Pireus Bank Follow up: still do not understand what they are thinking

I started this blog with two posts (here and here) about Pireus bank – the largest banking group in Greece.

The stock aroused my interest as I learned that prominent value investors, such as David Einhorn, Seth Klarman and John Paulson had taken long positions in Pireus Bank (via stock or warrants). I basically tried to “reverse engineer” their decision-making process, i.e. try to understand where the value is by looking intensively at Pireus financial statements. To make a long story short: I could not find any reason to buy the stock: the balance sheet looked horrible, with steadily increasing NPL ratios and one-third of the book value of the bank due to a rare bird – a “negative goodwill” item booked as a profit from takeovers of failed Greek and Cypriot  banks. Just to explain: if this value (“negative goodwill”) is correct, it implies that shareholders of the taken over banks have been massively screwed due to the forced takeover, i.e. they were paid less than their assets were worth. This is theoretically possible due to the good political connections of Pireus Bank management (the current governor of the Greek central bank worked at Pireus in the past).

Anyway, the market disagreed with my analysis and even priced the Stock at a slight premium to book value (1.2x). The stock has derated somewhat since then (I wrote about it in April), but still trades at 0,92 x book!

 Pireuschartpng

What has happened to the fundamentals since then?

brief answer:

the NPL ratio has risen in Q2 2014 to 38,5% from 37,9% in Q1, i.e. asset quality has deteriorated further. Net profit ytd. is around EUR -80 million (unaudited Q2: + 164, Q1: -247), not as bad as it was but still no reason to assume this stock could justify a valuation of EUR 8.5 billion. By the way, as long as the NPL ratio shows no sign of falling I do not trust profit figures of any bank: a rising NPL book basically means that bank management cannot unload NPLs at book value as selling them would lead to additional losses. I am sure they would, if they could. But, it gets worse…

Dubious accounting practices at Pireus bank

I have had debates about Pireus bank with Klaus Kastner, a retired Austrian banker whose wife is Greek and,  I understand, spends a considerable time in Greece. He generously shares his thoughts about the Greek economy on his blog “Observing Greece” which I read regularly, also because I am still trying to understand what the gentlemen from Manhattan find valuable in this stock.

He recently had a piece about a deal between Pireus and Marfin Investment Group (MIG), a well-connected Greek conglomerate. The piece is worth reading in full and can be found here. For those of you lazy to read the post, here is a quick summary:

MIG is basically insolvent (negative tangible equity), bleeding cash and, oh, almost half its debt is in contractual default (I am taking Klaus’s analysis of the financial statements at face value here).  Nevertheless, Pireus bank managed to book a gain – presumably a release of previously booked loan loss reserves – of EUR 144 million by refinancing its loan by a convertible whose sole buyer was, drumroll, the bank itself. At least, now I know how they managed to book a profit of EUR 164 million in Q2!

Only I few days ago I wrote about my recent trip to Asia that I felt the business practices leave something to be desired there. I also wrote how he types of deals seen there would not be possible in Europe and the US. Well, I stand corrected (in record time): carrying the debt of a defaulted company, with no signs of a turnaround, at par is ridiculous and requires a blind eye by regulators and auditors.

(A word of caution: given that neither Klaus nor myself have full disclosure about the nature of the transaction we, of course, might miss important details about this deal).

Conclusion 

For me there is no doubt that Pireus’s earnings are of very low quality. The same goes for its book value of which 1/3 is due to a “negative goodwill” item. I fail to see how the market can price this stock anywhere close to book.  The transactions mentioned above should raise all kinds of red flags with Einhorn or Paulson and I would have a few tough questions for management. I have never understood – and now understand even less – how they can touch this stock. Is it due to the institutional imperative of showing activity to your investors?

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3 comments

  1. Thanks for your intensive coverage of this interesting topic.
    As you were trying to reverse engineer the thought process of Einhorn & Co., you might find Einhorn`s recent presentation helpful:
    http://www.businessinsider.com/david-einhorn-robin-hood-presentation-2014-10

    In short, he argues that
    – Greece in an oligopolistic banking market with four players which will try to get along together and so competition intensity is not too bad.
    – Greece is on its way to recovery – the current situation is dire but the trend is improving and the”bitter medicine” will yield results.
    – Greek banks have improved operational efficiency and operating cost ratios are moving to the right direction. As for Piraeus Bank, they have closed branches and laid off staff.
    – Greek banks are relatively well capitalised as confirmed bythe ECB stress test. I do understand that there is a lot of justifiable criticism on the stress being to lax (which however has not prevented certain banks from failing)
    – potential loan losses for the likes of Piraeus and Alpha are covered by (a) Loss reserves and (b) collateral held. In fact, if I read the financials correctly, Piraeus Bank have 73 bn in loans outstanding, of which 14.3 bn have been reserved Plus they hold 41.1 bn in collateral. Whilst it is very difficult to assess the value of tangible collateral if it needs to be liquidated, some credit should be given for the collateral.
    – Also, as the economy improves, there appears to be some hope that loss reserves can be reversed and added back to equity.

    I think that some of these points make some sense, even though a lot of questions remain and an investment is a very risky undertaking. The examples you describe above, though not completely unexpected appear worrying. On the other hand, one should acknowledge that some progress clearly has been made, both in terms the Greek economy and recapitalising the banks. No need to love Piraeus’ balance sheet but it certainly looks better than 3 years ago.
    I have not yet invested in Greek banks but Ithink European banks in general are an iteresinghunting ground for value investors with a lot of unloved companies which have scared off investors with recent dilutive capital raises (one prominent example being Deutsche Bank).

    Thanks again for the hard work analyzing Piraeus.

    1. Thanx, had a quick look at the presentation and disagree with a few points – will post my answers in a full post. As with deutsch bank, just be aware that level 3 asstes were not inclused in the ecbs assessment. Deutsche has a significant percentage of its equity in level 3 assets- more than 100 percent the last time i checked…as for banks as an investment: not sure you can get a good margin of safety with balance sheets that are more than 20x levered…

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