From a systemic perspective, the recapitalization of the European banking sector is complete. So, while capital actions for certain banks are possible (i.e. Deutsche Bank), we continue to forecast limited EPS dilution from capital raises, overall. Moreover, the recovery in European banks from both an earnings and stock price perspective continues to track very closely the recovery of U.S. banks at a similar stage of the cycle (click here for “Déjà vu” presentation).
That said, despite the recovery of the of the so-called GIIPS countries, including improved economic performance from Ireland, Italy and Spain, it is clear that Greece continues to struggle. As part of the agreement struck this summer between the European Commission and Greek government, the European Central Bank, primary regulator for the eurozone banks, performed a comprehensive assessment of the top four Greek banks. The results of this review were released this past weekend and showed a €14.4 bln capital deficit under the so-called “adverse scenario”, which assumes an almost 7% decline in GDP through the end of 2017. Under the “baseline scenario” (i.e. a 1% decline in GDP through 2017), these four banks require an extra €4.4 bln.
While this is interesting, this announcement is – to us – of little value since, irrespective of these capital changes, we consider the Greek banking sector to be un-investable. Why?
First, Greek bank stock prices are simply too volatile. Regardless of what one believes of the fundamentals – and we expect them to be challenged in the coming years – Greek bank stocks have become de facto macro plays on a recovery in Greece, causing their prices to move violently day-to-day as the market reprices macro risk in real-time.
Second, we believe betting on a recovery in Greece is an extraordinarily weak investment thesis because the risk the Syriza government does not meet its recently agreed upon bailout conditions is exceptionally high. Moreover, after a tumultuous series of events this year, we believe that other eurozone member countries have neither the political will, nor the desire to provide additional funds to Greece should the country fail to meet its debt obligations.
This is important because it means that an incredibly painful internal adjustment process still lies ahead for Greek citizens, likely in one of two forms:
1) Greek citizens may endure a significant reduction in standard of living as they begin to live within their means, likely through a combination of lower pensions and social spending combined with wholesale fiscal/labour reform. Thus far, making meaningful progress on these reforms has proven to be politically unachievable.
2) Alternatively, if Greece’s debt continues to grow and reform languishes (or is simply too late), the country could eventually be forced to leave the eurozone as other countries refuse to make up the shortfall or loan the country more money. This could mean the internal devaluation process takes place when the country (re)introduces its own currency (the drachma).
We don’t know how this all turns out, and indeed, this saga could take several more years. It is even possible the country – finally – takes reform seriously enough to muddle through. However, history would suggest otherwise and that Greece will eventually seek another bailout or some form of aid from the other eurozone countries. We believe this request would be rejected, likely resulting in either a forced or voluntary departure from the eurozone.
Should this occur, it is very possible the banks would need to be nationalized, wiping out equity shareholders. In our view this dilution/insolvency risk is so high, it has rendered the Greek banking sector basically un-investable.
On the bright side, and by far the most positive development in Europe over the past year, is that the global fixed income markets appear to recognize that Greece – which at ~1% of total European GDP is as economically significant to Europe as Markham, Ontario is to Canada – is not material to the overall European economy, even if it dominates the financial press coverage.
European Trip to London, Frankfurt, and Madrid: Notes from the Field
Déjà vu? European Bank Credit Recovery Continues to Track U.S. Bank Recovery (2010)
On Greece, European Fixed Income Markets Remain Calm
Why This Weekend Was About Spain; Not Greece
European Banks End a VERY Strong 2014
Syriza Forms Government in Greece
Reinforcing “The Case for European Banks”: A Thesis Update
The Case for European Banks (and HCP European Bank Fund LP)