Loan loss provisions are down sharply. Liquidity and capital measures are strong. NBG is positioned well to provide support Greece’s economic recovery. Yet, the stock trades at less than five times my estimate of pro forma EPS.
A lot has happened to both Greece and National Bank of Greece (NBG or NBG Group) over the past two years. Greece is now well past the political and banking crisis that ensued when newly-installed Prime Minister Alexis Tsipras tried to push Greece’s major creditors (primarily euro area governments) to reduce the country’s debt and ease the onerous terms of its stability support program. After winning a mandate from Greek voters to exit the euro, if necessary, Mr. Tsipras agreed to continue to comply with the program. A new stability support program (i.e. the “Third program”) was subsequently approved by the European Commission (EC) and Greece and put in place in August 2015. Since then, Greece has largely complied with its terms. It is now seeking formal approval in the second review of the program so that it can receive the next tranche of aid in July, in time to meet debts coming due. After a setback in 2015, the country’s economy and financial system are once again on a path toward recovery.
Meanwhile, NBG has taken many important steps to refocus its business and shore up its capital structure so that it can continue to meet the continuing challenges of Greece’s severe recession. Along with the adoption of the Third program in August 2015, the European Central Bank (ECB) completed an asset quality review and stress test on all Greek banks. In this assessment, NBG was ultimately determined to have a capital shortfall of €1.46 billion in the baseline scenario and €4.48 billion in the adverse scenario. NBG was required to present its capital remediation plan to the ECB by Nov. 6, 2015.
NBG’s capital remediation plan began with shareholder approval of a 1:15 reverse split of its stock, which reduced its share count from 3.53 billion to 235.5 million. In December 2015, the Group increased its common equity capital by €2.19 billion from the issuance of 7.31 billion shares in several equity offerings and debt exchanges, including an international stock offering, a Greek public stock offering and exchange offers for NBG debt and certain notes of the European Stability Mechanism (ESM) that had been issued to the Bank by the Hellenic Financial Stability Fund (HFSF). All shares of preferred stock, including shares held by the HFSF and others traded on the NYSE were converted into 1.6 billion shares of NBG common, increasing common equity book value by €480 million. NBG also raised €2.0 billion from the issuance to the HFSF of contingent convertible notes (CoCos), which are treated as common equity. Excluding the CoCo’s, the HFSF held (and continues to hold) about 40% of NBG’s outstanding shares. In total, NBG increased its common equity capital by €4.67 billion, slightly more than the required €4.48 billion. The recapitalization resulted in total outstanding shares of 9.15 billion.
As a condition of the EC’s aid grant to NBG of €2.7 billion – which consisted of conversion of the ESM Notes and the purchase of the CoCos, both of which were channeled through the HFSF – NBG was required to adhere to the terms of a revised restructuring program which was intended to streamline its operations, improve its profitability and further shore up its capital base. The plan calls for NBG to achieve certain financial and operating targets related to its domestic operations – including reducing bank branches, full-time equivalent employees, other operating costs and the cost of deposits. It also specifies a maximum loan-to-deposit ratio and requires a reduction in the size and upgrading in the quality of NBG’s securities portfolio, disposal of private equity funds, caps on employee (and executive) remuneration and adherence to certain corporate governance standards.
In order to help NBG achieve its primary goal of supporting Greece’s economic recovery, the restructuring program also called for divesting virtually all of its international operations and redeploying the capital in support of its domestic operations. This led to the sale of certain real estate properties in 2014, NBG’s private equity funds in 2015 and its Turkish banking operation, Finansbank, in 2016. Finansbank was sold to Qatar National Bank for €2.7 billion, plus the repayment of €910 million of intercompany debt. (NBG subsequently received permission from the ECB to use €2.0 billion of the proceeds to repay the CoCos.)
NBG plans to close the €610 million sale of UBB and Interlease (its Bulgarian operations) in June and the sale of S.A.B.A. (its South African bank) in the second half of 2017. Also up for sale are its National Insurance operations and its Romanian subsidiary, Bank Romaneasca. Negotiations for both of these divestitures are in their final stages.
Financial Performance. After recording large losses in 2011 and 2012 during the early years of Greece’s downturn, especially in 2011 on its holdings of Greek government bonds, NBG was on a path to recovery, posting a small profits in 2013 and 2014. Credit losses had declined steadily from 2011 to 2013 but were still elevated. In 2014 and 2015, however, they rose again, especially after the 2015 financial crisis. In 2016, however, NBG posted a small profit from continuing operations. (The large net loss was due to a large loss from discontinued operations, reflecting losses on foreign exchange (i.e. the Turkish lira) that were recognized by NBG on the sale of Finansbank). More importantly, credit losses declined sharply from €4.2 billion in 2015 to just €800 million in 2016. The decline reflected stabilization and recovery in the Greek economy and financial system.
In the 2017 first quarter, NBG posted essentially breakeven profits from continuing operations, roughly on par with prior year results. Group core pre-provision income rose 27%, with gains in all three components – net interest margin, fee income and insurance income. Operating expenses declined 6.5%; but credit losses increased 40%. The increase in credit losses was due entirely to a downward revision in the valuation estimates of residential real estate collateral.
Management expects that the improvement in performance will continue for the balance of the year. It says that the quality of NBG’s earnings will improve, with last year’s one-off gains replaced by improving operating profits.
Non-Performing Exposures (NPEs) and Non-Performing Loans (NPLs) are still very high for NBG, but they have been declining since the end of 2015. NPLs are loans that are 90 days past due. NPEs are NPLs plus any current or <90 day past due loans which the bank believes are unlikely to be repaid without utilizing collateral.
NBG’s disclosures on NPEs and NPLs are sketchy. They provide different looks (e.g. for the Group, for the domestic bank only and for other measures such as the loans in the SSM perimeter) interchangeably. To some degree, this is due to a shift in emphasis by EU regulators that occurred during the comprehensive assessment of Greek banks that was conducted in 2015. Even so, NBG does not offer a consistent presentation that allows for an easy assessment of NPE/NPL development and resolution from say 2012 to the present.
Yet, the various perspectives offered by NBG do tell a similar story and thus offer some insight into how its problem loans are unfolding. Under the targets that NBG submitted to the ECB’s Single Supervisory Mechanism (SSM) (through which the ECB is charged with supervising and monitoring the financial stability of the banks of participating countries), NBG has set a target of reducing its NPEs (within the SSM’s jurisdiction) by €8.5 billion or 40% to €13.1 billion from 2015 to 2019. It also projects that NPLs will decline by €7.4 billion or roughly 50% to €7.7 billion over the same time period. Through the 2017 first quarter, NBG had reduced NPEs by €3.0 billion, which was €700 million ahead of plan. The Bank has only €400 million in NPE reductions left in order to reach its 2017 year-end target. This gives it some operational flexibility. For example, it has greater latitude in slowing some foreclosures, if it thinks that it might be able to achieve a better outcome by doing so.
According to NBG’s plan, NBG’s ratio of NPEs to total loans and advances (its NPE ratio) is expected to fall 15 percentage points to about 35% by 2019, which is consistent with the projections of the Bank of Greece, Greece’s central bank, for the entire banking system. Still, a 35% NPE ratio is high. Thus, banking officials expect that it will take many years to reduce NBG’s and other Greek banks’ non-performing exposures to normalized levels (say below 10%).
Nevertheless, with the sharp decline in NBG’s provision for credit losses in 2016 and expectations that it will remain low in 2017, the rate of increase in non-performing exposures has clearly slowed significantly. Indeed, NBG has reported that its net new formations of >90day past due loans (+90dpd or NPLs) declined from €1.0 billion in 2014 to €870 million in 2015 to only €65 million in 2016. NBG’s 2017 first quarter +90dpd formations increased to €137 million (after falling €253 million in the 2016 fourth quarter); but the Bank said that the increase came on mortgage loans that had already been flagged as NPEs, so they do not represent an adverse change in the operating environment. The declines in both the provision for credit losses and net new +90dpd formations help to support the view that the Greek economy has bottomed.
NBG’s NPEs appear to be well covered. Although its non-performing exposures remain high at €20.9 billion or about 44% of its total loan portfolio (excluding loans to the Greek state), more than half of the total NPE exposure – i.e. €11.3 billion or 56% – is covered by NBG’s loan loss reserve. The remaining unreserved NPEs, equal to €9.6 billion, should be covered by collateral. In its 2016 annual report, NBG disclosed that in the aggregate it has the equivalent of €5 of collateral for every €4 of unreserved NPE exposure. That equates to collateral coverage of about 125%. Assuming that the value of this collateral does not decline materially from current levels, NBG should therefore be able to resolve its NPE exposure without having to suffer any significantly greater loan loss charges.
Capital Position. While NBG should not have to take any more big credit write-offs, it has the capital to do so, if necessary. Alternatively, NBG can use its strong capital position to grow its loan portfolio over time.
NBG reported a common equity tier 1 (CET1) ratio of 16.0% (under the Basel III guidelines) and a CET1 ratio of 15.8% “fully loaded” (i.e. under the Capital Requirement Directive IV (CRD IV) guidelines adopted by the EC in 2013. NBG’s CET1 ratio is therefore will above the minimum requirement of 8.75% and also above the overall capital requirement (including other forms of equity capital) of 12.25%.
NBG will improve its capital position further through planned asset sales which will reduce its risk-weighted assets (RWAs) relative to its common equity capital.
A substantial proportion of NBG’s common equity capital is available through the recognition of deferred tax assets (DTAs). NBG’s DTAs arose from the significant losses that it has booked over the past several years. U.S. accounting rules do not permit recognition of DTAs, if an entity is unprofitable (because the DTAs can only be converted into cash if the entity has income to utilize them). Banking regulators likewise do not normally recognize DTAs as capital because they depend upon future profitability.
In the case of NBG and the Greek banks, however, the Greek government has passed a law allowing the DTAs to be converted into Deferred Tax Credits (DTCs) under certain conditions (namely the incurrence of future losses). Any DTA that it not utilized against taxable income can therefore be converted into a receivable from the Greek state. In exchange, the Greek state will get equity warrants, but existing NBG shareholders have pre-emption rights over the warrants.
The formula for calculating the specific amount of DTCs available in any given year is somewhat complicated. It is designed in such a way that NBG will only have access to the DTCs in years where it reports losses. The amount of DTCs available in any year is essentially limited to the size of the reported loss in the previous year divided by shareholders equity times the remaining available DTAs. As of Mar. 31, 2017, the amount of DTAs eligible for conversion into DTCs was €4.8 billion for NBG.
Liquidity. Throughout the financial crisis, NBG’s liquidity position has remained strong. Its loan-to-deposit ratio is currently 0.88. That is likely well below the EU average. (The European Banking Authority (EBA) reported an average loan-to-deposit ratio of 1.209 for year-end 2015.) That may have come down since, but it probably still remains above one.
NBG has also been able to reduce its dependence upon eurosystem funding significantly since year-end 2015. Its borrowings under the Emergency Liquidity Assistance program have declined from €11.5 billion in 2015 to €5.6 billion at the end of March 2017. Likewise, its ECB funding has been reduced from €12.5 billion to €4.6 billion over the same time period. The declines have come from funds raised from asset and securities sales (including €3.3 billion of EFSF bonds). NBG also replaced €5.2 billion of eurosystem funding with repos from major financial institutions. The Bank’s liquidity buffer of potential ELA borrowings (accessible after posting collateral) is currently around €10.8 billion.
The combination of a strong capital and strong liquidity gives NBG the ability to increase its loan portfolio in support of the anticipated economic recovery in Greece.
Valuation. On June 9, NBG’s share price closed at €0.33 on the Athens stock exchange and $0.39 on OTC Pink Sheets. That gives NBG an equity market capitalization of about €3 billion.
According to my calculations, NBG’s book value per share is €0.76. So its price-to-book value ratio is 0.44. NBG’s book value includes both €134 million of goodwill and intangible assets and also deferred tax assets of €5.08 billion. If both are excluded, its tangible book value per share is €0.19 and its price-to-tangible equity book value ratio is 1.77.
NBG’s valuation is best assessed on its future earnings potential. In a steady state environment, with 2016 adjusted results as the primary reference point, I estimate NBG’s pro forma earnings at about €580 – €720 million and its EPS from continuing operations at €0.06-€0.08. For the lower bound case, I took NBG’s 2017 first quarter results (after reducing the credit loss provision from €242 million to €100 million) and multiplied by four. For the higher bound, I took NBG’s results for the Bank for the second half of 2016 (which does not include results from Finansbank) and reduced the credit provision from €460 million to €200 million and then multiplied by two.
Obviously, this is a simplified analysis. As of the 2017 first quarter, NBG no longer reports results for the Bank separately, the presumption being that there is less need to do so because the Group’s financials are converging to the Bank’s financials as a result of asset sales. NBG continues to reduce risk-weighted assets through asset sales. That implies lower net interest income and perhaps even lower fee income going forward; yet this simplified analysis effectively assumes that pre-provision income will be flat. Likewise, NBG continues to cut operating costs; yet this analysis assumes implicitly assumes that operating costs will remain flat.
This analysis also assumes that credit charges will decline from €782 million on a rolling 12 month (R12) basis to €400 million. The 2017 first quarter provision was high due to the annual reassessment of residential real estate collateral values. Based upon management’s comments, I estimate that this reassessment added €40 million to the R12 credit provision. However, domestic +90dpd formations were only €75 million on an R12 basis. If that trend continues, my credit provision estimate of €400 million will prove to be too high.
My pro forma net income (from continuing operations) estimate of €650 million (at the midpoint of the range) also represents a return on adjusted Bank assets of about 1.1%. (I assume in this calculation that NBG will be able to cash out of the net book value of impaired loans (i.e. after the allowance for loan losses) of €7.1 billion and reduce its assets to about €61 billion.
My pro forma earnings estimate may therefore not take into account the changes to NBG’s business and cost structure that are yet to come, but it is consistent with the notion that NBG will be able to adjust its operating model and business mix to achieve a return on assets that is consistent with its European peers.
If you accept my pro forma EPS estimate of €0.07 (at the midpoint), NBG’s stock is essentially trading at less than 5 times earnings, which is well below its European peer group average of say 12-14 times. The low valuation implies that investors still do not have confidence that NBG’s profitability has bottomed.
My valuation does implicitly assume, however, that Greece’s economy and financial system have bottomed; but it does not incorporate upside potential for future growth, through an increase in loan originations or reversal of previously booked credit losses. Rather, it assumes that the Greek economy and financial system will just muddle along from here.
Nevertheless, my analysis suggests that NBG’s stock has significant upside potential, as its forward P/E multiple moves toward the peer group average.
Other Issues. There are at least a couple of changes that NBG’s management should consider that should help boost investor confidence (and one that might reduce operating costs).
First, in order to attract an institutional shareholder base, NBG has to complete another reverse split, perhaps as high as 1:40, in order to get its share price back above €10 per share. Doing so would also allow it to relist its shares on the NYSE, if it wants to do so.
Surprisingly, NBG still files financial reports and other disclosures with the SEC, even though it is no longer required to do so. NBG’s 20-F filing does include some useful disclosures, including its Operating and Financial Review and Prospects section, which is akin to the MD&A, its Risk Factors section and, most recently, its disclosures of a material weakness in financial controls relating to its accounting for NPLs. (NBG says it is well on its way toward curing that material weakness.)
At the same time, however, its financial statements are prepared in accordance with U.S. GAAP, which include some significant differences from IFRS. For example, under GAAP NBG does not recognize its DTAs, which is somewhat surprising given its arrangement with the Greek government to convert DTAs to DTCs.
In my opinion, if NBG has no plans to relist on the NYSE, it should save money by discontinuing its SEC filings and preparation of U.S. GAAP financial statements (but hopefully after incorporating some of the more useful 20-F disclosures into its primary financial statements and also perhaps after tendering for its remaining U.S. shares to give U.S. investors a chance to get out).
Finally, I believe that NBG should improve some of its financial reporting disclosures and performance measures. The Bank should standardize its delinquency disclosures, focusing primarily on its consolidated operations and incorporate standardized tables covering its entire NPE and NPL (i.e. +90dpd) exposures in its Board of Directors’ Annual Report and also in its quarterly disclosures. NBG should also provide reconciliations of its non-IFRS measures, such as its CET1 ratio, NPE ratio, cost of risk and loan-to-deposit ratio, among others, on a quarterly basis.
June 11, 2017
Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
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