David Einhorn In-Depth Thesis On Piraeus Bank Warrants

Updated on

Is this Einhorn? Yes, we thought it was and Greenlight Capital confirmed that this was not some imposer …. so we present to you  (in- depth) commentary from Einhorn is related to his recent presentation at Robin Hood.

David Einhorn on Piraeus Bank and Greece via Vienna Capitalist

Hi There,

I think that this is a thoughtful discussion of my Greek bank idea. Overall, I appreciate the discussion and hope that you find this post to be helpful. It is also much lengthier than the space I had for my presentation. That said, there are a number of things I would like to comment on (in choronolical order). This post is in response to Part I.

1. Greek Employment is improving. It was 28% in Sept 2013 and been flat or better every month since and is now below 26%

2. Greek GDP just did turn positive in Q3 (+1.7%). The 6 year recession appears to be over. While growth forecasts across Europe have disappointed, Greece has had a series of beats. Coming off such a depressed level, it is quite possible that there will be more beats in the future. But, like any forecast, time will tell.

3. I never said that Greece’s high debt load is “not an issue”.

I would argue that it is much easier to have all your debt basically with a single entity. Particularly when you owe that entity so much that there is little to nothing that they can do but make it easier for you over time – or of course risk that you suddenly default on all of it and leave a giant black hole in the EFSF. You can see how this has already played out with the bailout loans already having reduced rates of interest and longer maturities applied. Plus in any event of default on public debt the ECB will obviously be involved, as like last time, as they own it too.

4. Greece does not have a material budget deficit.

5. You ask how the debt services is so low absent a restructing. Here’s how:

Debt service is obviously a reflection of interest payments paid on the debt and he doesn’t seem to have thought about that – I never suggested the total debt amount was decreasing as it is not. Greek debt used to primarily GGB’s paying a market rate of interest back in a time where interest rates were not zero. Now the vast amount of the debt is borrowings owed to the EU and the IMF. Total debt is €320bn. Of that, €154bn is owed to the EFSF and the IMF as part of the second bailout. This carries no cash interest payments at all until the decade long grace period is over in 2022. The €53bn EU loan related to the first bailout pays interest at Euribor + 150bps, down from the original loan fee of Euribor + 400bps. In total Greece owes €245bn to the EU, ECB and IMF and pays cash interest on this of just over €2.5bn. They also pay zero interest on their €15bn of GTB’s (covered by ECB guarantee). The €30bn of restructured GGB’s pay 2% interest. All of this data is readily checkable on Bloomberg and the internet

You suggest 4.3% of GDP interest expenditure, which implies 8 billion of payments on 320 billion of debt, or 2.5%, yet we can see above that only a small portion of the debt carrries and interest cost above that rate. I suspect the EU forecast may include accrued interest on the 154 billion bailout loans that are adding up during the grace period. Even this is questionable as the EFSF loan does not have a fixed rate of interest chargable as far as I can see. In any case, I was referring to cash debt service costs, and I stand by my presentation.

6. We do not believe that the Greek banks we own have high direct sovereign exposures.

7. Regarding the issue of “moat”: I presented a thesis for 2017. I think it is extremely easy to suggest that there will not be any foreign banks in Greece again by then. And presumably if there are overseas banks that enter Greece, it is because the thesis has already worked very well. It’s hard to see why they would decide to allocate capital to Greece again unless the incumbents were earning outsized returns and they thought there was the opportunity to do the same.

8. Neither Dexia nor RBS were bailed out due to failures of their local banking franchises.

Dexia was a liquidity problem, where it lost wholesale financing and included massive Sovereign bond exposure to peripheral Europe into the peak of the crisis. It’s core Belgian operations have earned excess returns throughout.

RBS had its own problems (ABN deal, US real estate, over stretched balance sheet). It’s core UK business earned an ROE between 16-18% from 2004-2007 followed by 11% in 2008, and 3% in 2009, before returning to the teens in 2010. By 2012, with less competition, it hit 24% and was 30% in H1 2014.

We aren’t expecting anything that great in Greece, but it is illustrative of concentrated banking markets can yield excess returns, especially in a post-crisis recovery.

9. We used 15% ROE in our estimates for a recovery. Other markets have done better. But, I won’t quibble over 14%. Should that be achieved, I don’t believe the Greek banks will trade anywhere near the current discounts to book value. for example, Komercni, the listed Czech bank, trades at 2x TBV for its 14% ROE.

I will post comments on Part II shortly.


Hi There,

Here are my thoughts regarding Part II

1. Relating ot the fall in funding costs:

The 2.04% is the cost of new time deposits in August 2014. This is not the average cost of deposits in the Q2 2014 financial reports, which was 2.62% according to the same presentation (and 2.71% in Greece time deposits). This cost will reduce down to the new cost of deposits over the 1-2 quarter duration of the time deposits. So even without any additional lowering of deposit pricing you would still expect to see a near 60bps improvement. This is obviously very material given there are €29.6bn of time deposits (the rates are also coming down on savings and sight deposits but this is much less relevant). The 60bps is worth close to €200m of additional annualised PPI, compared with the €1.2bn annualised reported PPI in Q2 2014.
How low can deposit rates go? Time will tell of course but rates in the other periphery are around 1% and the management teams of the Greek banks are clearly trying to reduce them towards this level. I would suspect another 50bps.

2. Relating to the rising cost of long-term Greek Government debt

This is a classic confusion between correlation and causality. Both deposit rates and GGB yields were falling up until recently. Since then there has been a sudden rise in GGB yields. Why? I believe the primary reason is that markets have started to discount political risk in Greece (this has also impacted equities as well, of course) ahead of a likely full election in 2015. These GGB’s total €30bn nominal in debt and have a market value of around €18bn. They are primarily held by hedge funds and other similar investors. There is no obvious reason why the trading of these investors in Greek Government debt should influence the behaviour of the average Greek depositor (particularly since depositors that left the Greek market to deposit elsewhere in Euroland have not returned to Greece). And so far this is what we have seen. Deposits increased at the banks in October and both banks recently confirmed to me that they saw no change in consumer behaviour (as of last week). Deposit rates in November are still going lower.

3. Relating to lack of loan growth

I do not rely on loan growth in my analysis, but on cost reductions and funding costs. However it is reasonable to suggest that GDP growth and loan growth do tend to correlate quite well and so it is quite possible that some loan growth might return to the market, as the economy recovers.

4. Relating to Table 2.2 (Developed markets debt breakdown)

This table seems to show something quite different to what you think. Whilst the 304% is correct the loan growth, or lack thereof, is likely to come most from the private sector (households and non-financial companies). Here Greece has debt to GDP of 129% (with the Government adding 175% to get to the 304%). This is actually the second lowest figure in the table, with only Italy lower at 125%. The US is higher at 160%. Leverage at non-financial companies is only lower in Germany and household leverage similar to most of the core European nations (France, Germany, Austria, Belgium). So, there is at least some room for private sector loan growth.

5. Relating Piraeus’ topline growth potential:

Your analysis also excludes the other major source of gains in PPI, which is cost reduction. They have €152m of additional synergies as part of their restructuring programme. This is to come primarily from branch closures and employee cost reductions through redundancies. Their medium term targets assume they will go further than this and I also think that plausible given how over branched Greece still is given the # of banks.

6. We do not contend that the bankruptcy law change has anything to do with business foreclosures. Further, as we stated in the presentation, this will be a much bigger benefit for Alpha Bank than for Pireaus.

7. Relating to collateral:

Mortages are only a small part of Pireaus. The collateral is not PP&E. You ask a bunch of questions:

“What type of do they count here? I hope it is not property, plant and equipment. How do they arrive at the figures? Transactions? Hardly possible in a depressionary environment. Estimated values (Appraisals)? If yes, how old are they? Are the values reported nominal values or haircut values? And how much is collateral worth in an environment where enforcement is legally difficult, anyway?

Why don’t you try to answer them?

Blackrock published a 173 page piece of research on all these issues (they also came up with stress test cumulative loss provisions that are very similar to those that the ECB stress test calculated) and it is available online. It describes answers to all of these questions.

Let us take mortgages to start with. Piraeus, as per Blackrock in March 2014, had €17.3bn in mortgage loans. This represents 340k loans with an average balance of €51k, average coupon of 3.4%, average LTV of 71% and a weighted averaging seasoning term of 54 months (either since modification or since origination). 79% of these loans were current, 6% delinquent (90-359 days past due) and 15%. Values are updated on an annual basis through indexation to PropIndex. Blackrock then hired real estate agents to perform “drive-bys” to check to provide independent valuations. These valuations were 13-14% lower than on the books (this had strong correlation with loan size, and here Piraeus is lower than average so it’s possible that their adjustment factor might be lower). Let’s assume you haircut the collateral by 14%, then total mortgage coverage is 99% (cash and collateral). And this would be before ANY impacts from strategic defaulters or any recent modifications of loans ahead of the change in legislation.

8. Then you ask “If collateral covers the net loans, why is the NPL ratio rising and standing at a record 38% of all loans, why are they not getting rid of these loans?”

I think your question misses the point. Given that most potential purchasers of books of NPL’s do not possess servicing facilities in Greece, and that there was no law for reclaiming collateral in mortgages and an insufficient law for restructuring corporate loans, who would buy these loans and why would you want to sell them at the appropriate risk adjusted return these buyers would demand? In fact Piraeus has just got to setting up its restructuring division (2k employees were trained over the summer) and will take most of the next year from now to attempt to restructure its NPL’s. They can perhaps be criticised for taking too long to have got this far but then there has been bankruptcy, sovereign default, various cost restructuring plans, recapitalisation on the market, Blackrock I and II, the ECB AQR and stress test, running a business etc. Plus you are seeing a new law that will deal with corporate restructurings passing through Parliament now, which will enable rapid restructuring of Corporate NPL’s with agreement from 50% + 1 shares of the debt defaulted. Given that the banks will always hold this much they now have far more control over the process (this should reduce the process from 2 years to under 1 year).

Further, the first signs even in consumer credit are positive. Piraeus offered restructuring to 20k customers who had defaulted and had been threatened with legal action. They offered forgiveness of between 30 and 50% of the loan if they repaid the rest. 10k started paying again. There is evidence everywhere of people who can pay, at least a bit, and are not.

Also note that in areas where collateral is consistent with international peers some transactions have taken place, ie shipping, where Alpha have completed a few transactions in the space.

9. Relating to your conclusion that NPLs from say 2010 have lost value:

Most corporate customers are “cash and carry” businesses. So what happens when you get consumer spending growth and economic growth? Surely you get a much healthier corporate sector? As can clearly be seen from the Blackrock report companies fell in trouble due to large declines in EBITDA, in many cases leaving margins –ve or net debt to EBITDA of more than 8x. This is obviously why provision levels here are high at 67% in cash. But there could well be a significant change here if the cycle turns and growth returns.

10. Relating to Figure 8. The AQR adjustment chart:

Modifications were made to Piraeus totalling €2.2bn. This is a downwards adjustment in book value that they apply for the purposes of their analysis in the AQR and stress test. This analysis will not be reflected in the financial reports of the banks, and that probably gives a good sense of whether they are merely prudent or actively punitive (if they were prudent you would expect the banks to immediately adopt them). This largely relates to use of collateral vs cash in dealing with corporate exposures. In the event that a corporate is a “going concern” (defined as net debt to EBITDA of <6x) then only cash flows can be considered, and if the corporate is a “gone concern” then only collateral, with significant haircuts applied (mainly to real estate). This is a sensible measure to take for a stress test, but this is not the reality in which the banks are dealing with day to day in an attempt to get paid on their loans.

11. Relating to Figure. EBA Stress test results.

This is the Basel III fully loaded ratio under the adverse scenario in the ECB/EBA stress test. Obviously you would not want to own the Greek banks if you believed in the assumptions backing the adverse scenario, which include:

A cumulative GDP decline of 2% from 2014 through 2016

14% further price hits to real estate, and 38% to investment property

17% more NPL’s (as a % of gross loans) from 2014 through 2016, versus 1.5% in H1 2014

A decline in net interest income (driven by NPL’s and higher deposit costs) to 45% lower than the current run rate (which is more severe given that we have already earned higher rates in 9M 2014)

I don’t believe that any of these things are likely.

But, there are also further problems in this analysis.

The balance sheet date they have used for this is year end 2013, so of course this ratio does not include the capital that was raised in 2014, for a start

Basel III in principle is a very good thing. The aim was to link capital ratios to capital that is actually loss absorbing and not just accounting book equity. So no more goodwill, or embedded value of life operations, or DTA’s etc etc. This has hit the Greeks, and other periphery banks, who amongst other things have lots of DTA’s as they have had lots of losses. So for Piraeus (and Alpha) the bank capital ratio in the chart above would NOT include the Greek Government Preference shares, nor any DTA’s, nor Pillar I bonds (subsequently sold) nor any capital raised

The ECB has, apparently, informed the banks on how to restructure their DTA’s into DTC’s so they will be loss absorbing capital from a Basle III perspective. Reflect that, and the other changes I talked to, and the Basle III ratio will begin to be very similar to the CET1 ratio. This is still low – but then of course I do not expect the adverse scenario

12. You write “Piraeus bankwill have to come up with substantial equity in the next five years – it will be a long time before Piraeus can grow its loan book substantially, let alone pay dividends even if profitable. ”

This is simply incorrect. That is not the ramification of the stress test.

13. Relating to the margin of safety.

I think you are conflating our guess of future value with margin of safety. Margin of safety has to do with downside protection from current levels. Today, Piraeus trades at at significant discount to book value, even with full AQR adjustment.

As for the upside, you still assumes that PPI does not go higher than €1.2bn per annum, whereas there are obvious gains through operating expenses and deposit costs (already achieved at today’s market rates) that easily add over €0.35bn. This is with no recovery in volumes or other revenues or any further reduction in deposit costs (every 10bps is worth another €30m) or any more cost saves.

Time will tell how much upside can be achieved. But, in our experience taking a static analysis of banking results at the end of a six year local depression is hardly reflective of what can happen in a recovery.

Even using your view of the Czech as the proper comparison with a 14% ROE, the recovery value for Piraeus is far above current prices.

Overall, I hope you don’t mind my commenting. I enjoy a thoughtful response and a healthy debate.

Time will tell who is right and we will all see how this plays out.


Leave a Comment