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MINT

The level of Non-Performing
Loans held in the Southern
European Banking Sector
threatens the region’s
financial stability.

BILL BLAIN
Strategist, Head of Capital Markets
bblain@mintpartners.com
+44 (0) 20 7786 3877

BEN STHEEMAN
Associate
ben.stheeman@mintpartners.com
+44 (0) 20 7786 3877

NON-PERFORMING LOANS:
SOUTHERN EUROPE’S NEXT TIPPING POINT
1919 July 2017
th July 2017
CONTENTS

PREFACE 2

EUROPE’S TIER II PROBLEM BANKS 4

DEFINITIONS 5

SIFIs 5

NON-PERFORMING LOANS (NPLS) 6

GOOD BANK, BAD BANK 7

RESOLUTIONS: WHAT HAS BEEN DONE SO FAR 8

ITALY 9

UNICREDIT 14

GREECE 15

PORTUGAL 18

CYPRUS 20

SPAIN 21

IRELAND 22

GERMANY 24

THE ECB’S RESPONSE – IT’S A LEARNING THING 25

CONCLUSION 26
1 | MINT
PREFACE

Above is the Itraxx European Senior Financials CDS Index. It is a generic index
showing the spread of senior bank debt issues by European banks since the
Global Financial Crisis - a measure of how risky they are perceived to be.

The European Financials Spread is now at its tightest spread since the crisis.

WHAT DOES THIS TELL US?

Despite uncertainty about new bank regulatory regimes and the ability of
regulators to bail-in bond depositors in order to protect taxpayers, investors are
sanguine on European financials.

Spreads have tightened in line with the general inflation of all financial assets
caused by too much money chasing too few assets - a direct consequence of QE
and a negative interest rate policy.

A perception that the European economy is recovering has helped. Stronger
European growth will improve bank fundamentals, and rising rates will enable
banks to improve margins.

The successful resolution of the failing Banco Popular in Spain and the more
problematic solutions to Monte dei Paschi and the Venetian banks in Italy has
created an impression that problems around European banks are finally being
addressed.

However, while the 30 largest SIFIs (Systemically Important Financial
Institutions) in Europe look, on the whole, secure, we are more concerned about
two aspects of European banking.

1. Among the Second Tier Financial Institutions there are a large number
of undercapitalised European banks still struggling with unsustainably

2 | MINT
large volumes of Non-Performing Loans (NPLs). The next European
financial crisis is as likely to be triggered from long-term issues in the
mid-sized sector as an idiosyncratic event at one of the SIFIs. For this
reason, it is worth looking at these mid-sized institutions in detail.
Following an analysis of all Eurozone banks with balance sheets greater
than €10bn, this report below examines 26 European banks with serious
NPL imbalances.

2. There is a clear geographic divide across Europe: in the North banks
have NPLs capital levels under control but towards the South this is not
the case. Of the 26 banks this report focusses on, 23 are based in
Southern Europe, and 3 in Northern Europe. This NPL Divide highlights
future difficulties in creating an EU Banking Union with a single set of
enforceable regulations due to national self-interest and the propensity
of borrowers to honour their debts.

Our analysis suggests there exists a total capital shortfall of €120bn in the
Eurozone. With a capital shortfall of this size, Europe’s Tier II banking sector
remains in a precarious condition.

The banks which we highlight as particularly at risk of needing to be
recapitalised are Banca Carige, Unipol Banca, Banca Popolare di Bari, Banco
BPM, Iccrea Banca Impresa, Novo Banco, Bank of Cyprus, Alpha Bank, Piraeus
Bank, Eurobank Ergasias, and National Bank of Greece.

Our primary concern for Italy is the lack of a strong banking champion. There is
simply no large Italian bank secure enough to take on the responsibility of
recapitalising these banks, meaning public funds must be used instead. This is
putting pressure on Europe’s attempt to unify rules on resolutions, and protect
taxpayers’ money.

Resolving Europe’s NPL problem will require a change in policy. There still
remains stark differences between Eurozone-wide resolution rules and the
individual actions of member states. In its current form, the ECB’s banking
regulation will not suitably deal with a European banking crisis.

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EUROPE’S TIER II PROBLEM BANKS
Below is a table of the 26 banks this report focusses on. These banks are those
facing capital shortfalls or, in UniCredit’s case, are very close to facing a capital
shortfall.

In particular, the two key ratios to look at are the NPL ratios and the CET1 Capital
ratios, and their difference, as this shows the capital shortfalls faced by these
banks.

The table highlights that there remain plenty of Southern European banks with
significant NPL ratios, which are not supported by their corresponding CET1
ratios.
Total NPL CET1
Assets NPL Coverage Capital
Bank Country EURbn Ratio ratio Ratio
Alpha Bank Greece 64.87 53.80% 49.00% 17.30%
Piraeus Bank Greece 81.50 51.90% 46.10% 16.80%
Bank of Cyprus Cyprus 22.17 51.80% 42.00% 14.40%
Eurobank Ergasias Greece 66.39 45.00% 50.80% 17.30%
National Bank of Greece Greece 78.53 43.60% 56.00% 16.00%
Unipol Banca Italy 12.35 42.30% 45.80% 13.90%
Novo Banco Portugal 52.33 39.01% 50.00% 10.80%
Banca Carige Italy 26.11 34.68% 46.40% 10.90%
Credito Valtellinese Italy 25.47 30.64% 41.60% 11.60%
Banca Popolare di Bari Italy 13.57 24.71% 44.90% 9.92%
Banco Bpm SpA Italy 168.00 23.32% 48.20% 11.66%
Iccrea Banca Impresa S.p.A. Italy 10.86 22.18% 42.90% 8.60%
BPER Banca Italy 64.96 21.70% 45.60% 13.33%
Caixa Económica Montepio Geral Portugal 21.45 20.00% 53.80% 10.20%
Liberbank Spain 38.32 17.67% 40.00% 12.00%
Millennium BCP Portugal 72.08 15.93% 100.00% 13.00%
Banca Popolare di Sondrio Italy 37.20 15.49% 46.91% 10.81%
Caixa Geral de Depositos Portugal 92.82 15.40% 55.20% 12.30%
Intesa Sanpaolo Italy 725.10 14.38% 48.72% 12.50%
UBI Banca Italy 112.38 13.90% 35.83% 11.44%
Banca Sella Group Italy 13.30 13.80% 52.10% 11.96%
Ibercaja Banco Spain 58.34 11.77% 45.00% 11.00%
UniCredit S.p.A. Italy 859.53 11.40% 56.30% 11.71%
Permanent TSB Ireland 23.60 30.98% 42.00% 15.10%
Allied Irish Banks (AIB) Ireland 95.62 22.70% 44.00% 16.00%
HSH Nordbank AG Germany 84.37 16.50% 49.20% 14.90%
Total: Ave: Ave: Ave:
€2,921bn 27.10% 49.17% 12.90%
.

Source: Published Information using EBA definitions

As of 31/12/2016 or later

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DEFINITIONS
CET1 Common Equity Tier 1 measures equity capital plus
declared reserves. It is the core measure of the financial
strength of a bank.
CET1 Ratio The Common Equity Tier 1 Ratio measures a bank’s
capital against its risk-weighted assets.
Non-performing Defined by the European Banking Authority (EBA) as
loans (NPL) loans which are:
1) 90 days past-due or loans which the debtor is
unlikely to repay, or
2) Impaired or defaulted according to the
applicable accounting or regulatory
frameworks.
NPL Ratio The amount of gross non-performing loans over a bank’s
total gross loans
NPL Coverage A measure of a bank’s ability to absorb potential losses
Ratio from its NPLs. It is calculated as provisions set aside for
impaired assets divided by NPLs.
Total Capital A second capital measure calculated as the sum of a
Ratio bank’s tier one and tier two capital expressed as a
percentage of its risk-weighted assets.

SIFIs
Financial Institutional Investors typically focus on the SIFIs (Systemically
Important Financial Institutions). They are important because, according to the
Financial Stability Board, their failure would produce widespread shocks to the
financial system due to their “size, complexity and systemic connectedness”.
Basel III addressed these institutions in particular.

However, as the recent noise around Italian banks highlights, while it is
important to monitor SIFIs, there exist plenty other smaller banks whose failure
would still have significant consequences on investor confidence in the wider
financial system. Greater concern should be expressed on these banks due to
the abundance of poor quality loans on their balance sheets, particularly when
compared with their levels of capital.

The focus of this report, will therefore not be on the SIFIs, but on the smaller,
mid-sized banks based in parts of the Eurozone which are struggling due to the
poor quality of many of their loans. This report does discuss one of the SIFIs,
UniCredit, as its balance sheet weakness directly affects the scope for private
sector recapitalisations of mid-sized Italian banks.

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NON-PERFORMING LOANS (NPLs)
The primary weakness of the Southern European banking sector is NPLs.

 While the Eurozone’s NPL ratio peaked at 8% in 2013, it has since
decreased to 6.17%.
 Despite this, there remains a handful of countries in which significant
improvements are yet to be made: NPL ratios remain at double-digit
levels in six Eurozone countries, and over €900bn of such loans held by
banks directly supervised by the ECB remain.
 The Eurozone’s NPL coverage ratio amounts to about 46%.

The basis of good banking is sound lending. In contrast, a weak balance sheet
propped up by poor quality loans is a sign of a poorly run bank in which far too
little care was taken to ensure that only reliable loans were taken on. Due to the
large number of NPLs in the Euro Banking Sector, there are a number of banks
which are beginning to pay the price for their careless lending. The countries
which these banks are concentrated in are Italy, Portugal, Spain, Greece, Cyprus,
and, for different reasons, Ireland and Germany.

The comparison of German and Irish high NPL banks with Southern European
high NPL banks highlights the differences in state responses to the balance
sheets of these institutions.

Despite the EBA’s efforts, there remains a lack of harmonisation in the definition
of an NPL. While some banks will report their level of NPLs using the EBA’s
definition, many do not.

 When using the NPL ratios provided in their annual reports, the average
ratio of the 26 banks discussed in this report was just under 22%.
 When using the EBA definition for NPLs, the average NPL ratio increases
to 27.10%.
 As a result, the total capital shortfall for European Banks increased from
just over €75bn to over €120bn when using the common EBA definition.

Therefore, in this report, NPLs have been calculated using the EBA’s definition
rather than those appearing in the earnings reports of banks. In addition, non-
performing loans (NPLs) and non-performing exposures (NPEs) were used
interchangeably, as recommended by the ECB Banking Supervision in March.

6 | MINT
GOOD BANK, BAD BANK:
In April last year, Italy’s financial sector agreed to contribute €5bn to establish
a rescue fund Atlante helps recapitalise weaker banks struggling to raise capital,
and purchase the securities of mezzanine and junior tranches of NPLs.

The creation of Atlante should not be discouraged. Having said that, questions
exist over the timing of its creation and its funding.

The rationale behind the creation of this rescue fund is a sound one. There are
various examples of successful European rescue funds: Ireland created the
National Asset Management Agency in 2009, which functioned as a bad bank
aiming to improve credit availability in Ireland, while Spain also created the
Fund for Orderly Bank Restructuring in 2009. As a result of these funds, the
banks of both these nations do not dominate this report.

However, a common theme with the creation of these successful bad banks is
their timing. They were all created at the height of the Financial Crisis, and as a
result, since then, Ireland and Spain have made far more progress in cleaning
up their banking sectors. Italy, on the other hand, have waited eight years
before acting.

Further questions arise regarding the funding of Atlante. Italy faces a capital
shortfall of over €32.6bn, and there are a total of €324bn of NPLs in the nation’s
financial sector. €5bn seems a drop in the ocean relative to these figures,
particularly when Spain’s bad bank was funded to the tune of €99bn.

It seems as if, in its current state, Atlante will struggle to meaningfully change
the banking sector it has been tasked with cleaning up.

7 | MINT
RESOLUTIONS: WHAT HAS BEEN DONE SO FAR
In the last several weeks, four Southern European banks have failed, all as a
result of excessive volumes of NPLs on their balance sheets.

Monte dei Paschi di Siena

Following its performance in July last year as the worst performing European
bank in stress tests, MPS attempted unsuccessfully to raise €5bn in equity to
plug some of its capital shortfall.

As a result, the Italian state was forced to step in and announce a precautionary
recapitalisation of up to €8.8bn. Through a five-year restructuring plan, MPS will
dispose of €28.6bn of bad loans, priced at about 21% of their gross value, to the
government sponsored and privately funded back-up fund Atlante. On 5th July,
the European Commission granted formal approval of this restructuring plan as
junior creditors agreed to contribute €4.3bn to the rescue.

The two Venetian banks:

At the end of June, the ECB confirmed that Veneto Banco and Banco Popolare
di Vicenza were “failing or likely to fail”. The ECB decided the resolution of the
banks should be dealt with according to national insolvency laws, and so Italy
agreed to inject €5bn of taxpayers’ money while handing their good assets to
Intesa Sanpaolo. As part of the resolution, the state offered guarantees of up to
€12bn to cover losses from the two banks’ bad loans.

Fabrizio Viola, the CEO of one of the Venetian banks, Popolare, was the former
chief executive of MPS who left following the results of the EU stress tests.
While MPS’ failure was not exclusively due to Viola’s management, Viola
oversaw MPS burn through €8bn of fresh capital. His appointment at Popolare
is a clear indication of the revolving door of Italian banking.

The chronic mismanagement of Italy’s financial institutions highlight that many
of their weaknesses are structural.

Banco Popular:

At the beginning of June, a resolution to save Banco Popular took place
demonstrating the private sector’s potential to help deal with Europe’s NPL
crisis.

Popular’s NPA ratio (its NPLs plus its problematic stock of real estate assets) was
32.2%. This is a very high figure but there still remain eight other Euro Area
banks with assets over €10bn that have higher NPL ratios.

Popular had raised €2.5bn in equity in June 2016 in an effort to secure its
balance sheet, and had also borrowed €7.2bn from the ECB. This is a clear
example that efforts to improve a bank’s balance sheet far from guarantee that
bank’s security. In contrast to the Italian government bailing out their failing
banks, the responsibility of Popular’s recapitalisation fell to the private sector
as Santander recapitalised the bank. As a result, Popular’s resolution was largely
considered a success.

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ITALY
Italy’s high levels of NPLs are, in part, related to its poor growth levels. The IMF
predicts the economy will take a decade to return to pre-crisis levels, presuming
there is not another. Italy’s economy has not performed much worse than
Spain’s, yet its NPL ratio is over triple that of Spain’s. For this reason, there must
be other reasons why Italy’s banks are in trouble such as differences in cultural
attitudes towards debt repayments and financial reporting.

Italy punches far above its weight in terms of NPLs:

 €324bn of Italian bank loans are non-performing.
 This has decreased from a peak of €341bn at the end of 2015.
 Despite Italian bank assets accounting for only 13% of the Eurozone
total, Italian banks held one-third of all NPLs in the Euro Area.
 In total over 17% of Italy’s loans are non-performing.
 Our analysis suggests the total capital shortfall for Italian banks is
€32.64bn.

It is therefore unsurprising that Italy’s banks are over-represented in the list of
bad banks. “High NPL banks”, according to ECB guidelines are those with NPL
ratios over 7%. This means that 16 of Italy’s 19 banks with balance sheets
greater than €10bn are considered “High NPL banks”!

Many Italian banks are beginning to offload their NPLs by selling them on to
hedge funds. Caution should be exercised here since this will merely move the
problem elsewhere. Furthermore, flooding the market with NPLs will only
reduce the price banks receive for their NPLs because of increased supply. For
this reason, it should be expected that Italian banks will end up receiving a price
at a far greater discount than hoped for.

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Unipol Banca: UNIIM Corp, UNI IM Equity

This is a relatively small bank in a very insecure state:

 Its NPL ratio of 42.3% is the highest of any Italian bank, even when
considering MPS and the two Venetian banks.
 Its CET1 ratio of 13.9% is relatively low for a bank with its level of NPLs

The bank is beginning to recognise its precarious situation by creating an
internal bad bank to house €3bn of its NPLs. This will cost €780mn in terms of
extra provisions paid for by Unipol Group selling two insurance businesses to its
main insurance subsidiary. If successful, its NPL ratio will be reduced to 10%
which will represent a large step towards confirming the safety of the bank.

It should be noted though that Popular failed even while it was attempting to
offload its NPLs. Unipol aims to implement the entire project by the end of Q1
2018. Until this is completed, the bank remains in trouble, and is one to be
watched.

Banca Carige: BANCAR Corp, CRG IM Equity

Following the recapitalisations delivered to the Veneto Banks, Carige is one of
the most troubled European Banks out there.

 Its NPL ratio is 34.7%
 It has a coverage ratio of 46.4%.
 Carige’s total capital shortfall of almost €4bn is very large for a bank of
its size.

These are very similar figures to Veneto and Popolare di Vicenza before both
had to be recapitalised.

The bank is showing some signs of recovery following a €500mn rights issue and
a €1.2bn disposal of NPLs but it has some way to go still. Carige has pledged to
reduce its portfolio of bad loans by a further €1.8bn.

It requires a greater level of stability if it is to survive - there was a no-confidence
motion approved last month in the Bank’s CEO who had only been in charge for
just over a year.

Its CET1 ratio lags behind the ECB’s recommendation of 11.25%. It is expected
its CET1 level will fall to 10.3% at the end of this year. While it will remain above
the ECB’s regulatory requirement of 9%.if such a trend continues, Carige’s
shortfall will only increase.

Carige is in the unfortunate position of having an extremely high level of NPLs
while lacking the capital needed to offset the winding down of these NPLs - not
a good mix.

Credito Valtellinese (Creval): CRVALD Corp, CVAL IM Equity

 Creval’s NPL ratio of 30.6% is high and has only been marginally reduced
in recent years.
 Its coverage ratio of 41.6% is low.

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 Its CET1 ratio of 11.6% is low.

Reducing Creval’s stock of NPLs will require increased provisioning which will
hamper its profitability.

On 14th July, it announced that it had completed the securitisation of a €1.4bn
portfolio of NPLs. Through securitisation, loans are packaged together and
transformed into bonds of varying levels of risk.

This is a significant move but more will need to be done to confirm the safety of
this bank. It is worth noting that many retail investors have money tied up in
Creval, increasing the chances of a State recapitalisation if it fails.

Banca Popolare di Bari: BPBARI CORP, BPB HM Equity

 Bari’s CET1 ratio is less than 10%.
 This is low for a bank with an NPL ratio of almost 25%.
 Its coverage ratio is less than 45%.

To provide the bank with the capability of winding down its NPL stock, it will
need to boost its capital reserves in the coming months.

It is being investigated by Italy’s finance police for alleged obstruction of
regulators, something both Venetian banks were being investigated for before
their failure. Having said this, being investigated by the authorities is not a rarity
for an Italian bank.

Banco BPM: BBPMSPA Corp, BAMI IM Equity

This is a relatively new bank created on 1st January this year by the merger of
Banco Popolare and Banco Popolare de Milano.

 It faces a capital shortfall of over €9bn, the largest in Italy.
 Its NPL ratio of 23.3% is large given it is the third largest bank in Italy,
while its core equity ratio of 11.7% is low.

It is attempting to reduce its NPLs by selling €693mn of bad loans in June at a
valuation well above what it hoped to receive. However, for a bank that has
over €29bn of NPLs on its balance sheet, BPM has a lot more work to do. Juggling
the complications of integrating two large banks while trying to reduce its large
stock of NPLs represents a big challenge in the coming months for this bank, and
one it might not be able to overcome.

Iccrea Banca Impresa: BNAGRI Corp, 1273Z IM Equity

This is another typical weak Italian bank.

 It holds the lowest Euro Area core equity ratio of 8.6% following MPS’
failure.
 Its coverage ratio of 42.9% is low considering it has very little capital to
fall back on.
 For a bank with a balance sheet of just over €10bn, its capital shortfall
of over €1bn is significant.

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Iccrea has made very little progress so far in attempting to improve the quality
of its assets and more needs to be done.

BPER Banca: BPEIM Corp, BPE IM Equity

 BPER has an NPL ratio of 21.7%
 This is large considering its CET1 ratio is 13.3%.
 In Q1, its CET1 and total capital ratios decreased by 47bps and 55bps
respectively, at a time when its peers’ capital ratios have been
improving.

At the end of June, BPER completed the acquisition of Nuova Carife, one of the
banks bailed out in 2015 by the Bank of Italy, for €1 in a deal that would
marginally improve its NPL ratio as it receives Carife’s good assets.

Despite this, we are worried about BPER’s lethargic response to its high NPL
ratio. Little has been announced regarding a significant move to reduce its non-
performing loans and while this bank has had little negative media regarding its
NPLs, they remain at a troubling level.

Banca Popolare di Sondrio: BPSOIM Corp, BPSO IM Equity

 Sondrio’s NPL ratio of 15.5% is high.
 Gross impaired loans increased by 8% during 2016 and a further 2%
during Q1 2017.
 While this does represent a slower growth than previous years, the fact
that its NPLs are increasing at a time when its peers’ are decreasing is a
cause for concern.

Credit Rating Agency Fitch is sceptical of Sondrio’s 2017-2021 strategic plan to
manage its impaired loans arguing it will “fail to reduce the stock of impaired
loans in a meaningful manner.” Sondrio’s present failure to reduce its NPL
volumes supports this opinion.

Furthermore, Sondrio’s profits have been volatile in recent years falling 22% in
2016. This volatility is set to continue unless Sondrio makes genuinely
meaningful steps towards reducing its NPLs.

Intesa Sanpaolo: ISPIM Corp, ISP IM Equity

Intesa, the second-largest Italian bank, is a typical example of Italy’s large banks
being no more secure than their smaller counterparts.

 It faces a capital shortfall of almost €5.3bn due to its €57bn stock of
NPLs.
 Its NPL ratio is 14.4%.

The intervention by the Italian government following the failure of the two
Venetian banks involved state support for Intesa to pay €1 for their good assets,
worth €5.2bn, without harming its capital ratios in the process, on top of a
guarantee of up to €12bn for potential losses incurred from their NPLs.

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In May, Intesa announced a change of strategy which would involve a reduction
of its non-performing loans by a third by 2020 as well as closing hundreds of
branches to reduce its costs by hundreds of millions of euros. Such a move is
necessary to guarantee the security of Intesa, but is long overdue and not a
particularly radical shift when compared with some of its peers.

Intesa may not be in imminent danger of failing but it is certainly not in great
shape. The lack of Italy’s big banks’ financial security is the primary reason why
Italy’s banking failures are not being dealt in the private sector. There are no
large reliable banks which can cover for the weakness of the smaller banks in
the same way as Santander was able to with Banco Popular.

UBI Banca, UBIIM Corp, UBI IM Equity

 UBI’s NPL ratio is 13.9%.
 UBI has been making progress towards reducing its poor quality loans,
but still faces a capital shortfall of almost €1.5bn.
 UBI’s weakest aspect is its coverage ratio of less than 36%, which
exposes it to financial shocks.

At the beginning of the year, UBI bought, for €1, the good assets of three lenders
rescued by the state in 2015. UBI recently completed a €400mn rights issue to
ensure its CET1 ratio remains above 11% in the wake of this purchase.

Banca Sella Group: BNSELL Corp, BSEL HM Equity

 Its NPL ratio is relatively high at 13.8%.
 It faces a capital shortfall of around €138mn.

Sella is not in as deep financial stress as some of its peers, evident from its more
modest capital shortfall. For this reason, it should not encounter significant
troubles, relative to its Italian counterparts, even though its NPL ratio would still
be considered high by most countries’ standards.

13 | MINT
UNICREDIT, UCGIM Corp, UCG IM Equity
Italy’s biggest bank is far from the safest.

 UniCredit holds over €55bn of NPLs.
 Its NPL ratio of 11.4% is marginally smaller than its CET1 ratio of 11.7%.

Its capital ratios were extremely poor at the end of 2016 falling to 7.54%, below
the ECB’s regulatory requirements. This was as a result of a one-off charge of
€12.2bn in Q4 2016 incurred by UniCredit as it increased its NPL coverage. The
lender warned that its capital position was not stable. Last summer, UniCredit
was the sixth-weakest institution of the Eurozone’s biggest lenders in ECB stress
tests.

In order to combat this, investors approved a €13bn rights issue at a 38%
discount at the beginning of the year. As a result of this, it does not currently
face a capital shortfall. Nevertheless, due to UniCredit’s size, any small increase
in NPLs or decrease in capital would lead to a significant shortfall.

UniCredit announced at the end of last year that it had agreed on the sale of
€17.7bn of NPLs, in a move dubbed as Project Fino. On 17th July, UniCredit
signed this deal off, and expects a resulting 10bps increase in its CET1 capital
ratio. The loans were sold at an average price of about 20 cents each. This is a
promising start to reducing its NPL volumes, but much still remains to be dealt
with.

Similar to Intesa, UniCredit is not in imminent danger of failure, but it is not in a
strong state. In instances of other Italian bank failures, UniCredit is not in a great
position to aid these banks in the same way as Santander did with Banco Popular
in June. This means that failures will more than likely be dealt with by the public
sector in the same way as the other Italian banking failures in recent weeks have
been. This would harm a nation whose government debt stands at 133% of GDP,
the highest in the Eurozone after Greece.

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GREECE
Greece’s banks have long been endangered, being the primary focus of the third
Greek bailout package of over €80bn. This package included a €25bn
recapitalisation for the Greek banks and €7.7bn of cash buffers for liquidity in
the system to protect them from the flood of withdrawals they were facing at
the time. The bailout programme expires at the end of August next year.

 During the Greek debt crisis of 2015, Greece’s Central Bank provided up
to €89bn in Emergency Liquidity Assistance (ELA), an expensive form of
bank lending, to the nation’s banks with the permission of the ECB.
 The current cap on ELA to Greek banks has since fallen to around €41bn
per month.
 Deposits in these banks have decreased by over 50% from a peak
reached in 2009 to less than €120bn in January, which has weighed
down Greek banks’ balance sheets.

Despite the assistance provided to Greek banks, they are by no means secure.

 Greece’s NPL ratio has increased from less than 5% in 2008 to 46% in
2016, a figure which continues to increase.
 Of loans to SMEs and freelance workers, 60% and 70% respectively are
non-performing.
 Greece’s largest four banks cumulatively hold a capital shortfall of over
€59bn.

Greece also suffers from an industry-wide problem of poor management.
Greece’s rescue vehicle, the Hellenic Financial Stability Fund (HFSF) found in
2016 that about 20 of the 55 board members of Greece’s four major banks failed
their “fit and proper” test.

15 | MINT
Greek Banks are aiming to reduce system-wide NPEs to 34% in 2019 driven
primarily by the curing of loans and write-offs. Considering that Greece, since
the GFC, is yet to have a year in which it decreased its NPLs, this is a very high
target. Some small co-op banks have NPL ratios of over 80%, a figure which must
suggest a different cultural attitude towards the repayment of debt. If such an
attitude exists, Greece will struggle to meaningfully reduce its NPLs in the short-
term.

Alpha Bank, ALPHA Corp, ALPHA GA Equity

 Over half of Alpha Bank’s exposures are non-performing, providing
Alpha with a capital shortfall of €18.36bn.
 The bank’s ELA in March 2017 stood at €12.2bn, down from €19.6bn in
December 2015, comprising 19% of its total assets.

Alpha’s ELA covers its capital shortfall to some extent, but it does not cover it
entirely, particularly as its ELA will likely decrease in the coming months and
years.

There has been a lack of comprehensive action towards reducing its NPLs as it
missed its target for Q1 2017. Alpha Bank’s relatively high level of core equity
capital does mean that it can afford to hasten its reduction of its non-performing
exposures for a short time at least.

Piraeus Bank, TPEIR Corp, TPEIR GA Equity

 Piraeus, now the largest Greek bank by assets, has an NPL ratio of
almost 52%.
 It holds the largest capital shortfall in the Euro Area of €18.65bn.

After three rounds of recapitalisations undertaken in recent years, Piraeus has
been forced to issue billions of new shares in an attempt to boost its equity
capital. In the wake of Greece’s sovereign debt crisis, Piraeus has seen over 99%
of its market capitalisation wiped out.

It remains 26.2% owned by Greece’s bank rescue fund HFSF and is planning to
sell its Bulgarian, Romanian, Serbian, Albanian and Ukrainian subsidiaries as a
part of its ‘Agenda 2020’ plan to reduce its foreign exposures and bad loan
portfolio. It aims to increase new funding to €5bn annually by 2020, up from
€2bn in 2016 and divest stakes in the shipping company Hellenic Seaways and
the fish farms Nireus Aquaculture and Selonda.

Piraeus will then create a separate division known as “Piraeus Legacy Unit” to
clean up its balance sheet and leave €28bn in risk-weighted assets (a reduction
of almost 50%) and a 2% NPL ratio. These targets are ambitious but, if
successful, would secure Piraues’ safety.

Eurobank Ergasisas, EUROB Corp, EUROB GA Equity

 Eurobank has an NPL ratio of 45% with a coverage ratio of 50.8%.
 It faces a capital shortfall of €10.7bn.

16 | MINT
Eurobank is in the process of selling €2.8bn of NPLs in an attempt to reduce its
bad loans by 40% by the end of 2019 but they are struggling with offers which
are reportedly only around 5% of the original value of these loans.

While its CET1 ratio of 17.3% will help them absorb some of these losses, they
will struggle to reduce their NPLs to the extent they plan to. This is because 75%
of its CET1 capital is made up of eligible deferred tax assets, leaving it with a
poor level of loss-absorbing tangible capital available.

National Bank of Greece, ETEGA Corp, ETEGA Equity

 NBG has an NPL ratio of 43.6%, the lowest of the four major Greek
banks.
 It has a coverage ratio of 56%, the highest of the four major Greek
banks.
 It faces a capital shortfall of €11.4bn.

NBG is trying to restructure, having sold 75% of its insurance subsidiary which
represents a part of its non-core assets, which tend to be the worst quality
assets in a bank. This is a welcome move but far more progress remains to be
done.

It also announced the sale of many of its Balkan operations as it focusses on
banking at home, while using the proceeds to boost capital ratios and liquidity.

NBG remains 40% owned by HFSF but it hopes to eliminate ELA funding in 2018.
This is the most secure bank in Greece but everything is relative.

17 | MINT
PORTUGAL
 Portugal’s NPL ratio currently stands at 19.5%.
 Due to its high levels of NPLs, Portugal’s banks with assets over €10bn
face a capital shortfall of €12.6bn, 6% of its GDP.

Portugal exited its three-year bailout programme in 2014 but is yet to
meaningfully address its stock of NPLs, which is widely considered to be its
primary obstacle to growth in the medium-term. The weakness in asset quality
is particularly concentrated in the corporate sector and drags on the banks’
profit margins, as they averaged a decrease in profits by 7% in 2016.

Portugal’s NPL ratio has not seen any meaningful decrease as it only decreased
by 30bps in 2016. If this is to change, Portugal’s banks will first need to increase
capital levels to offset the loss incurred through write-offs, and the restructuring
and discounted sales of its poor quality loans. Portugal’s CET1 ratio of 12.3% is
the second-lowest in the EU, Portugal currently lacks leeway with which it can
effectively reduce its stock of NPLs.

As Portugal’s debt to GDP ratio is at 130%, the government’s ability to
recapitalise and bail-out banks, as it did with Caixa Geral de Depositos at the
end of last year, is limited. There is also little finance available for the state
provision of a “bad bank” to take on the NPLs held by the nation’s banks.

Novo Banco, NOVBNC Corp, 1045860D PL Equity

Novo Banco has been widely discussed in the press as the poster-child of
Europe’s bad banks.

 Its NPL ratio of 39% is very large.
 Its CET1 ratio is very small at 10.8%, meaning that Novo Banco faces a
capital shortfall of over €10.2bn, which represents over 20% of its total
assets.
 This ratio has been decreasing, falling 150bps in the space of a year,
while its NPL ratio increased by 250bps in the same period.

It is unsurprising that Novo is fraught with difficulties considering it was initially
intended as a transition bank following the bailout of Banco Espirito Santo in
2014. If all goes to plan, this period of transition will be completed by November,
when it will be sold to US Private Equity firm Lone Star.

Having said this, the completion of this deal is not entirely guaranteed. It is
deeply unpopular in the public eye as the Portuguese government, rather than
Lone Star, will remain exposed to Novo’s NPLs. Furthermore, a group of
bondholders led by BlackRock have sought an injunction to block the sale
fearing it would damage their claim to be compensated for €1.5bn in losses
suffered on Novo’s bonds. Despite this, the completion of a sale of some sort is
most likely a question of when rather than if. Once this is completed, losses on
its NPLs will no longer be incurred by Novo and its new parent company, so the
bank should survive.

18 | MINT
Caixa Económica Montepio Geral (Montepio), MONTPI Corp, MPIO PL Equity

 Montepio’s CET1 ratio of 10.2% is poor for a bank with an NPL ratio of
20%.
 This CET1 ratio has been increasing but from a very low base – at the
end of 2015 it was only 8.8%.
 Its non-core capital ratio was only 0.3%, meaning it cannot not rely on
other capital reserves.

The bank’s profitability is extremely volatile, in part due to its high NPL ratio, as
the company recorded a loss of €86.5mn in 2016, and a €243.4mn loss the year
before. It has not been profitable since 2013. Having said this, the CEO does
expect Montepio to post a profit this year, and stated that the bank did not need
to raise additional capital.

Montepio does seem to have improved from its position of technical bankruptcy
whereby Montepio held €107mn of negative equity. Nevertheless, it has not
made virtually no progress in reducing its NPL stock. For this reason, it certainly
remains a bank to watch.

Millennium BCP, BCPPL Corp, BCP PL Equity

The largest private bank in the country, BCP had to be rescued in 2012 by a state
bailout of €3bn as a period of severe financial stress caused its CET1 ratio to fall
below regulatory requirements.

 The bank now has a CET1 ratio of 13% and a NPL ratio of almost 16%.
 However, its coverage ratio of 100% is reassuring.

It is also increasing its capital, most notably through a €1.33bn rights issue at
the beginning of the year, which included the Chinese Conglomerate Fosun
increasing its stake in BCP to 24%. Following the issue, BCP repaid €700mn of
the €3bn bailout package.

BCP does now look well capitalised, but it must continue to reduce its NPLs. BCP
plans to reduce its total NPLs by €1bn annually over the coming years, which
should be manageable considering the progress it has made thus far. For this
reason, despite its capital shortfall of over €1.1bn, BCP should recover.

Caixa Geral de Depositos (CGD), CXGD Corp, CXGD PL Equity

 CGD has a relatively high NPL ratio of 15.4%.
 Its capital position has been improved as the government injected
€2.5bn of capital into CGD earlier this year in state aid.
 It is beginning to correct its weak balance sheet through the sale of
€476mn of NPLs to Bain Capital.

CGD has, over the past few years, been in a position of financial stress and is
one to keep an eye on. Although, with the latest capital injection, and sales of
its NPLs beginning to take place, one would expect that CGD should be relatively
well protected.

19 | MINT
CYPRUS
 Cyprus’ NPL ratio of almost 45% is the second highest in the Eurozone.
 Its coverage ratio is only 40%.

The Cypriot Central Bank stated that at current growth rates, it will take up to
10 years for the nation’s NPLs to drop to manageable levels.

Cyprus experienced a financial crisis in 2012-13 largely due to Cypriot banks’
exposure to local overleveraged property companies and the financial
turbulence Greece was experiencing at the time. As a result of this crisis, Cyprus
received a €10bn bailout from the ECB.

Bank of Cyprus, BOCYCY Corp, BOCH LN Equity

In 2013 BoC was forced, under the terms of Cyprus’ bailout, to seize cash from
its savers, the first example of a bail-in in action. The bank relied on €11.4bn of
ELA, equal to 60% of Cyprus’ GDP at the time.

At the beginning of this year, BoC finished repaying this, allowing it to resume
its dividend for the first time since the crisis. At the same time, it returned to
the debt markets with a €250mn issuance of Tier 2 securities. €500mn of senior
debt is expected to follow. Its debt is expected to improve to investment grade
in the not too distant future.

It is clear that there has been some large improvements in BoC’s fortunes but
much more needs to be done in regard to its NPLs.

 Its stock of NPLs is €10.37bn (over 52% of the nation’s GDP), providing
an NPL ratio of 51.8%.
 This has been reduced from 62.9% in 2014, and the last eight quarters
have seen continuous reductions in its stock of NPLs.
 Its CET1 ratio is 14.4%, and so it faces a capital shortfall of almost €7bn,
over 35% of Cyprus’ GDP in 2016 - a phenomenal figure for a single
bank.
The reasons behind its high NPL ratio are, at least in part, structural and this
ratio is unlikely to ever return to a figure deemed reasonable by most countries.

It has been making progress in reducing this but it is clear that in the medium
term at least, BoC remains extremely vulnerable to any shocks.

20 | MINT
SPAIN
Spain’s NPL ratio on the whole is not too troubling.

 At 5.7% it is marginally greater than the EU average.
 It has been decreasing at some pace in recent years from 9.4% in 2013.
 It faces a relatively modest capital shortfall of €1.23bn for an economy
of its size.

Liberbank, LBKSM Corp, LBK SM Equity

Following the resolution of Popular, Liberbank is now the most troublesome
Spanish bank. It is a relatively small retail bank created in 2011 from the merger
of three regional savings banks.

 Its NPL ratio of around 17.7% is high
 It has a low coverage ratio of 40%.
 Liberbank’s faces a capital shortfall of over €1bn

Investors became worried about this bank in the wake of Popular’s failure, as
Liberbank’s share price decreased by over 40% in a week. This caused Spain’s
stock market regulator to impose a ban on shorting Liberbank’s shares until 12th
July. However, most agree that Liberbank is not in the same position as Popular,
and investor reactions were exaggerated, even though its high NPLs and low
provisions expose it to economic and financial shocks.

Ibercaja Banco, CAZAR Corp, 1091Z SM Equity

Ibercaja is the other mid-sized Spanish bank with relatively high NPLs.

 Its NPL ratio stands at 11.77% and its coverage ratio at 45%.
 Due to the bank’s low CET1 ratio of 11%, it faces a capital shortfall of
€178mn.

Ibercaja has been trying to reduce its stock of NPLs, selling €489mn of real estate
loans to Bain Capital on 11th July. This is reassuring and if more of this is done,
Ibercaja should not encounter too many problems. However, its scope for
selling further NPLs will be tested due to its relatively low CET1 ratio.

21 | MINT
IRELAND
Ireland suffered a large financial crisis between 2008 and 2011, during which it
had to nationalise its third largest bank, Anglo Irish Bank, before winding down
its operations. The net cost of bailing out Anglo Irish amounted to a predicted
value of around €40bn. During the crisis, Ireland received a bailout package from
the EU and IMF.

While Ireland has been the fastest growing country in the EU for three
consecutive years, its banks remain weak as a result of the GFC.

 Ireland’s NPL ratio was around 14% at the end of 2016, significantly
reduced from the peak level of 27.1% at the end of 2013.
 Its NPL coverage ratio is only 35%. This figure leaves the nation’s
banking extremely vulnerable to any shocks which might occur.
 In total, there is a total capital shortfall of over €5.3bn for Ireland’s
banks which have total assets greater than €10bn.

While Ireland’s NPLs remain at a high level, their near 50% reduction illustrates
the differences between Northern and Southern Europe’s commitment to
reducing their NPLs.

Permanent TSB (PTSB), IPMID Corp, ILOA ID Equity

PTSB, formerly Irish Life & Permanent, was recapitalised in 2011.

 It has a high NPL ratio of almost 31%
 Its coverage ratio of 42% is relatively low.
 Its CET1 ratio is 15.1% is reasonably strong and should provide PTSB
with enough leeway to absorb some losses incurred from reducing its
NPL load.
 It faces a capital shortfall of around €1.68bn, a high figure for a bank of
its size

PTSB, 75% owned by the taxpayer, has engaged in a number of NPL disposals
over the last couple of years, reducing its stock of NPLs by 11% in 2016, and 40%
since 2013. Providing such progress continues, PTSB should recover.

Allied Irish Banks (AIB), AIB Corp, ALBK ID Equity

 AIB has a high NPL ratio of 22.7%
 Its coverage ratio of 44% is relatively low.
 The bank does have a strong CET1 ratio of 16% which will allow it to
absorb losses from disposing its NPLs.
 Due to the large amount of RWAs that it holds, the bank still faces a
capital shortfall of over €3.6bn.
 AIB predicts its CET1 ratio will fall to 13% as it reduces its stock of NPLs.

In June, AIB returned to the stock market; its IPO was well-received, with shares
over four times oversubscribed. AIB was nationalised during the Irish banking
crisis, and this offering represented the government selling a quarter of the

22 | MINT
bank. The government has appeared willing to potentially sell more of its
ownership.

Last month, AIB sold €400mn NPLs to Goldman’s at a 50% discount showing an
intention to reduce their exposures to poor quality loans. The fact that it is
predicting reductions in its CET1 ratio show that it has plans to continue this in
the future. Similarly to PTSB, AIB is trying to reduce its NPLs. The same cannot
be said of many Southern European banks.

23 | MINT
GERMANY
 Germany’s NPL ratio is low at 2.5%.
 While its coverage ratio is also low at 37%, its banks tend to be well
capitalised, with an average CET1 ratio of around 15%.
 Therefore, the majority of German banks should be able to convert
sufficient capital into provisions if need be.

Due to these impressive figures, there is a perception of German banks being
among the securest on the continent. This is largely true, but there are a couple
banks whose assets are of a far poorer quality, and should not be overlooked.

The most notorious example was Bremer Landesbank.

 Bremer’s CET1 ratio of 5.29% was extremely weak and fell well below
the ECB’s regulatory requirement.
 Its NPL ratio of over 17% was extremely high and its coverage ratio of
36.2% far too low.
 This was primarily due to the bank’s exposure to shipping loans which
have performed very poorly in recent years.

Due to its high level of NPLs and weak capital position, NORD/LB took full control
of Bremer.

HSH Nordbank

Another German banking facing NPL issues is HSH Nordbank.

 HSH currently has €7bn in shipping loans so is unsurprisingly weak.
 Its NPL ratio of 16.5% is high.
 Its CET1 ratio of 14.9% is relatively strong which means its task of
reducing its capital shortfall of €432mn is not too daunting.

Despite its weakness, HSH’s risks are concentrated in the short-term. This is
because the bank, 85% owned by the states of Hamburg and Schleswig-Holstein,
must be privatised under European state-aid rules by the end of February 2018.
It is currently receiving binding offers for Nordbank’s sale, and described
indicative offers as a good basis for its subsequent sale.

Once HSH Nordbank has been sold, no German bank with assets greater than
€10bn will have an NPL ratio of more than 5.3%. Germany would have dealt with
financial weaknesses across its entire banking sector. In contrast, Southern
European nations tend to be either addressing the weaknesses of only a handful
of banks, or in many cases, no banks at all.

24 | MINT
THE ECB’S RESPONSE - IT’S A LEARNING THING
There were stark differences in the ways the Single Resolution Board (SRB) dealt
with the failure of Popular and the failure of the Italian banks, highlighting the
work that still needs to be done if a single European banking rulebook is to be
achieved.

Following Banco Popular’s troubles, the SRB, the Eurozone agency responsible
for dealing with bank crises, enacted a resolution scheme forcing Popular’s sale
of €1 to Santander. Because the private sector took full responsibility for the
resolution of Popular and business was able to continue, it was seen as a success
for the SRB.

In contrast, the SRB decided that putting the Venetian banks into resolution was
not in the “public interest of the bloc” due to their relatively small size. This
paved the way for Italy’s government to recapitalise the banks using taxpayer’s
money. The SRB justified this decision by claiming that these banks did not hold
systemic risks to the rest of the Eurozone but held regional risks and so should
be dealt with on a national level.

However, by allowing these bailouts to take place, the SRB disregarded its own
rule book. The ECB’s bank resolution framework, made up of three separate
pieces of legislation, was created with the purpose of preventing taxpayer
bailouts yet the Italian government is contributing up to €17bn for the re-
capitalisation of two banks. As this report shows, more may yet follow.

The data on the larger Italian banks suggest that this intervention was permitted
because there are simply no large Italian banks in a secure enough position
themselves to actually take on the responsibility of recapitalising these banks, a
concerning outlook for a nation whose bad loan problem is far from solved.

Further scrutiny of the SRB’s response to Popular’s failure is not reassuring. The
Board’s head described the resolution as “lucky” due to there being a willing
buyer. This raises the question of whether the SRB is effective only if luck aligns
itself in an advantageous way.

Additionally, on 18th July, Brussels’ lawmakers negotiated a new draft regulation
banning the securitisation of mortgages where borrowers certify their own
income. This move will restrict the European securitisation industry’s ability to
create a market for the NPLs held by banks. This is because buyers of these loans
rely on securitisation markets to fund their acquisitions.

Other EU leaders, including Schäuble, have criticised Italy’s response
highlighting the differences which remain between EU-wide resolution rules
and national insolvency laws. The viability of a banking union abiding by a set of
common rules comes under questions when such great financial divisions
separate Northern and Southern Europe.

Nicolas Véron from the Brussels think-tank, Bruegel, put it eloquently: “The
single resolution mechanism is not really single as long as you have different
insolvency regimes for banks.”

25 | MINT
CONCLUSION
In the same way as the European Financials Spread has been tightening in recent
weeks, Italian bank stocks have been rising following the rescue of Monte dei
Paschi and the two Venetian banks.

There is a growing sense that the worst is behind us, as Italy’s Finance Minister
declared we have reached a “Turning point in the progressive elimination of
non-performing loans”.

Despite these bold claims, Italy, and the rest of Southern Europe, have some
way to go before such a turning point is achieved. With a total capital shortfall
of €120bn, the lack of a strong banking champion in Italy, and disparities in
national resolution regulations, Southern Europe’s banking industry remains in
a precarious state.

The transfer of NPLs from banks’ balance sheets to Hedge Funds and state-run
“bad banks” should be welcomed, albeit cautiously. Action needs to be taken to
reduce the load of NPLs weighing down banks, but it would be wrong to believe
this would signal the end of Southern Europe’s NPL problem. These NPLs will
not be eliminated, only relocated. Such a strategy risks failing to account for
these loans remaining in the financial sector.

For this reason, Southern Europe’s second-tier banks and their level of non-
performing loans are worth keeping on your threat-board.

26 | MINT
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27 | MINT