Tuesday, June 7, 2011

A Crack At The Seams: The Curious Case Of National Bank Of Greece Preference Shares

On June 1st, 2011, the Board of Directors of National Bank of Greece proposed that no dividends shall be paid to holders of the redeemable non-voting and non-cumulative preference shares traded on NYSE (NYSE: NBGPRA or NBG-PA). Following the suspension of the annual $2.25 dividend per share, the stock closed the trading session on June 2nd, at $12.18 per share, down a cool $5.02 per share or a little under 30%!

Why did the BOD make such recommendation to the forthcoming annual shareholders’ meeting? Under the best-case scenario, it wanted to preserve capital. Under the worst-case scenario, it was not permitted to make such distribution.

National Bank of Greece (NBG) is the largest bank in Greece and one of the largest in South East Europe. In addition to its leading market share domestically, it has substantial presence in neighboring Turkey (through its majority-owned subsidiary Finansbak) and the Balkans.

In June 2008, during better times for the banking industry in general and Greece in particular, NBG had successfully issued 25 million preference shares in the form of American Depositary Receipts on the New York Stock Exchange. The shares were issued at $25 per share and the bank intended to declare an annual non-cumulative dividend of $2.25 per share.

Preference shares are a sort of hybrid security, sharing elements with corporate bonds and common equity. Like corporate debt, the holders of preference shares are paid a fixed annual dividend, and have a senior claim to the common shareholders on the company’s net assets. But like common equity they are entitled to a dividend only subject to the availability of distributable earnings.

In fact, preference shares look a lot like municipal revenue bonds. Revenue bonds pay interest only out of a specific tax revenue and are not backed by the full faith and credit of the municipal agency. For that reason, revenue bonds are considered riskier than general obligation bonds and normally carry a higher interest coupon. Likewise, preference securities are paid a preferred dividend only out of distributable earnings. They are considered riskier than corporate bonds and offer a higher yield.

At the time of issuance, the bank was hugely profitable, having earned € 915 million at the parent level during fiscal year 2007, and having amassed in excess of € 1,600 million in retained earnings. Since the annual preferred dividend was only about $ 56 million or approximately € 42 million per year, it was considered safe.

But, the general banking crisis at the end of 2008, followed by the Greek sovereign crisis last year, have hit the bank very hard. National Bank of Greece had to make increasing allowances against unrealized losses in its available-for-sale securities portfolio (which included Greek sovereign bonds). Its available for sale securities reserve at the parent level rose from a paltry € 38 million at the end of 2007 to € 1,473 million at the end of 2010.

During the same period, National Bank of Greece saw its retained earnings at the parent level falling from € 1,603 million to € 316 million. If that were not enough, the bank reported a net loss at the parent level of € 361 million for fiscal year 2010, despite reporting a consolidated net profit of € 405 million (The majority of which came from its Turkish subsidiary Finansbank)!

The non-availability of distributable reserves at the parent level (Net loss of € 361 million versus retained earnings of € 316 million) proved our worst fears and forced the Board of Directors’ hand to recommend suspension of the dividend for this year.

Will National Bank of Greece have the capacity to declare a dividend next year? It is possible but not very likely. For the first quarter of 2011, the bank had a net unconsolidated loss of € 26 million and its reserves & retained earnings at the parent level remained flat at € 321 million. Given the Greek Government’s persistent fiscal difficulties, we cannot envision National Bank of Greece returning to profitability at the parent level during 2011. Therefore we forecast that the travails to the holders of preference shares will continue into the foreseeable future.

Note: We based our analysis on reported figures at the parent level because according to the offering prospectus for the preference shares, preferred dividends are paid out of the bank’s distributable funds as measured on an unconsolidated basis.