Read our analysis of the impact of Basel III elsewhere in the world.
Greece
Sovereign debt downgrades and a harsh economic environment have made it increasingly difficult and costly for Greek banks to raise funds and maintain liquidity. Even though major banks' regulatory ratios are currently adequate, the Bank of Greece has urged financial institutions to maintain capital ratios well above the minimum as a precaution. In addition, the central bank plans to gradually implement Basel III regulations by 2018. In order to National Bank of Greece meet the new regulatory measures, the Bank of Greece has pushed for sufficient credit risk reserves and controlled costs. In its view, mergers and strategic alliances are among the best way to attain these goals.
Indeed, such was the rationale for National Bank of Greece's (NBG) friendly bid to merge with former, Greece's largest financial institution, argued that substantial cost synergies--both funding and operating-- could be realised and that the combined entity would have a much better liquidity position. However, the transaction was rejected, and if NBG comes back with a higher bid we would be even more sceptical about the true value creation from the deal.
By itself, National Bank of Greece's capital position is adequate currently. At year-end 2010, the firm's core capital ratio was 12.0%. Furthermore, management expects that the public offering of a portion of its Turkish subsidiary, Finansbank, will add another 150 basis points to this ratio. Even though on paper this ratio looks among the healthiest in Europe, we do not rule out the need for more capital infusions. First, 8.5% of NBG's loan book is nonperforming. Second, the firm holds nearly EUR 14 billion of Hellenic Republic debt in its books. By our calculations, this amounts to just over 10% of NBG's balance sheet and 1.4 times its equity base. Thus, even a minor restructuring in Greece's sovereign debt could have dire implications for National Bank of Greece's capital, in our opinion.
Ireland
Ireland's banking system is a mess and is close to basically being nationalised. Each major Irish bank already has capital requirements they must meet over the next several years, but with little in the way of public interest in their equity issues, the government is making up the difference. While this will likely result in satisfactory capital ratios, it's the liquidity ratios that may be the toughest for the banks to handle. They require long-term funding to be in place and the ability of basically nationalised banks from Ireland to tap the long-term credit markets is expensive at the best. The beleaguered banks are not helped by their large pension fund deficits--which may have to be subtracted to Tier 1 capital under Basel III. Bank of Ireland's last reported pension deficit was EUR 1.5 billion, and Allied Irish's was EUR 1.26 billion.
Bank of Ireland (BKIR) has pledged to raise EUR 4.2 billion to increase its core Tier 1 capital ratio to 10.5%. The bank is looking at more than just the equity markets to do so. Bank of Ireland has put its Burdale lending business up for sale--one of its most profitable divisions (consistently profitable throughout the crisis with earnings of 30 million pounds last year). The bank is currently 36% owned by the state; however, if private investors cannot be found, the state may have to help in the capital raise--increasing its stake in the bank. Allied Irish is in a much worse situation. Already 49.9% owned by the government, the bank has to raise an additional EUR 10.5. When it fails to garner enough private investor interest, we expect it will head to the state for funds and effectively be nationalised.
Italy
Early in 2011, Bank of Italy governor Mario Draghi implored Italian bankers to raise capital ahead of the latest round of Pan-European stress tests. Intesa Sanpaolo (ISP) plans to raise up to EUR 5 billion in a rights offering and presented a plan to maintain a core Tier 1 ratio of at least 10% over the next several years--up from 7.9% as of Dec. 31, 2010. A possible spin-off of asset management unit Banco Fideuram has also been rumored for some time, giving Intesa even more room to raise capital. We expect this announcement to pressure UniCredit (UCG), the other Italian lender we cover, into matching Intesa's capital position, though bank executives have expressed mixed feelings about raising more capital. UniCredit's core Tier 1 ratio was 8.6% at year-end, and CEO Federico Ghizzoni recently estimated that it would be 7.6% if Basel III were applied immediately.
Spain
In an effort to strengthen its banking system, as well as improve the market's impression of Spanish financial institutions, the Bank of Spain began its financial sector reform in 2008. More recently, in early 2011, new laws were enacted in order to accelerate the adoption of the new Basel III regulations. Indeed, a stricter definition for core capital was devised and the minimum set at 8% for most companies and 10% for those with less access to capital markets. In this respect, banks are in a better position than the cajas, or savings banks, which except for the largest national institutions have a very limited capacity to raise external funds. Lastly, the central bank has also pushed for a substantial consolidation of its banking system, mostly aimed at the cajas in order to make them more efficient, lower their funding costs, increase their liquidity position, and make them more independent (traditionally,
these regional savings banks have had strong political ties with local governments).
In our view, both Banco Santander (SAN) and Banco Bilbao Vizcaya Argentaria (BBVA) are in relatively good standing. As of Dec. 31, 2010, Santander's and BBVA's core capital ratios were adequate at 8.8% and 9.6%, respectively. In addition, we like that the banks' revenue streams come from well-diversified sources that encompass Latin and North America and other European countries. We think that, while not stellar, both banks are relatively profitable (ROEs above 10%) and have manageable credit quality issues (nonperforming loans around 4% of their total portfolios) that should allow them to keep enhancing their capital positions slowly but surely.
Banco Popular Espanol (POP) is different, mostly because it lacks the geographic diversification its larger peers enjoy, in our view. However, for the time being, its core capital ratio seems fine at 9.4%. Notwithstanding, being much more exposed to its home country's economy, its NPL ratio is slightly more worrisome at around 5% and its internal capital generation will be constrained with ROEs under 10% in the near future, in our view.
We think all three institutions can skate through the remainder of the crisis without having to raise more equity and still comply with the Bank of Spain's regulations. However, we think their fate is tied to Spain's creditworthiness, and if the Iberian Peninsula's economy does not improve or it is subject to more credit downgrades, the banks could suffer. Thus, these companies could be subject to tap the markets at the same time where the risk premium is increasing, which could raise their cost of equity or debt meaningfully. If such were the case, we think that either BBVA or Santander would fare better since they have better access to international capital markets and can sell some of their assets to both raise equity and decrease their size.
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