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Saturday, 19 February 2011

I KNOWZ, A MERGUR WILL FIX IT!


I love banks in my day job as a small business policy guy, mostly for the endless entertainment and stimulation they provide. I don't follow them in my private life though, so my knowledge is limited and often dated.

Yesterday, however, news reached me through a reader of this blog that the National Bank of Greece has approached Alpha Bank with a 'Proposal for a Friendly Merger' and been rejected for now while the Alpha board holds out for a better price. The announcement apparently followed about a month of negotiations (admitted in the proposal), and hence Alpha's rejection prompted cries of manipulation, especially in the States where EUR140m was reportedly lost by those who bought on the announcement.

I am in no position to assess these allegations. What I do know is that our Government weighed in almost immediately, with the Minister of Finance tellingly releasing a written statement in which he supports the NGB bid as a step towards the strengthening of the Greek banking sector. Immediately following the first rejection of the NBG bid by the Alpha board, unnamed Government officials commented to a sympathetic To Vima:

"Don't jump into conclusions regarding the fate of the NBG bid. The Alpha board only controls about 10% of shares"

To put it mildly, our Government is signaling that it wants the acquisition to work and will go out of its way to help. The idea is that consolidation is to be welcomed in our banking sector as a better capitalised sector should be able to support the economy and, I cannot help but add, continue to buy those much sought after Greek government bonds. As one person put it on Twitter:



I am personally very suspicious of M&A regardless of country or sector - the financial press generally gets very excited about them individually and I can't help but feel that the lack of M&A activity is treated by many as some kind of financial erectile dysfunction. However, M&A are on average not particularly value-adding events. Bank mergers are not clearly aimed at producing economies of scale and banks that make a point of growing by acquisition generally destroy value in the process. NBG is not the worst offender on record but up to 2007 they were pretty active.

While this drama plays out, let's go into the background, briefly, of this story.

Here's an OECD table from the time of the ridiculous EU Stress Tests, i.e. last Autumn . It shows that, at the time, Greek banks held Greek bonds to the tune of 223% of their Tier 1 Capital. This means that a 23% haircut, the (reasonable) amount the stress test applied to Greek bonds held on the trading books but somehow not the banking books of banks, would, in a pretty stressed market, have wiped out about 51% of the banking sector's Tier 1 Capital. How bad is that? It means most of our banks would be, well, not insolvent but definitely undercapitalised from a regulatory perspective. Certainly both NBG and Alpha would fall short of the Basel III capital requirement if they had to write off half of their Tier 1 capital.

With some sort of default or other on the cards, capitalisation is the only thing that matters right now. Not earnings, not synergies (a doomed word in M&A parlance), just capitalisation.

If we ignore the stress tests' convenient distinction between trading and banking books, NBG holds EUR22bn of Greek government bonds overall, while Alpha holds a mere EUR5bn. Applying the stress test haircut to both totals would cost NBG EUR5bn out of EUR6.7bn of Core Tier 1 capital and Alpha only EUR1.1bn out of  EUR5.7bn of its high quality capital.

UPDATE: One reader has pointed out that the haircuts are likely to be a little smaller than I assume above because the two banks did not necessarily buy their bond portofolios at par value. If they bought recently, they would have bought them slightly cheaper than thus and will therefore be carrying them at a lower nominal value. Thus I may be underestimating capitalisation in both banks by a small amount although the comparison still holds. 

Note also that 22% of NBG's funding comes from the ECB, as opposed to 14.5% (possibly less as they've since raised funds) of Alpha's funding.

The point here is that NBG would be insolvent in case of a sovereign default by Greece and possibly even if it had to mark to market right now, while Alpha is in much shallower shit, and hence in a position to negotiate. In the eyes of a cynic, Alpha is the bigger bank by a mile. It's a simple case of "Meet the Denominator".



Note the reversal of reality in the NBG people's original response to the first rejection:


"a single reed standing on its own' [ed: a popular Greek metaphor for a person with no friends/allies] is not best placed to deal with the crisis." 
This in my mind makes negotiations very difficult. A notionally insolvent bank is worth next to nothing. Promising Alpha's shareholders a bigger share of nothing should not make the merger more attractive, unless one is unable to see past promises to create Greece's biggest bank and Europe's '25th biggest bank' (which echoes Borat's praise for his sister). Then again, never say never: almost half of Alpha is owned by individual retail investors.

However, the bid's troubles do not end here.

The combined bank is supposed to have a core Tier 1 ratio of 10,7%, but as you can probably see for yourselves it stands to lose nearly half of that, EUR6.1bn out of EUR12.4bn, if it takes a 23% haircut on Greek bonds. This will not kill the bank but it will make it insolvent for regulatory purposes, and possibly for the markets' purposes as well.

It is likely that there is some benefit to be had in terms of capitalisation since NBG is more exposed to mortgages and credit card debt than Alpha, which is in turn more exposed to commercial loans. But let's not forget that in Greece's ongoing sovereign crisis, all of these losses are increasingly correlated: the benefits of diversification to the NBG/Alpha hybrid will probably be much lower than they look on paper.

One thing the merger will achieve, when it inevitably takes place, is to create a Greek bank that is way too big to fail and thus a good recipient of unprecedented bailout largesse from the Greek Government and beyond. Such a bank would receive help from somewhere even after a Greek default. Could this be the first of the tactical mergers I discuss in the scenario section?


UPDATE: Under IFRS, if NBG does take over Alpha, it will have to test Alpha's assets (including but not limited to Government bonds) for impairment (i.e. loss of value), which could force it to take a haircut immediately. However, don't hold out for a big haircut because assets will only have to be written down to their 'value in use' - the present (i.e. discounted) value of the expected cash flows from them. This means that NBG can decide for itself how much of a haircut it takes on Alpha's assets by marking 'to model' - i.e. its own estimates of the expected cash flows. In the case of Government bonds, for instance it could argue based on Greece's ridiculous credit ratings that we have a tiny probability of default - less than 10% over 5 years, as opposed to the market consensus of 'DUH!!!'.

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