Saturday, December 16, 2017

Greek Bank Wars: Return Of The Jedi

This week Sudden Debt pays homage to the opening of yet another Star Wars episode. The title comes from the third installment released in 1983, but my version is more recent and less galactic.

"Greek banks lack earnings visibility."  
"There is no story, other than bad loans." 
"Their balance sheets are shrinking."  
"There are no creditworthy borrowers."

If you are at all familiar with the Greek Depression and its Greek banking saga you have certainly heard one or all of the above.  In fact, up until recently I would be the one saying them - but no more.  I now strongly believe there is a story and strong earnings visibility for Greek banks.

What's new, you ask, what has changed?  To answer that I must first take you back almost a quarter century. In line with Star Wars, let's call it a prequel.

A long time ago in a galaxy far, far away...
In early 1994 the Greek socialist government made a seminal decision: it would do everything necessary to meet the Maastricht criteria for membership to the European Monetary Union and its planned common currency, the euro.

One of its first actions came in May of the same year when it abolished FX and capital controls on the drachma. Speculators immediately attacked, betting on a massive  devaluation. However, the Bank of Greece raised short-term interest rates sharply to triple digits and ended the crisis within two months.  Speculators who had shorted the drachma  withdrew with heavy losses. 

What followed was a seven year period of unprecedented prosperity for banks and investors who followed the Convergence Trade: huge profits were made by borrowing foreign exchange at low interest rates (mostly German marks, DEM), exchanging them into Greek drachmas (GRD) and investing at much higher interest rates, either in drachma deposits or high yielding Greek Government bonds (GGBs).

It was a safe bet because the government, acting through the 
Bank of Greece, was committed to a slow and predictable devaluation of the DEM/GRD exchange rate (i.e. a sliding peg) which was always less than the cross-currency interest rate differential.  In simple terms, investors made, say, 12% in drachmas annually and lost only 8% on the gradual DEM/GRD devaluation.  That 4% differential was pure profit.  As time went on this differential narrowed with Greek interest rates dropping gradually and eventually converging to other EMU currencies' rates.  Thus the name Convergence Trade.

D0zens of local and foreign banks rushed in.  Institutions such as JP Morgan, Deutsche Bank, Bank of America, Morgan Stanley, Citibank, UBS, Credit Suisse, HSBC, Merrill Lynch, Goldman Sachs, SocGen, ABN and many, many more were in the drachma market daily. Even the erstwhile Lehman Brothers and Bear Stearns made guest appearances to what was, literally, a "money for nothing" party.. (Well, it wasn't really "nothing": these profits were ultimately paid by Greek taxpayers, the price paid for admission to the eurozone).

Greek banks profited handsomely, too.  At the time when retail and corporate banking was sleepy at best, dealing rooms were roaring.  Some of them exploded from 5  to 50 employees within just two years, as profits soared and bonuses were lavished on one and all.  For several years, over 50% of Greek bank profits came from Convergence trading gains.  

As time drew closer to Greece's admission to the eurozone drachma interest rates dropped and the party finally ended in 2001. Dealing room profits dropped sharply and several foreign banks that had set up shop in Athens shut down and moved on. 

But what about Greek banks?

At the time, Greek bank shareholders were suffering the effects of a punishing bear market on the Athens Stock Exchange.  It was the result of a truly historic bubble that took place in 1997-99, one that saw even mountain goat herders selling their flocks to buy into the craze.  Stocks had doubled, and then doubled again and again... it was madness, until the inevitable crash which started in late 1999 and concluded in 2003.

Apart from the effects of the bubble bursting, banks were suffering from the imminent loss of Convergence Trade profits and a lack of future earnings visibility (ring a bell?).  

As you can see from the charts for Alpha Bank, after first going ballistic, shares dropped as much as 80% top to bottom between 1999-2003. Earnings fell 58%.
   Price of Alpha Bank shares on ASE (split adjusted)

After 2002, however, earnings and share prices recovered strongly as banks focused on retail and corporate lending.  Prior to the euro, Greek households and businesses carried very little debt since drachma interest rates were very high.  Things changed rapidly after 2002, when a combination of Greece's entry to the eurozone and globally low interest rates post 9/11 events made borrowing cheap and easy. Credit expansion ran at breakneck speed, boosting real estate prices and GDP growth.  Shares soared again.

Then the global debt bubble burst in 2007-08.

Greece, facing ever larger budget deficits, and unable to borrow on its own, had to accept bailout loans from the EU and IMF;  its bonds suffered deep haircuts.  Bad loans inundated bank balance sheets (today NPLs and NPEs amount to approx. 50% of all loans), profits turned into losses and banks were re-capitalized three times, with massive dilution to their original shareholders, who saw their investments collapse 99.5%. Balance sheets contracted by 45% in 2010-17 and the industry consolidated furiously. There are now just four major Greek "systemic" banks, accounting for a whopping 97% of all  assets.

 OK, enough with the prequel. 

What is the sequel? Where are future profits going to come from (visibility), what is the "script" for our Greek Bank Wars?

In my estimation Greek banks are uniquely placed to take advantage of two major opportunities:

  • Because of the bailout programs Greek government debt is currently 80% in the form of non-tradeable loans from the official sector - that's 260 billion out of a total 325 billion euro.  With a return to more normal conditions, economic growth and increased investor confidence, Greece will seek to slowly at first and then more rapidly,  swap official loans with its own bonds. The reason is that the loans impose strict oversight rules that restrict fiscal freedom.  Such bonds will initially have attractive spreads over other government bonds and yield far above banks' cost of money, making them ideal profit-generating machines for Greek (and other) banks.  Longer term, Greece will seek to replace at least 75% of loans with new GGBs, because that's the level at which oversight is terminated. That's a very nice business for banks, and for a long time, too.  Think of it as Convergence Trade II, creating earnings visibility for several years going forward.  The convergence has started: 10-year GGBs are now at 3.95% (German Bunds are at 0.30%), the lowest since 2006 and down from nearly 12% in 2016. Two year notes are at 1.95% (German 2-year notes are negative at -0.72%), below even the government's average overall funding cost (approx. 2%). They were at 10% last February.
Historical Data Chart

  • Despite the mess in consumer, mortgage and corporate loans, banks are finally and rapidly dealing with their NPLs and NPEs through a combination of loan sales, write-offs and foreclosures/auctions. By the end of 2019 they will have halved their bad loans.  Such a bitter medicine leaves a lasting aftertaste to lender and borrower alike.  Meaning, Greeks have now gotten a hard lesson in coping with debt and have, at last, acquired a credit ethic. Renewed credit expansion, when it comes, will be based on much firmer ground.  And it will come, because banks' assets are now at just 155% of GDP - or even less, when we adjust for the rapid deleveraging from the bad loan reduction. By comparison, Germany is at 261% and Italy at 248%.
Aha! You say.. Where are banks going to get the money to buy new GGBs and make fresh loans?  After all, they are still borrowing (if less every week) from the ECB's Emergency Liquidity Assistance program, aren't they?
Here's the answer: deposits.  Yes, deposits - those that fled in a panic during the Greek crisis, going to safe havens abroad, in safe-deposit boxes and under mattresses. Banks in Greece held 281 billion euro in deposits in 2009 (122% of GDP) and a mere 144 billion as of this past October (80% of GDP). But, unlike the US Great Depression, Greek bank customers have not lost a single penny of their deposits. Their money is still intact. Even if we deduct foreign depositors from the 2009 figure above, there is a very, very large pool of money that, given the right conditions, will come  rushing back into Greek banks - perhaps as much as 100 billion. 

All right... Just like the Star Wars space opera, this has been a larger post than I normally write. Yet, I think the subject is really worth it.  Since I don't think readers of Sudden Debt need me to spell out the obvious conclusions (you are much too smart an audience), I will leave you with...
May the Force be with you.

Friday, December 15, 2017

Greek Bonds And The IMF (Plus A Note On Banks)

Greek Government Bonds (GGBs) have been this year's fixed income star performers.  In the past 12 months the 10-year benchmark GGB has rallied impressively from 8% to 4.15% as public finances consistently exceed targets and the economy shows signs of solid and sustainable growth.  

A recent bond swap consolidated many smaller issues into fewer benchmarks and added liquidity to the secondary market, prompting more institutional investors to participate.  Most transactions now take place over the counter therefore volume data are not readily available, but the Bank of Greece has its own trade platform where  volume in just the first week of December is already 2.5 times higher than the average monthly volume for all of 2017.

The shorter end of the yield curve has benefited the most from the rally: 2-year GGBs now yield 1.99%, a level that is  below Greece's overall weighted average cost of funding at the end of 2016. 

While loans from Greece's European official sector lenders (ESM, etc) carry very low interest rates and have long maturities, the IMF's loan facility of around 11 billion euro costs 3.5% and has a much shorter weighted average maturity, around 2.5 years.  Its maturities are staggered every few months, with the last being in 2024.  

Therefore, it is becoming increasingly possible for Greece to repay the IMF early and lower its annual interest costs substantially, through a carefully balanced issue of new short and medium term bonds (2-5 years).  Total face amount of debt would remain the same, but lower annual interest payments reduces its net present value, resulting in a credit positive event.

Why is this important, if it were to happen?

Firstly, repaying the IMF early is a political decision between Greece and some of its European lenders who see the IMF as Greece's fiscal "policeman". So, even though it would make very good sense from a narrow financial perspective, it may not happen for political reasons.

Still, the very real possibility that Greece can now repay the IMF early and disengage from its rather harsh oversight means that Greece is firmly standing on its own feet, after a decade of tottering on the edge. This is a powerful message to all investors: Greece is back.

A final note concerning Greek banks: for the last few months Greek banks have been haunted by the IMF's thinly veiled threats that it will demand yet another recapitalization (completely unnecessary, IMHO).  Their shares have suffered on the Athens Stock Exchange, some of them falling as much as 50% from their summer highs. Thus, even the possibility that the IMF can now be completely removed from the Greek program acts as a positive factor.
The current bond rally also creates substantial capital gains for the Greek banks who own several billion GGBs, and who will mark them to market at much higher prices, significantly boosting their annual profits and/or increasing their ability to write off even more non-performing loans.

I will have more to say about GGBs and Greek banks on my next post.

Wednesday, December 13, 2017

Greece Outperforming The World: Cassandras Beware

If you own a basket of global government bonds during 2017 you have a ho-hum total return so far: a mere +1.60%.  

But if you ignored the Cassandras and bought Greek Government Bonds (GGBs).... oh boy... what a spectacular year: you are now up well over +30%. And if you were even more of a risk taker and bought them back in 2015, you have more than doubled your money.

Yields on the benchmark 10-year GGB are now at 4.35%, the lowest since March of 2008, having plunged from a high of 8% just this last spring and 20% in the troubled summer of 2015. 

Conversely, if you were a Cassandra (alas, I know quite a few of you) and bought uncovered Greek CDS  betting on a collapse, you are now nursing 60% losses - just this year alone.

Now, there is yet another species of Cassandras out there, very much alive and kicking: those who are stubbornly still shorting Greek bank stocks, plus selected other shares like the Public Power Company.

Guys, a word of advice from one who has been through the boom-bust-boom cycle a few times.  You are shorting ... NOW? 

I mean, Greek banks are already down 99+% from their bubble highs and have been through three successive, massively dilutive re-capitalizations... and you are shorting.. now? Where were you when the party was going full swing and everyone was so drunk they couldn't see a shack without thinking it a mansion? Ain't you a bit LATE to the party?

But hey, that's what makes a market...

OK, OK, one last teeny bit of advice for you Cassandras, boys AND girls: the 2-year note is now at 2.09%.  What does this mean, you say? If you are active in the Greek market and you don't understand, good luck to you AND your jobs.  

For all the rest, it means that Greece is now very close to being able to fund itself from the market at a level very near that of the official sector loans (around 2.0%). And, much more importantly, it is rapidly becoming possible to expunge the IMF from the Greek program by repaying its 14 billion loans early - they carry a high 3.5% interest rate.

FYI, Greek government bonds are now at:

2-years: 2.04%
5-years: 3.45%
10-years: 4.25% 

The IMF has been the biggest "thorn" on the banks' side, agitating for more asset quality reviews and - possibly - yet another recapitalization.  Now... what if... well, you get my drift...

Monday, December 11, 2017

Greek GDP Prospects: Housing And Tourism

Understanding Gross Domestic Product (GDP) boils down to just three numbers: consumption, investment (also known as capital formation) and trade balance.  That's it.

Understanding the Greek Depression is even easier, since it boils down to just one number: investment in housing, i.e. new home building.  As you can see in the chart below,  housing construction - the largest driver of investment in the boom years, by far -  collapsed to nearly zero (0.65 billion euro in 2016).  I don't know how far one has to go back to see similar numbers - statistics only go as far back as 1995. If I had to guess, I would say at least back to the 1970's.

Transportation equipment (new car and truck sales) have also come down, while the rest of the sectors are basically unchanged.
The chart also points to how the Greek economy may revive. Given that a massive boost in consumption is unlikely with constricted personal incomes, substantial growth can only come from two sectors: construction and tourism (i.e. service exports).

How are things there? There is good news on both.

  • After ten years of constantly dropping (chart below), private sector building permits are finally on the rise.  Year to date (Sept. 2017) the number of permits are up +8.6% and the surface area +16.8% versus 2016.  There are more, and bigger, buildings being constructed in Greece this year.  

  • Tourism is going very well in 2017.  For the first nine months tourist arrivals and receipts were both up 10% and it looks like the fourth quarter is up strongly, too. Tourism is the single largest industry, accounting directly for roughly 8% of GDP and nearly 20% when all effects, indirect and induced are accounted for, so a strong showing there has a multiplier effect on the economy.

Strength in the tourist sector is also attracting capital investment, so we have a rather nice one-two punch going on here.

Assuming consumption does not take a dive (unlikely, given the robust increase in tourist arrivals), GDP should show a healthy rise in 2017, gathering momentum for 2018.

P.S.  Interestingly, new car sales are up, too: +21.6% ytd in September.

Saturday, December 9, 2017

Greek Residential Real Estate Construction

Just one chart today (ok, three ;) - the complete evaporation of new home building in Greece. 

Top to bottom the annual value of new home construction collapsed 25 billion euro, going from 26 billion per year in 2007 to just 1 billion in 2016. That's a 95.5% collapse!

In the same period Greek annual GDP dropped 50 billion, from 225 billion to 175 billion.  In other words, an amazing 50% of the Greek Depression is due to the collapse in residential real estate construction.

Housing construction is a sub-component of gross capital formation (a.k.a. investment), itself one of the three main components of GDP : consumption, gross capital formation and trade balance. 

From the chart below it is easy to see what led the Greek economy into a tailspin: housing construction collapsed from an unsustainable high 11.2% of GDP to a likewise unsustainable low of 0.65%.

 Why do I say "unsustainable"? Because (a) in the "boom" years Greek population,  new household formation and external demand (e.g. foreigners buying vacation homes) did not rise nearly as fast as the new supply of homes and, (b) in the current "bust" years this natural demand must be rapidly absorbing the excess housing stock created in prior years.

Using the number of weddings taking place every year in Greece as a very rough guideline for new housing demand, we can see how the boom years created a housing bubble (marriages did not rise nearly as fast as construction), and why the bust may now be overdone (marriages have not fallen off as dramatically as construction). 

 My prediction is that housing construction will soon start rising again to more sustainable levels, boosting gross capital formation and - thus - GDP growth.

Wednesday, December 6, 2017

And Yet, It Moves..

One of the most obvious characteristics of bubbles, manias and their opposites, implosions and apathy, is the stubborn refusal of the crowd to see what stares them in the face, choosing instead to believe only their version of "truth" - no matter how outrageous.

Thus, tulips are forever rare and precious, people invest in companies formed "for carrying-on an undertaking of great advantage but no-one to know what it is!!” (1720 South Seas Bubble),  real estate only goes up, big banks can't go bust, Capesize bulk carriers are "worth" $250 million each, garbage (sub-prime loans) cut into small pieces turns into gold (CDOs), etc.

It doesn't matter what it is, once people fall victim to the crowd mentality they take leave of their common sense.  Those who try to say otherwise are scoffed, ridiculed or outright threatened with dire consequences.  Galileo was a famous case in point, when he had to choose between scientific nonsense or death on the pyre - though he did manage to say "E pur si muove" (and yet, it moves) sotto voce.

Today's case in point is the cacophony of analysts who stubbornly refuse to accept that the Greek economy is rebounding and that investor confidence is returning fast.  

On the economy (see previous posts), one can parse the GDP numbers and come up with their own interpretation - at least for a while. But you definitely cannot "spin" government bond yields crashing to 4.78%, the lowest levels since 2009 when they stare you in the face.  Greek risk is going down fast, period.

The good news is that some smart money is taking notice.  Brevan Howard is one of the world's most respected hedge fund money managers with some $20 billion AUM, and it just announced the launch of two long only funds to invest in Greek securities and real estate.

 Yes, it moves.  And IMHO it has a very long way to go before Greek assets are fairly valued once again.

Tuesday, December 5, 2017

Greek Electricity Consumption

The Greek economy is finally growing again. Official projections put real GDP growth for 2017 at 1.6% but many think it will be less, closer to 1%.   I disagree with the lowball estimates because, as always, the devil is in the details.

In my opinion current euro (aka "real") GDP numbers are more valid in an economy going through a long period of deflation because GDP deflators can be very tricky in such circumstances. For example, Greek CPI jumped from -1% to +2% in just a couple of months early in 2017.  

Greek CPI: Red dot is month YOY, Blue line is 12 month average

The latest 3Q GDP growth number in current euro came in at +2.1% versus 3Q2016, the highest since 2008.  Also, GDP has been growing for three consecutive quarters, also a first since 2008. In contrast, "real" growth came in at just +1.3% showing just how noise in the CPI series can affect popularly reported GDP.

 Being an engineer by training, I prefer to pay attention to more basic data such as electricity consumption.  Looking at the chart below, it is clear that the Greek economy is rebounding strongly in 2017 when compared to a weak 2016, particularly in the summer tourist season which went very well this year. As of October electricity consumption is up 3.8% year to date versus 2016.

Monday, December 4, 2017

Greece: The Emperor's New Clothes

Today's post will feature mostly charts, and some will be a bit repetitious from previous "Grecian" posts.  Unlike the US, Greece is a small country with fewer parts to examine, so repetition is inevitable.  I will attempt some insights, nevertheless.

Between 2008-13 Greece suffered an economic meltdown of epic proportions as GDP plunged 25%, unprecedented for a country not at war. It's been been going sideways ever since.
Gross fixed capital formation (i.e. investment) collapsed 70%.

Why? Greece saw its share of  the "Sudden Debt" bubble between 2000-2010, when loans to the private sector doubled as a percentage of GDP, albeit from low levels when compared to other Western nations.

Public debt soared, too, and the budget - always in deficit - went into deep red, reaching over 15% of GDP.

Fearing a repeat of the Great Depression's bank failures or Weimar Republic type hyperinflation, deposits fled, credit vanished and loans turned sour. Bank balance sheets have shrunk 43% since 2010.
Markets went into a tailspin. Government bond yields reached 40% (a significant bond haircut took place in 2012) and the Athens Stock Exchange (ASE) index collapsed 90%.

While the rest of the world found its post-bubble footing and markets eventually reached new highs, Greece did not.  The performance gap between S&P 500 and ASE is eye-popping.

S&P 500 (bars) vs. Athens SE General Index (line)

The reason for this lag is twofold:
  • The structure of the Greek economy itself was an unproductive Borrow-Import-Consume bubble which boosted GDP but did not have any permanent positive effects.  Investment was mostly in residential real estate, also fed by easy credit. Reshaping the economy has taken a long time and is still ongoing.
  • Politics. When the bubble burst and the EU stepped in with its bailout, all Greek politicians went populist. Even though they knew that hard reforms were necessary they fought hard against them.  Until a year ago governments did not "own" the bailout programs they promised to follow.
Having told this tale of Woe it is my opinion that Greece is now rapidly changing for the better and has - finally - become an Opportunity.  

Why? As is common after prolonged bear markets, people ignore positives and choose to remain apathetically focused on negatives only.  This creates a gap between current asset prices and their  value as calculated by normalized P/E ratios, book/tangible values, ROAs, rent yields, etc.

To put it another way, this is the exact reverse of Andersen's tale about the Emperor's clothes: after years of seeing him go about naked, his subjects ignore it when he shows up in new breeches. For those more inclined to quantum physics, your reality exists as you expect it.  

And therein lies opportunity.

Sunday, December 3, 2017

December 2, 2006 - A Day To Remember

I started this blog on December 2, 2006.  Wow! Literally, an Age ago: The Age Of The Debt Bubble.

I feel almost humbled by that younger person who went on a crusade against that Debt Bubble with a zeal that now seems somewhat naive and idealistic. But, hey, I was right and I was earlier than most.

Even after the first signs of trouble, a lot of people still doubted that we were in for a truly epic meltdown. Until Lehman collapsed, Bear was bought out for a pittance, Citi and AIG were bailed out, Merrill was sold... and so on and so forth. The global financial system teetered on the edge of the abyss until money started pouring down from the Ben Bernanke helo, a process that lasted almost a decade and is still ongoing in Europe.

 For me, the greatest “I told you so” came in 2015 as I watched The Big Short. I must have been the only one in the movie theater who didn't need those cute vignettes with Selena Gomez and Anthony Bourdain explaining CDOs and other such financial mines. And though I don't play the drums, I do play the piano (sort of..).

Alright... but this post is not about patting myself on the back for being right in the past (ok, ok, just a little).  As my first boss in the securities business used to say, "yeah, yeah... and what have you done for me today?"  Stan was demanding - and rightly so, because finance is: a) not for the lazy or fainthearted, b) a dog-eat-dog business and, c) an activity where your decisions are marked-to-market ALL THE TIME.

So, what is this post about? It's to explain that I am primarily a serial bubble hunter, one who tries to identify financial extremes on the upside (Greed/Mania) AND the downside (Fear/Apathy).

With "regular" bubbles, people ignore the obvious because they are blinded by their Greed. With "reverse" bubbles people initially become gripped by Fear and then fall victim to Apathy. 

I believe that I have now identified such a "reverse bubble", so I have been posting  about Greece, its economy, bond and equity markets
As the saying goes, "bear markets end with a whimper".  Another goes, "nobody rings a bell at the end of bull or bear markets".

Well, I think I see a bell... or is it a coffee cup? Time will tell.

Tuesday, November 28, 2017

Hey, Anyone Remember The DotCom Craze?

People have short memories when it comes to swinging from caution to exuberance, from panic to greed.  Thus, history is littered with the empty purses of those who so madly plunged into "investments" like tulips, South Seas undertakings, silver mines in Peru, Florida real estate in 1890's, inept canal and tunnel projects, loony dotcom ideas, Peak Oil baloney (the very top of the craze, not the fundamental idea)...

And the empty purses don't belong to just the IQ lightweights, as Isaac Newton's disastrous foray into the South Seas Bubble so glaringly attests.

Thus, when something goes ballistic and "analysts" start projecting even more stratospheric levels... curb your Greed and raise your Fear. 

Bitcoin... seriously, folks?

Oh, and just like the dotcom craze there are now a bunch of crypto-currency imitators out there... Ding, ding, ding...

The same contrarian concept holds true on the downside, when fear and apathy blind people to obvious value-price discrepancies, but that's another story..