Friday, November 17, 2017

What Next, Greece?

After nearly a decade of economic misery today's title arises spontaneously: where is Greece headed? 

Unlike other economies that got into deep trouble when the Debt Bubble burst in 2007 (e.g. Ireland), Greece hasn't managed to bounce back yet and is scraping along the bottom for four long years.  
For independent confirmation of GDP numbers I look at the total consumption of energy, a more fundamental measure of economic activity. The two charts are in agreement: Greek GDP is down approx. 25% from its peak and is bottoming out.
The reason for the prolonged malaise is the non-productive model of the economy, a situation going back decades.  There is no value in rehashing ancient history here; suffice it to say that when in 1980 the rest of the world went towards economic liberalism with Thatcher, Reagan and Deng Xiao Ping leading the way, Greece went in the exact opposite direction towards state sponsored socialism and - even worse - crony capitalism.  And when the country decided to join the Eurozone twenty years later, it did so without first transforming its economy to match the strict requirements of a strong currency.

I won't delve into Greek politics. I believe it to be a complete waste of time and, besides, there are thousands of other outlets that do nothing else.  Instead, I will focus on hard data.

So, how is the economy doing now?

Public finances are finally under firm control;  the budget runs large primary surpluses and debt has stabilized.

Unemployment peaked at 28% and is gradually falling, reaching 20.6% this past August.

Tourism is hitting records, a major positive contributor this year.

Industrial production, manufacturing and retail trade are all trending up in the last 12-18 months.

Revenue from shipping, a traditional Greek stronghold, has dropped almost 50% from the 2010 high, suffering from the global weakness in shipping rates. However, charter rates have bounced back strongly in the last 18 months, pointing to a more positive outlook.

Overall, it looks like Greece is bouncing back, albeit slowly.  What could make things move faster towards pre-crisis levels?

Let's compare the makeup of GDP  in 2007 and 2017: household and government consumption, capital formation and the import-export balance .

 Two things immediately stand out: the collapse of capital formation (i.e. investment) and the notable rise in exports.
  • The massive trade deficit, which routinely ran 10+% of GDP in the past, is now balanced - a positive development.
  • On the investment side, however, the situation is highly negative. Capital formation imploded 75%, going from 64 billion in 2007 to just 16 billion in 2017.
(An explanation  is necessary here: given the high level of investment in Greece in the past, how come it did not become more productive and competitive?  Because investment was mostly in overpriced residential and commercial real estate, largely built "on spec".  In some years new home building vastly exceeded new household formation, creating a large number of unsold properties.  The debt bubble created a real estate bubble and funded a massive trade deficit.)

It's obvious that rapid and significant incremental growth can only come from investment and secondarily from exports. In fact, the best possible combination would be export-oriented capital investment, e.g. factories producing goods for export and hotels catering to foreign tourists, to mention just two examples.

Capital for such investment is not going to come from Greek banks who have slashed their loans to the private sector by 27% during the long recession.  In any case, until they recover from the vise of NPLs and low deposits they simply don't have the money to lend.

To bounce back Greece must clearly attract foreign direct investment (FDI), where decisions are made based on a country's  comparative economic advantages, including political stability, taxation, legal and labor conditions.  

In the next post I will try to answer two questions: a) is Greece a good FDI opportunity right now and b) how "investment friendly" is it?

P.S.  I just saw this interesting graph from a respected Greek economic research periodical. It shows that residential real estate construction is expected to rise almost 30% in the near future, based on the number and size of building permits issued.  It's the first increase in at least 10 years and, if it materializes as strongly as predicted, it could have a measurable impact on GDP.

Of course, this increase comes from a VERY low base after 10 years of constant decline. The next chart is pretty astonishing, IMHO.  Private construction activity is now just 12% of what it was in 2007. Bars are number of permits, dotted line is total surface area in sq. meters. Truly explains the collapse in the investment component of GDP.

Sunday, November 12, 2017

Greek Banking: Part III, The Moonshine Blues

As we saw in previous posts, the Greek Debt Party ended in 2009.  After borrowers chugged easy credit moonshine by the jugful, their hangover was, predictably, a humdinger.  Let me remind you how raucous the party truly was.

Greek households increased their debt eight-fold in just eight years;  in relative terms, it went from 12% to 55% of GDP - see Chart 1.

Chart 1

The aftermath was catastrophic: bad loans rose from just 5%  in 2007 to 36% in 2016.  This year they are starting to come down slightly (34% as of September) and are expected to drop sharply to 20% by the end of 2019 - at least that's what the Bank of Greece (i.e. the local branch of the ECB) is mandating in its directives to Greek banks - see Chart 2.

Chart 2

Chart 2 is interesting: OK, the Greek Depression started in earnest in late 2008, so it is logical that bad loans would go on rising for some time.  But, c'mon... the economy bottomed out in 2014 and has been flat ever since, so how come bad loans are still such a huge proportion of loan portfolios?  No, it's not a lagging effect.

The answer is as simple as it is astonishing to anyone with even a modicum of credit mores: Greek banks were legally prohibited from liquidating collateral (e.g. homes and business properties), so bad loans have stayed on the books, festering for far longer than basic banking procedures and common economic logic would dictate.  Unfortunately, populist politics are writ large in Greece, Left, Right and Center.  Slogans like "Not a single home shall fall into the hands of a (filthy?) banker" were very common in 20014-15.

The same chart, however, shows that 2018 and 2019 are expected to see sharp reductions in the NPL stock.  At least, that's what the Bank of Greece demands banks to accomplish via a combination of collateral auctions, loan sales, provisions and write-offs. The first two are to be the major drivers. How come?  Reality is a tough mistress, even for previously delusional Leftist politicians who now have to grow up and "meet a payroll", as the saying goes.  Laws shielding borrowers have been amended and auctions are expected to start in late November.  They are to be held online, i.e. hopefully fast and effective.  

This being Greece, nothing happens without lots of hiccups, but auctions are now a key demand by the EU, IMF and ECB before Greece can conclude its bailout program next summer.  Notaries, who are by law responsible for all auctions, recently voted to abstain from the process until December 31 demanding legal due process and police protection from radical groups who threatened them in their duties.  The government immediately concurred with the notaries' requests (shows they are finally "getting it", IMHO) - they are likely to cancel their abstention in a special General Assembly on Nov. 20.

If banks manage to clean up their bad loans by as much as they are expected without taking serious hits to their capital, then the question arises... what are their earnings going to look like in the next few years?  That's the multi-billion euro question, given the current extremely low market capitalization of the banking sector on the Athens Exchange.  

As of today, total market cap for the four Greek systemic banks comes to a mere 7 billion euro, a truly puny 4% of GDP and an even tinier 1.5% of their assets - such as they are, of course, given their high NPLs and NPEs.  By comparison, Spain's Santander and BBV market caps are at 6.7% and 6.4% of assets respectively, while Portugal's BCP and BPI are at 5.2% and 4.4%.

Even if we arbitrarily haircut Greek banks' assets by a radical 50%, current market cap still comes to just 3% of their "haircut" assets - see Chart 3.

Chart 3

Given the above, let's take a closer look at one Greek systemic bank's results, starting in 2008 (I don't want to mention its name, this is not an investment advice blog).  We are looking for trends in core operating earnings and how they compare to loan write-offs/reserves. For better comparison, I have excluded the one-time hit from the GGB haircut (PSI) in 2011 (4.8 billion euro). Results for 2017 are 6 months annualized - See Chart 4.
(*) 2011: A loss of 4.8 billion from the GGB haircut (PSI) is excluded (**) 2017 results are 6mos annualized
Chart 4

To me, the most interesting trend is the rise in profits before loan write-offs and reserve charges.  If the second half of 2017 comes in as the first, pre-charge profits will reach around 1.27 billion euro, surpassing even the all time peak of 2007 (1.21 billion euro). Despite the challenging environment, management is doing a really good job of running their core business and driving down expenses.  (Remember yesterday's chart on the sharp reduction in branches and the overall concentration of Greek banking.)

But good management is meaningless if bad loans continue to engulf results in red ink. 

In the same chart we see that write-offs and reserve charges peaked in 2015 and have been coming down. Again, if the second half of 2017 goes as the first, such red ink will ebb back to 2010 levels and the bank may show decent net profits for the first time in six years.

Obviously, there are lots of "ifs" here.  Bad loans during a deep recession are finicky and can come up or down depending on macroeconomic trends, disposable income and business sentiment.  

Short term, however, I think the deciding factor is going to be the effect of finally restarting auctions to liquidate loan collateral. Given the high percentage of "strategic defaulters" amongst Greek borrowers (variously estimated at 15% to 25%), it is possible that banks will experience a healthy drop in NPLs and NPEs when those people are forced to cough up their hoarded cash or lose their homes and businesses. Mind you, we are not talking about your average Joe and Jane here;  these are people with very significant assets.

Bottom line?  Greek banks are facing a crucial challenge: if they can successfully wield the auction weapon against their bad faith defaulters and force them to pay up, their stock of NPLs and NPEs will come down, perhaps significantly.  They will then have more breathing room to deal with their less fortunate borrowers who have been hit hard by the economic crisis and cannot now service their loans.  

For them, and for the ultimate return of health for Greek Banks, it will be all eyes on the economy.  And that will be the subject of the next post - are there any "green shoots" showing out there? 

Friday, November 10, 2017

Greek Banking: Part II

When the Debt Bubble wave hit in 2007-08, first on the shores of America and then expanding quickly all over the world, most Greeks - politicians in particular - thought that Greece was going to avoid the tsunami.  They were awesomely wrong, and the Depression which followed is still keeping the country scraping the bottom of the barrel ten years later.

We saw how the debt party ended in Greece.  What followed, however, was a textbook case in crisis mismanagement.  For at least two years the government attempted to alleviate the deepening recession by borrowing even more and - incredibly, criminally even - hid real budget deficit numbers by manipulating data published by the Greek Statistical Authority.  When the truth eventually came out major foreign investors in Greek Government Bonds (GGBs) were appalled and stopped buying.  Trust went out of the window and resorting to the IMF became the only option for the country.  The rest is, as they say, history.

Greek banks suffered mightily, not only because their loan portfolios started showing large blots of red ink, but also because their substantial holdings of GGBs were quickly subject to a mandatory haircut, adding further to their losses.  The bond haircut was a prerequisite of the Greek bailout program put together by the EU, IMF and ECB.

Hit by massive losses, banks' regulatory capital shrunk substantially so they had to go through successive re-capitalizations, each one driving their share prices ever lower.  Greek banks saw their share prices collapse over 99% on the Athens Exchange.  Several "shotgun marriage" mergers were arranged, forcing "better" banks to accept "bad" banks onto their books. 

Where do we stand right now?

Bad loans (NPLs) and other non performing exposures (NPEs) currently stand at 50% of the lending portfolio, and loss provisions take huge chunks out of operating results.  The major problem here is that banks have thus far been severely restricted by politicians from liquidating collateral to recoup loan losses, even partially.  Laws protected mortgaged homeowners from auctions, and even large business debtors have avoided them by using more nefarious methods.  Auctions are routinely  cancelled when "action groups" crash into courtrooms demanding "justice".  It is estimated that up to 25% of all bad loan amounts are owed by such "strategic" bad faith defaulters.

The banking business is now highly concentrated.  The number of domestic banks has shrunk to a mere four large "systemic" institutions, plus one very small one.  These five banks currently control 97% of all bank assets, up from 70% in 2008.  Several foreign banks have sold or outright shut down their activities. The number of bank branches, which once seemed to occupy every corner of Athens and other major towns, is down from 4.100 in 2008 to approx. 2500 today. There is now one branch per 4.600 residents versus 2.650 in 2008.  These numbers are way ahead of Eurozone averages  - See Chart 1.


Chart 1

Unquestionably, the major issue for Greek banks is how they will handle their NPL and NPE portfolios. I will look at this issue vs. underlying core profitability, plus some more recent developments in the next post...

Thursday, November 9, 2017

Greek Banking: Part I

To better understand the current state of Greek banks we need to  go back in time.

During the late 1980s to early '90s Greek banking was a ho-hum business. Inflation ran at 15-20%, so banks were limited to gathering deposits from the public and lending to the state, its associated enterprises and a few large private businesses. Mortgages were rare, since home buyers mostly paid cash or arranged installment plans with builders. No credit cards, no car or vacation loans, no securities business, no trading other than day-to-day book balancing. It was a boring, belt-and-suspenders kind of culture, with bankers accorded almost civil servant status.

Things changed radically after 1994, when Greece decided to adopt the Maastricht Treaty and eventually become a member of the planned Eurozone. There were a couple dozen domestic banks operating by then, plus another dozen or so foreign ones - and business boomed.

The main profit driver was the "convergence trade" consisting of borrowing cheaply in foreign exchange (usually German marks) and investing in higher-yielding drachma assets (depos, bonds and repos). This simple cross-currency arbitrage was nearly risk-free, since the government had instituted a gradual and predictable sliding peg for the drachma's exchange rate against the mark.  The slide was maintained at less than the interest rate differential between drachmas and marks, thus all but guaranteeing large arbitrage profits for several years.

Global banking giants caught on to the game and piled in: BofA, Citibank, HSBC, JP Morgan, Goldman Sachs, Morgan Stanley, Deutsche, SocGen, Credit Suisse and many more, were very active in the drachma market.  Even Lehman, Bear Sterns and AIG showed up to the party...

The festivities eventually wound down when Greece formally adopted the euro in 2001 and spreads evaporated.  Dealing rooms in Athens, London, Frankfurt, Paris and New York bid a fond farewell to the drachma and went on to bigger - and eventually much riskier - trades (eg CDOs, CDS, tranches, etc -  what this blogger saw very early as the makings of a global disaster. Read my posts starting in 2006 and watch The Big Short).

Greek banks turned to traditional meat-and-potatoes retail banking: mortgages, consumer and business credit.  Given the complete absence of a credit culture amongst Greeks, however, it was like giving moonshine to a teen.  Starting from a very low level of private sector debt, things quickly got out of hand. The party was back on, this time going on in every bank branch across the land; household debt zoomed from a mere 15 billion euro in 2000 (12% of GDP) to 120 billion in 2010 (55% of GDP), see Chart 1.

Chart 1

While most other western nations’ households had significantly larger debt loads as a percentage of GDP, Greeks increased their debt so fast, and had so little experience in handling it, that it spelled serious trouble for banks down the road.  And as we saw in a previous post, such explosive growth in easy credit created a bubble economy centered on highly overpriced real estate and consumer spending of imported goods.

The Greek economy grew strongly for a decade, but it was all based on a sea of debt.  It was not long before the debt storm that started on the shores of America would engulf Greece, too...

Wednesday, November 8, 2017

Greek Debt Basics: Part IV - Present And Prospects

Greece is going through its eighth year in a row of economic funk.  GDP is down 24% from its peak, unprecedented for a country not at war. It is the result of the implosion of the Greek debt bubble which formed after the country entered the eurozone, even though it was not fundamentally prepared to do so.  The country's economy was very unproductive and focused on low value added products and services. It is indicative that, even today, the main export by value is gasoline and other refined products (Greece, of course, is not an oil produced itself).

Let's take a look at the components of Greek GDP, then and now (in billion EUR):

Year                    Consumption         Investment       Trade Balance
2008                         203                        57                     -28
2016                           158                         18                        -1
 Difference               -45                        -39                    +27
% Change               -22%                     -68%

A quick analysis reveals that 60% of the drop in consumption has come from sharply reduced imports, not necessarily a bad thing.  But the real GDP killer between 2008-16 has been the plunge in investment, down a massive 68%. In fact, capital investment is now running below annual depreciation, meaning that the country's productive capacity is eroding. Bad news for an economy that is trying to rise from the bottom of the barrel.

Where is growth going to come from? 

  • With unemployment around 20%, sharp drops in personal income, and negative credit growth it won't come from consumption. In any case, final consumption is already a huge 90% of total GDP, another indication that Greece is scraping by on just the basics.
  • Greece is not an export-oriented economy, neither can it become one in short order.  Although there has been some improvement, the economy still exports little.
  • This leaves investment as the only viable growth engine, particularly Foreign Direct Investment (FDI).  Coming from such depressed levels, even a modest increase will produce a significant positive impact on GDP growth.  For example, a mere 5 billion euro extra translates to +3% GDP growth.
 Is Greece today ready, willing and able to become FDI friendly?  After two years of a loony economic policy that fought against private business investment, there are signs that the government is finally changing its tune.  The rhetoric has certainly changed, and it remains to be seen how quickly it will be translated into action.  There have been major deals with airport, port and rail privatizations, with more in the pipeline in real estate development (Astir Hotels, Hellenikon old airport re-development), energy production and distribution.

Prices in assets such as commercial and residential real estate are down 40-50% from the peak, while labor cost are also lower. The tourism sector, where growth is particularly apparent, is attracting major hotel chains and operators.

Still, much more is needed to sustain growth at the levels needed to pull Greece out of its funk.  One recent study claimed that Greece requires a total of 100 billion euro in capital investment to bring its  economy back to pre-crisis levels.  Is there such a prospect? Intriguingly, the money largely exists, and it exists in Greek hands. I'll explain..

Beginning in 2009 Greek banks have lost a massive 143 billion in deposits, a drop of 44%.  Because, unlike Cyprus, there hasn't been a deposit "haircut" (also known as "bail-in") in Greece, this money is still largely intact, albeit sent abroad in foreign accounts and squirreled away in safe deposit boxes and under the proverbial mattresses. This 143 billion euro amounts to over 80% of current GDP, a huge pool of capital that could, potentially, be put to better use boosting growth.

What is the catalyst to make it happen? In a word, confidence.  Greeks have been so badly beaten down by eight years of constant misery that they are understandably reluctant to invest.  Yet, one can see that there is plenty of fuel available to power the economic engine, if there was to be a "spark" of confidence.

 For such a "confidence indicator", I turn to Credit Default Swaps, a good gauge of sovereign credit risk (see Chart 1).  Greek risk has in fact been improving rapidly in recent months, with the benchmark 5-year CDS now at 427 bp, down from a high of 990 bp earlier this year -  and much higher at the height of Grexit anxiety. (For comparison, Portugal is currently at 117 bp and Italy 113 bp.  Not bad at all, given the hoo-hah in the media about Greece).

Chart 1

I'll leave it here today.  In the next post, I will look at Greek banks - a very much maligned bunch...