On Sunday, the far left party, Syriza, won the Greek election, and with a smaller (far right) anti-austerity party, has a coalition to form a government. While this could change over the next few days and weeks, the immediate market reaction has been surprisingly muted (given the press coverage). The Greek banks have all fallen sharply and Greek 10 year yields are up over 50 bps.
Before reviewing the Greek election; a reminder. Profitability of the European banks is improving/recovering rapidly towards “normal”. Capital/reserves are very strong, and valuations are low. And finally, Greece is just 1% of total European GDP.
#1) At the Moment, a Greek Problem (i.e. No Contagion)
For a very long time, Greece CDS and yields essentially pointed to very high risk of re-default (the latter now ~9%). That being said, by far the most positive development over these past few months has been the absolute lack of movement in yields of Ireland, Italy, Portugal, and Spain. In fact, please note the following extremely low 10 year yields and changes in the last month: Ireland (1.1% – down 20 bps), Italy (1.5%, down 42 bps), Portugal (2.5%, down 25 bps), and Spain (1.4%, down 30 bps). These declines were driven/supported in part by looming quantitative easing. However, CDS spreads are also flat to down over the last month (and year), as well. One of the main reasons for this divergence is the fact that European banks have added over €500 bln in tangible common equity – i.e. the highest quality capital – to their capital base.
#2) Brace for Tough-Love “Grexit” Headlines
It is very difficult to predict how this all plays out. However, we just do not see how Greece wins significant concessions. We also do not see how it has any leverage over the Troika, as a messy departure would be ruinous for the country. It has debt coming due as soon as March. In fact, in our view, the Troika has a powerful incentive to take a very tough love approach to Greece, given the following: (a) it is an immaterial country, (b) the Syriza platform is so unrealistic, and more importantly (c) it would not want to incent voters in other countries, namely Spain in the short-term (6% of European GDP), to see an “easy” path to debt relief. The Troika has every incentive to make sure a departure from the eurozone looks – and is – painful.
Note, the HCP European Bank Fund LP (HCP-EBF) currently has no exposure to Greek banks.