Greek Banks: What are David Einhorn and John Paulson thinking? (Part 2)

Assessing the earning power of Pireus bank

After having looked at the balance sheet it is time to see what this bank can earn on a normalized basis. For that purpose I have chosen to reproduce the income statement below:


The net interest income (NIM) has jumped by 62% yoy, suggesting impressive improvement in operating performance. Looking at the components we see that Interest income (i.e. what the bank earns from its customers and its securities portfolio) has increased by 23% – in line with the balance sheet expansion – whereas interest expense has stayed more or less flat, despite an increase in liabilities. How is this possible? The answer: interest rates on deposits have come down substantially in Greece. From this month’s bank presentation to equity investors we get the following chart:


As can be seen time deposit rates have fallen by a third and are currently at 3 percent, meaning the increase in volume was fully offset by a fall in cost of funds leading to an increase in the net interest margin (NIM). Whereas rates could go even lower I do think we are pretty close to the bottom in Greece already, further improvements should be marginal going forward. As a consequence, we should treat the boost in net income as a one-time event, further increases will require balance sheet growth. Applying the net interest income of 1.6 bn. to the average balance sheet size in 2013 (80 bn.) gives us a normalized net interest margin (NIM) of 2%. Doesn’t sound terrific for Greece, but makes intuitive sense: as we have seen before, a large chunk of the balance sheet is represented by “slow” assets, that is by customers who are not paying at all (default) or not paying in time (past due but not impaired).

If we take the 2 percent margin and multiply by the current balance sheet size we get an approximation for the steady state NIM of Pireus bank: EUR 1.8 bn. This assumes neither significant deterioration nor improvement in the average asset quality of the bank.

If management can turn underperforming loans into winners (big if), the interest margin would improve. It is difficult to say by how much but I will be generous and assume that a 2.5 percent margin is achievable in a positive scenario, leading to an optimistic NIM of EUR 2.25 bn.

The biggest item on the income statement is the “negative goodwill” of 3.5 bn. resulting from the acquisition of above mentioned banks. Clearly this is a one-time profit that will not repeat in the future and can be discarded for valuation purposes.

Operating expenses are up by 80% most of which are staff costs. Understandable: lot of redundant staff has been taken over due to the acquisitions. Taken from the above mentioned presentation to the equity investors: management estimates that synergies (read: lay-offs) amount to EUR 300 mln. per year. I will take that at face value and assume operating expenses will come down accordingly.

Provisions are a notoriously difficult to estimate as much of it depends on how real the recovery in Greece is. Without arguing back and forth and being generous I will assume substantially reduced provisions of EUR 1 bn. for the base case and EUR 0.5 mln. for the optimistic scenario.

A further aspect which needs clarifying is tax line in the income statement which was positive both for 2012 and 2013. According to note 16, the positive entry results from an increase in corporate income tax in Greece which increased the tax shield stemming from past losses and was applied retrospectively for 2012 as well. At the end of 2013 the bank had a corporate tax asset of EUR 2.7 bn. which basically means the first EUR 10 bn. in profit will be tax-free!

Finally, after adjusting the income figures we get the following income statement. For items I have not explicitly referred to above I have either extrapolated 2013s figure or ignored it if inconsequential.


As one can see: in the base case – which I personally think plausible – the bank is not able to turn out a profit. A strong recovery indeed would have to take place in Greece for a profit of EUR 890 mln., which translates into a return on tangible equity of 11 percent. Depending with what your cost of equity is or a Greek bank you will come to different conclusions. I, personally would say that, given the risks involved, a cost of equity should at least be 12 percent for a Greek bank, i.e. the bank barely returns its cost of equity in a positive scenario.


Given the significant headwind the bank is facing (liquidity, asset quality, potential haircut Greek debt a.s.o.) I think the optimistic scenario highly unlikely. The potential return if all goes well doesn’t strike me as attractive and I do not know how the market arrives at a valuation of 1.2 x book for this bank. However a word of caution: maybe I am missing something, some hidden assets, some feature of the recapitalisation that I have not accounted for and that I have overlooked.

Further, Basel III regulation which comes into effect in 2015 contains explicit regulation limiting the liquidity risk a bank can take. I could not find any hint with respect to that in the financial statement but just looking at their balance sheet I do not thing they meet the Basel III ratio (Net stable funding and liquidity coverage, but from what I can tell looking at its balance sheet I would assume there is some way to go



  1. I think the 3,8 BEUR revenue from negative goodwill, even though recognized as a one-off item, deserves further analysis. Does the report explain how that came about? The item would suggest that Piraeus could acquire assets at 3,8 BEUR below book value. Apart from the fact that the total number is mind-boggling, let’s assume that the assets which Piraeus bought were worth book value but, miraculously, Piraeus could get them for 3,8 BEUR less. Who in his right mind would sell Piraeus assets at 3,8 BEUR below value and why? On the other hand, let’s assume that the assets were not worth more than Piraeus bought. Why would they have been written-up? Only to generate revenue on the P+L? Bottom-line: should that 3,8 BEUR be considered as part of net worth (as negative goodwill normally would be) or should it be considered as part of the loan loss reserve? If the latter, why didn’t one make a simultaneous provision to the loan loss reserve?

    1. Klaus, I agree with you that negative goodwill doesn’t make sense. I suppose the previous owners could not meet regulatory ratios and could not add further capital. So, probably they were forced out of their bank by the regulator, i.e. They probably did not really have a choice and maybe pireus got a sweethart deal since I understand they somewhat like an establishment bank in greece with the corresponding political clout. Then again the prevoius owners would make mor noise and try to sue the grrek government. Second possibility: the assets are shoddy, and the previous owners happy to get rid of them (thats why we havent heard of them) but the deal allowed pireus to increase its capital artificially, it proposed it to the government, which approved happily as it could recapitalize the bank without putting up money- sure the greek government would not skip that opportunity. One ahould track the coments of the previous owners for more insight I think.

      1. Below is what I wrote to Varoufakis who had asked my about the negative goodwill. The ‘manufactured negative goodwill’ is included in retained earnings; i. e. in equity. Without that negative goodwill, the equity and the equity ratios would look very differently!

        “Hi Yanis,

        I have looked through the 248 pages of the Annual Report. It’s the first Annual Report of a Greek bank I have seen. The standards are VERY high (much more information than one normally sees; a lot of notes). Don’t know whether this is standard for Greece or whether Piraeus is a trendsetter. Obviously, what matters is substance and not form. The negative goodwill resulted from the following acquisitions:

        Acquisition of the Greek banking operations of Cypriot Banks (Bank of Cyprus, Cyprus Popular Bank, Hellenic Bank): 3.414 MEUR
        Finalization of the purchase price allocation exercise of Geniki Bank S.A.: 355 MEUR
        Completion of the purchase price allocation of former ATEbank S.A.: 84 MEUR
        Acquisition of Millennium Bank S.A.: 308 MEUR

        No acquisition is ever made at exactly book value. Good and voluntary acquisitions are normally above book value, creating a positive goodwill. The negative goodwill incurred by Geniki, ATE and Millennium can probably be explained by ‘market conditions’. The negative goodwill from the Cypriot operations is definitely out of the ordinary. Below are my thoughts on the Cypriot deal.

        The question is who negotiated the sale on the part of the seller. Was it the banks’ management? A bankruptcy judge? A government-to-government deal? Whoever did the negotiating agreed to ‘give away’ assets at 3.414 MEUR below book value.

        If those assets had been carried by the previous owners at fair value, then Piraeus got real gravy to the tune of 3.414 MEUR. Dean Plassaras suggests that this was so on purpose. In that scenario, ‘someone’ (whoever that was) decided to give Piraeus gravy so that Piraeus would have reserves to finance the future ‘conversion from zombies to stars’. To me, that’s a very unlikely scenario because that ‘someone’ would have exposed himself to endless lawsuits by other creditors of the Cypriot banks who would see their interests damaged.

        The alternative is that the previous owners had not made sufficient loan loss provisions and, thus, those assets had been overstated by 3.414 MEUR relative to fair value. That strikes me more likely. However, that raises a very serious question: why would Piraeus have left those assets on their books at the previous (overstated) book value and created negative goodwill in the process? If Piraeus bought those assets at fair value, they would have had to make a 3.414 MEUR loan loss provision for these assets to offset the fictitious gain on the negative goodwill.

        As it stands, the 3.414 MEUR are now part of Piraeus’ reported net worth (shown under ‘retained earnings’). If those assets were indeed bought at fair value, then Piraeus’ net worth is overstated by 3.414 MEUR. How will that ever show up? Well, that overstated net worth will evaporate over time as the overvalued assets are written down.

        One of the reasons I think that there was no real gravy is that if it had been real gravy, the other Greek banks would have cried ‘foul play’. Unless they got their own sweetheart deals in other forms…

        I want to point out that I have no particular ‘beef’ with Piraeus. Given the state of the Greek economy, I wouldn’t expect ANY Greek bank to have strong financials. I am sure one could take the financials of ANY Greek bank apart if one wanted to. That’s why I have not paid any attention to the financials of any Greek bank (not to mention the fact that a bank’s outsider can’t make a definitive judgment, anyway). As a matter of fact, only a month ago, I knew of Piraeus only its name.

        The eye-opener for me was the announcement of the Piraeus/MIG deal. That deal is so far removed from anything that I would expect Greek banks to do these days that it defies description. For all I know, all other Greek banks may be doing exactly the same deals all the time. For all I know, Piraeus might even be the most virtuous among them (as Dean Plassaras suggests).

        Not so with MIG/Vgenopoulos. There I feel comfortable that I can pass judgment. First, you can’t play around with corporate financials as much as you can with banks’ financials. And, more importantly, I look at the man’s track record, which is just awful from the standpoint of a banker like myself who has been trained to act seriously with other people’s money and to judge customers accordingly. In the world of Warren Buffett’s and Gordon Gekko’s, Vgenopoulos is definitely on the side of the Gordon Gekko’s”.

      2. Thanks Klaus, this confirms what I was suspecting. If the assets were given away too cheap, the previous owner would start suing. would be interesting to find out who the previous owner were: if ownership was dispersed, i.e. small shareholders they might have no clue, whereas insiders of greek banks (managment) got a fine bonus package.
        I will try to get my hand on the financials of one of the cypriot banks, just for the fun of it.
        Anyway, this MIG deal already gives you a feel for the quality of management of this bank…

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