Deferred tax credit has
been an ally of the Greek banks when it was put into law. The purpose of the
deferred tax credit (DTC) was to cover any needs that may had arisen as a
result of the stress tests by the European central bank (ECB), as well as the
hair cut that banks underwent on their bond portfolios as a result of the private
sector investment (PSI) program.
DTC was aimed at being a
tax incentive for banks for the purpose to compensate losses. They have the
ability to offset losses due from PSI and bad loans with taxes due in the
future. Since DTC has been passed into law, banks have already wrote these
gains in their balance sheets, thus increasing their capital.
One may argue that this is creative accounting since it shows banks’ capital as overestimated. The reality is that for the next 20 or 30 years banks will deduct from this “cushion” taxes that should have been paid to the Greek treasury.
DTC will also be used to
deduct an equal amount from their capital, should a need comes up from the
stress tests. The DTC has the guarantee backing of the Greek treasury in case
any bank reports losses on their income statements. This loss will have to be covered
by the Greek treasury with cash. In return, the banks will issue rights of
common shares whose value will correspond to 110% of the gain from the DTC.
These rights will be converted to stock ownership. The benefits are estimated
to be about €2.5 billion, while the profits from the stress tests are estimated
at €300 - €500 million.
In addition to non-performing
loans (loans in delay, not expected to be paid) banks have added loans not
being expected to be paid due to the pandemic. So if a bank reports a loss it
would be required to issue share capital increase, and if that is not covered
by existing shareholders, then the government will have to step in and pay in
cash. The banks started to get rid of these loans from their balance sheets by
securitizing them as were instructed by the SSM (supervisory mechanism by the
ECB), but due to the pandemic this process has stopped for a while. The sale of
these securitized portfolios has been put on hold until market conditions (economic
growth) returns in 2021.
Two banks have made
progress such as Alpha bank and bank of Piraeus. They estimated their losses
from non-performing loans at €2 billion and €1 billion, respectively. The idea
is to clean up the banks’ balance sheets, transfer the bad debts to a “bad bank”.
A bad bank is set up to
buy the bad loans and other illiquid assets of a financial institution. The
entity holding these non-performing assets will sell these holdings to the band
bank at market price. By transferring these assets, the original institution
cleans up its balance sheet, but will be forced to report write down.
A write down is a
reduction in the book value of an asset (bad loans) when its fair market value
has fallen below book value. A write down becomes a write off if the entire
value of the asset becomes worthless. Write downs have a serious impact on the
company’s net income and balance sheet.
For example, during the
financial crisis of 2002-2008 the drop in the market value of assets on the
balance sheets, forced financial institutions to raise capital in order to meet
minimum capital requirements.
The solution of the bad
bank is one policy that the Bank of Greece supports and will soon present its
plan to the government. DTC correspond to 56% of owners’ equity. One can assume
what this may mean as far as real capital banks have in the event of having to
come up with capital to cover for losses.
The gradual decrease of
the capital adequacy (than bank’s capital to risk) of Greek banks, and the
degree of dependency, requires then return to profitability of Greek banks.
Covid and new generation of non-performing loans due to the pandemic, requires
banks to make increased projections for allowance for doubtful accounts.
Recently the IMF
expressed its doubt on the DTC and believes the Greek budget may be under
pressure in the future. DTC was placed in law in 2004 and the Greek government
at the time used it PSI program and bad debts. Despite objections from the EU,
Greece claimed that it was used successfully (in 2014) by Italy, Spain, and
Portugal. The fact is that the aforementioned nations did use DTC but on the
contrary to Greece, these countries first solved the problems of bad loans, and
then activated the DTC.
The government allowed
losses to be offset with profits for the next 20 years, which means, the banks
will not pay any taxes due for profits until the amount of €19 billion is fulfilled
(the amount of DTC). The amount of €19 billion is shown on the banks’ balance
sheets at capital.
Thus the banks struggle
to show profitability so as to depreciate the DTC, otherwise, if they report
losses in any fiscal year, the public treasury will step in to provide cash for
the increased in share capital, and this create a fiscal burden which will show
up in the public debt as well as create a budget deficit.
The other problem which
worries some in the EU is that if none of the existing shareholders are able to
cover the increased of share capital, this will create a dilution of the current
shareholders, as well as government subsidy.
To provide some data (Wood
research 2018) which shows the magnitude of the problem, during fiscal 2017,
the balance sheets showed the percentage of capital of common equity Tier1
(CET) (mostly common stock held by a bank) corresponded to 63% of DTC.
Therefore of the total capital CET1 worth €25.8 billion, €16.2 billion came
from DTC, while €10 billion real capital.
So the Bank of Greece
believes that to tackle this problem the solution is the bad bank, a special
purpose vehicle which will transfer all the bad loans to, as well as part of
the DTC. By doing both, the ratio of non-performing loans will be reduced, and
the capital base of the Greek banks will be improved. A more realistic plan
that the creative accounting currently in existence.
Non-performing loans are currently estimated to be €40 billion along with the DTC which is €7.4 billion. The Bank of Greece expects to reduce the percentage of bad loans by 47%.
Bill T. Alexandratos
October 2020
