallow than feared, with GDP growth estimated at -0.3 percent versus
-2.3 percent underlying the programme, the outlook remained highly uncertain. The announcement of a €25 billion buffer took markets by surprise, coming so soon after the 2014 comprehensive assessment, but ultimately provided comfort that an adequate backstop would be available if needed. Uncertainty about the economic outlook and MoU implementation probably also explain why the SSM required higher capital ratios in Greece in 2015 than those underlying the 2014 pan-European comprehensive assessment: 9.5 percent for the baseline scenario (vs. 8.0 percent in 2014) and 8.0 percent for the adverse scenario (vs. 5.5 percent). Presumably European banking supervision targeted higher capital ratios for Greek banks than for their European 110 | BRUEGEL BLUEPRINT peers because their Pillar-2 SREP ratios are higher, reflecting their exposure to Greek sovereign risk and high levels of NPLs. Despite the higher standard, the big gap between the initial estimated need for public funds of €25 billion and the final outcome of €5.4 billion suggests that the SSM had underestimated the loan asset quality of Greek banks, as well as their ability to attract private capital.
Non-performing loans When the MoU was agreed, provisions covered 40 to 45 percent of non-performing exposures (NPEs = NPLs + performing restructured loans), which themselves represented half of total gross loans – an unusually high level resulting from six years of recession, fears of exit from the euro area, and the general erosion of the payment culture in Greece, including strategic defaulters who took advantage of a 2010 law intended to shield primary residences from foreclosure.
Comprehensively resolving the NPL issue before the bank recapitalisation in late 2015 would have required a ‘bad bank’ scheme, which would be hard to set up in a country with weak institutions like Greece.
Moreover, NPLs in Greece were recession-driven and broad-based, rather than focused on real estate as they had been in Ireland or Spain.
By sector, NPEs in agriculture, manufacturing, construction, food services, telecoms IT and media, and commercial real estate exceeded one-half of loans at end-2015. By type of loan, NPEs to very small companies and SMEs, and consumer loans, all exceeded one-half of all loans, while large corporate loans and mortgage loans fared better.
Asset quality deteriorated during 2015, with NPEs rising by 9 percent to €117 billion. MoU conditionality helped clean up bank balance sheets by suspending the state’s super-seniority in asset sales and liquidation, and by permitting home foreclosures of the primary residence of borrowers who meet certain income and wealth thresholds.
However, further steps are needed to improve loan recoveries, accelerate bankruptcy procedures and clarify which loans banks are allowed to sell to distressed debt funds or service companies. Further delay in
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resolving the NPLs would undermine the ability of banks to lend.
Governance MoU conditionality required a modification in October 2015 of the HFSF’s founding law91 to spell out strict criteria for the qualifications of bank executives. The criteria exclude former politicians and require extensive banking sector experience for board members, including inter alia fifteen year’s international experience in banking for members chairing committees. These extremely prescriptive guidelines, which are additional to the usual ‘fit and proper’ requirements imposed by the SSM (Gortsos, 2015, p.175) were imposed by the troika to avoid government interference in a country where clientelism is extreme. It appears that the SSM is currently applying tough criteria in their assessment of board members in order to signal the end of state involvement in the banking sector. That said, finding candidates who meet the criteria will be difficult. Remuneration is modest by international standards and legal risks are high, so Greek banks are unlikely to attract applications from many high-calibre professionals.
Business plans A Restructuring Framework Agreement between the European Commission and Greek banks was signed in 2014, in the aftermath of the 2013 recapitalisation. The agreement was based on EU state aid rules, which require banks to sell assets held abroad and non-core businesses if state aid exceeds 2 percent of risk-weighted assets. The business plans were revised in 2015 in view of the banks’ changed circumstances, with plans to divest foreign subsidiaries in the Balkans and non-core assets brought forward and broadened for the two banks that relied again on state aid. These banks considered that they were given tight deadlines to divest assets, and that ongoing sales were not taken into account in assessing capital requirements. However, they
91 Law 3864/2010.112 | BRUEGEL BLUEPRINT
recognised that the implementation of the BRRD’s bail-in provisions as of 1 January 2016 did not provide banks with sufficient time to meet capital requirements through asset sales, and therefore viewed the restructuring plans as broadly appropriate. The baseline scenarios of the SSM stress tests of both 2014 and 2015 were based on the assumption that the asset sales assumed in the bank business plans would be implemented.
The case of Attica Bank Attica Bank, a bank majority-owned by the Greek engineers’ union pension fund, failed to raise the full amount of additional capital required (€0.8 billion under the adverse scenario), even after a large capital injection by its main shareholder. It also appears that state-controlled enterprises were strong-armed into participating in the Attica offering, including Athens Airport and the Athens Water Company – a move that went against the effort to break the link between banks and the Greek state. Partly as a result of this alleged state aid, Attica Bank managed to raise 91 percent of the needed capital, reaching a CET1 capital ratio of nearly 20 percent. However, the recapitalisation was concluded at a price-to-book of 0.82, far above the 0.30-0.35 range for the systemic banks, presumably to avoid near-full dilution of the equity holdings of the Greek Engineers’ Fund in Attica Bank.
In early March 2016, European banking supervision started an audit of Attica Bank over possible irregularities in its capital-raising efforts.
Discussions between European supervisors and the bank’s management have been ongoing regarding corporate governance and the bank’s business model, which relies heavily on the construction sector that has been hard-hit by the crisis. All of the above suggest that Attica Bank may end up in resolution. If so, the ECB should have taken it under its direct supervision sooner, before public sector entities sunk in €0.7 billion of new capital and before bail-in rules took effect.