Wednesday, January 17, 2018

Leverage In Haste, Collapse At Leisure

"Sin in haste, repent at leisure" goes the well known sobriquet.  In the case of Greek businesses and households, they leveraged themselves so fast that the implosion was all but inevitable, particularly since state debt was also rising fast at the same time.  But, unlike other bubbles, the aftermath was not only painful but unnecessarily drawn out, too.

Going back to the beginning, we can see that private debt rose much faster than GDP between 1998-2008, going from 34% to 103% of GDP in just ten years. It was not so much a case of "too much" as "too fast", which created the real problem in Greek private sector debt and which left banks with a mass of non-performing loans. Unlike other western economies, Greeks were previously very under-leveraged and had no credit culture.  When the bubble economy collapsed many Greeks simply refused to pay their debts; their populist politicians played along, essentially prohibiting real estate and other property to be auctioned to satisfy debts.



Hobbled from enforcing loan agreements, banks were swamped with bad loans and had to be recapitalized several times. Naturally, they quit making new loans.

So, after the initial shock that saw GDP collapse 25% in just 3-4 years, the economy sat at the bottom for five long years, unable to capitalize on lower asset and labor costs. And how could it, since there was no fresh capital, no fuel to energize the positive part of the creative destruction process?

The Greek economy has been repenting its debt bubble sins for too long now and it is high time to start growing rapidly again.  Healthy, well capitalized banks are crucial in this process.

I strongly believe that Greece is now very close to achieving this necessary condition: its banks have consolidated massively, slashed operating costs and driven core profitability (pre-provisions) to near record levels.

What is the next step? The complete abolition of capital controls is an absolute must, if deposits are to come back in size.


Saturday, January 13, 2018

Greece: Creditless Expansion

The Greek economy is growing once again, and this time it is doing so without the benefit of credit expansion to drive consumption and investment.  For us schooled in chemical engineering, it is like running a reaction without the benefit of the necessary catalyst: if it proceeds at all, it does so at very low speeds and product yields.

For the first three quarters of 2017 (latest data available) nominal GDP has been rising, despite the credit contraction. Banks are scaling down their balance sheets, and the government is running very large primary budget balances, i.e. not borrowing at all.

In other words, monetary and fiscal policies are very restrictive in Greece.

 Nevertheless, the economy is growing - and what does this tell us?  Firstly, it says the economy is largely "importing" its growth via increased tourism and exports, instead of rising domestic consumer spending. Secondly, and far more importantly, it says that growth will accelerate once credit conditions improve.  Will they?

Yes, they will.  
  1. Banks are finally on track to deal decisively with their NPLs via a combination of sales, write-offs, reserves and workouts (collateral auctions are crucial, here).
  2. Confidence in Greek credit is improving, as seen in plunging interest rates on bonds and bills.  The last 3 month bill auction came in at 0.99%, and CDS's are at multi-year lows at 332 bp.
  3. Bank funding is also improving with customer deposits rising (too slowly, as yet) and more interbank transactions (bank-to-bank repos).
  4. Banks' reliance on the ECB's expensive Emergency Liquidity Assistance is constantly shrinking and will likely terminate within 2018.
  5. Once Greece is finished with its bailout program in August 2018, with or without a standby loan facility, the road will be clear to abolish capital controls imposed in 2015.  This should rapidly bring deposits back into the system, allowing banks to start expanding credit once again.
  6. Fiscal policy is set to remain restrictive for several years, since future large primary surpluses are a bailout condition. Therefore, once deposits start flowing back in, banks will have to expand credit as one of only two ways to increase earnings (buying new government bonds is the other).
It looks like 2018 is going to be a crucial year for the Greek economy.  So far, all the "reactants" are coming together in the chemical reactor vessel - the only ingredient still missing  is the credit "catalyst".  But I think I can see the truck bringing it in, out in the distance. 

Friday, January 12, 2018

Driving Ms. Hellas

Another alternative data set which better follows Greek economic conditions than headline GDP figures.

First-time vehicle registrations are up in 2017 for the fourth year in a row, now higher than 2011 levels.  More significantly, the rise comes from pricier automobiles (+22.1%) and trucks (+14.6%) rather than cheaper motorcycles, which were down 28.2%.


 While still very far from the unsustainable debt bubble days of 2000-08, the rise is indicative of core economic growth precisely because of the absence of auto loans.

Tuesday, January 9, 2018

Greek GDP And Credit Expansion - No Money, No Honey

Credit expansion, i.e. easy and cheap access to bank loans, is an essential ingredient of economic growth.  But as with all good things, too much of it can lead to trouble.

This was certainly the case with the economy of Greece during its debt bubble years.  The chart below shows how credit expansion grew much faster than GDP-  sometimes as much as 10 times faster. And this chart shows only bank credit, i.e. it does not include government borrowing which was also rising very fast.

The bubble burst in 2009 and the economy went south, staying in recession for eight straight years.

Can the economy now recover and grow without credit expansion? It is already doing so in 2017, even as banks shrink their balance sheets by selling or writing off bad loans (thus the large credit contraction in 2016-17).  Moreover, the government is not adding any new debt, instead producing oversize primary budget surpluses.

Therefore, credit conditions are currently very, very tight in Greece - one would characterize its economy as the diametrical opposite of a debt bubble;  let's coin a phrase and call it the "no money, no honey" economy..

The economy can continue growing for a while by focusing almost entirely on expanding its external markets such as tourism and exports - and that's exactly what is happening right now.  But this creditless expansion will not, and cannot, create the vigorous growth necessary to bring Greece back to financial health and raise living standards back towards those of a decade ago.

Greece needs healthy, well capitalized and deposit-rich banks that can once again provide sound businesses with plentiful credit to stimulate economic growth well above the 2-3% range.

Is this a realistic possibility? After all, everyone in Greek banking is focused on dealing with bad loans, meeting new regulatory criteria and cutting operating costs.

I believe it is more than possible, and there are early signs that astute, experienced bankers and investors are catching on to this idea.  There are - apparently - several entities preparing to submit applications for new banking licenses to establish credit institutions unencumbered by old bad loans, ready and willing to provide fresh credit.

This will play out over the next few months - so how are the four large systemic banks going to respond?  Certainly, they won't roll over and die... they have several factors in their favor, and I am willing to bet they will use them this year.

Stay tuned, because we may soon see fresh money coming into the Greek banking sector... otherwise, no honey!

Monday, January 8, 2018

Greek GDP - A Better Estimate

I have in previous posts expressed my doubts about official Greek GDP numbers as reported by the statistical authority (ELSTAT).  The major reason is the large "shadow" economy which operates under the table to avoid high value-added, income and social security taxes.   

A recent study by the Institute for Applied Economic Research at the University of Tübingen says Greece has the largest shadow economy in the world at 21.5% of GDP. 
 


It follows that calculating growth/recession rates becomes quite problematic since variations in the shadow economy cannot be counted. Thus, the need for a better yardstick, one that is not as affected by cheating on taxes.

My personal favorite is energy consumption (after all, every activity requires energy), and in this post I will try to provide a better estimate for real Greek GDP in 2017.

British Petroleum publishes an annual energy statistics study, widely considered the most authoritative of its kind.  Doing a quick division of official real GDP to energy consumption, I come up with the chart below: Greek GDP per unit of energy consumed.
We see that it varies between 6.1 to 7.1 billion euro per million metric tons of oil equivalent (MTOE).  There is a  good explanation for the large rise between 2006-10: during its bubble years the Greek economy was driven mostly by housing construction, a notorious source of tax cheating;  it is also very energy intensive.  Therefore, while energy use was increasing, reported GDP wasn't following pace, hiding in the shadows instead.  This changed abruptly when the construction business tanked following 2010.

Construction is now moribund (down almost 90%), so I'm pretty comfortable with using an average of 6.7 billion euro per MTOE as a useful correlation factor between economic activity and energy consumption.  The variation has been quite small, between 6.5 and 6.9 in the last five years and even smaller during 2014-16.

Moving right along, I'll also assume that in 2017 total energy consumption increased 3.8%, i.e. the same as for electricity alone (total energy data won't be available by BP until later in the year).



It all boils down to this: in 2017 my estimate for real (i.e. inflation-adjusted) GDP is

 GDPe =1.038 x 6700 x 25.9* = 180.1 billion euro

 or +2.4% over 2016, double the growth rate reported thus far (up to 3Q) by ELSTAT (1.2%).


Is this figure supported by other data? Yes, it is: for example, we know that tourism accounts for approx. 20% of all economic activity in Greece by direct, indirect and induced effects. Since we saw a 10.6% increase in tourism receipts during 2017, it follows that GDP growth from tourism alone should be +2.12%.




Bottom line: by my calculation real GDP growth in Greece during 2017 was +2.4%, give or take.




(* 25.9 MTOE was 2016 energy consumption as per BP)

Saturday, January 6, 2018

Greek Bonds Continue Massive Rally

Greek Government bonds continued their rally into the first week of the 2018.  The benchmark 10-year bond now yields 3.75%, the lowest since March 2006.  It was at 8% a year ago.
 
 The star of the market is unquestionably the short end, with the 2-year going from 10% to 1.45%, a massive 85% drop.  It now yields even less than the latest 6-month bill auctioned just four days ago at 1.65%!


I will note, once again, that this is far below the 3.5% interest rate charged by the IMF for its 11-12 billion euro loans to Greece, which have an average weighted maturity around 2.5 years. (From this perspective, Greece should arrange to immediately repay the IMF.)

Markets now discount a rapid return to normalcy for the country, driving credit default swap (CDS) premiums to 338 bp, down from nearly 1,000 a year ago.


  






 

Thursday, January 4, 2018

Greek Banks - It's The Economy, Stupid!

When it comes to winning elections, one piece of wisdom reigns supreme, as given by Bill Clinton: "It's the economy, stupid!"  But it also holds true when dealing with non-performing loans, particularly in Greek banks.

The obvious connection is that as the economy improves so do incomes, company profits and asset prices.  Loans that were not being serviced - intentionally or not - can become easier to pay, and underlying collateral becomes more valuable.  Couple that with the recent resumption of real estate auctions for property seized by banks, and you can see how NPLs may become less of a problem for Greek banks sooner rather than later.

The latest piece of news on the economy is quite good: the manufacturing Purchasing Managers' Index (PMI) for December is the highest since 2008, driven by new domestic and international orders.  Business confidence is the highest on record, too.

 You can find the press release here. 
 An excerpt: 
"The Greek manufacturing sector closed out 2017 on a firmly positive footing, with business conditions improving to the greatest extent in nine-and-a halfy years. Strong expansions in new orders, on both a domestic and foreign basis continued to drive the upturn which, in turn, contributed to a further round of job creation and the joint-sharpest growth in output since August 2008."

Monday, January 1, 2018

Greece In 2018 - A New Beginning

Happy New Year Hellas!
I strongly believe that 2018 will be a comeback year for Greece, a true New Beginning for a country coming out of an unprecedented seven years of economic misery.
  ⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎⇎

In previous posts I have detailed the Greek Depression sufficiently, so I won't repeat the telling here.  For us financial markets types one chart is enough to capture the whole drama: 10-year government bond yields.


So, if the past is history, what lies in the future?

Again, charts.
  • The government's primary budget (i.e. before interest payments) is solidly in surplus at around 3%-3.5% of GDP, a huge and rapid improvement from a disastrous 9% deficit in 2013.

  •  The current account (trade balance, cross-border payments, etc) is now balanced, also up from very large deficits in prior years.
  •  Government debt has stabilized, albeit at high levels.  However, what matters most is the cost of servicing it, and that is the lowest in over a decade.


  • Employment bottomed out in 2013 and is slowly rising, nearing 2011 levels.  The increase is occurring in the absence of any significant upswing in construction activity, which is at the lowest level in decades (housing construction was Greece's main economic driver during the bubble years). Therefore, the current improvement is more structural than cyclical, so when construction revives employment will rise very fast.

  •  And what about headline GDP numbers? I confess that I am very dubious about them, since there are structural distortions which make accurate GDP measurement problematic. For example, Greece has a very large "shadow" economy: according to the OECD around 25-35% economic activity goes unreported, mainly due to tax evasion.  Even a minor fluctuation in this percentage can skew growth figures disproportionately, so it is better to look at alternative indicators. The next chart is a comparison between total energy consumption and real GDP. There are obvious divergent years: 2007-08, 2011 and, perhaps, 2017 as well - though it's still too early to tell. In general, I believe energy data are more accurate (yet, there is tax evasion in the fuels market, too, so...).  Maybe it is best to just look at trends instead of absolute figures. Either way, the Greek economy seems to be expanding once again in 2017 - and if I had to guess, faster than the GDP numbers are showing.
*(2017 data are up to 3Q for GDP and only for electricity for energy)
The official verdict for the extend of the Greek recovery is still many months away.  However, it is certain that after so many years of pain, Greece is making a new beginning.
  
It is no longer an unstable debt bubble economy. It is now based on a solid foundation of fiscal budgets in surplus, balanced current accounts, low debt service and rising employment.  Markets have taken notice, too - it is no accident that yields on 10-year government bonds are the lowest since 2008.
The New Year is looking rather good for Greece.

Thursday, December 28, 2017

Greek Electricity Consumption Up Again

One of the best indicators of economic activity is electricity consumption.  It's pretty simple why: activity requires energy, and in modern, services-heavy economies electricity dominates.

The latest data for Greece (Nov. 2017) confirm my conviction that flash 3Q GDP estimates from ELSTAT, the Greek statistical authority, underestimate actual economic growth and will likely be revised upwards, just like the second quarter. 

Electricity consumption for Jan-Nov 2017 is up a very healthy +3.8%. Conversely, ELSTAT estimates real (inflation adjusted) GDP growth for the first nine months at just 1.1%. Such a large difference is too large to be ignored as a fluke, particularly since electricity consumption growth has been steadily higher for the entire year.


Looking into the electricity data in more detail we see that consumption increased most in the mid-voltage sector, i.e. commercial customers such as hotels, restaurants, large retailers and small manufacturers (+7% ytd).  That’s exactly in line with this year's rise in tourism, for example.  Low voltage consumption (mostly households) is also up +3.3%, while at the high end (i.e. industrial customers) there is a drop of -1.12%.

                            Pct. of total consumption    Change YTD
Low Voltage:                    62.3%                               +3.33%
Middle Voltage:               25.3%                               +6.96%
High Voltage:                   12.4%                                 -1.12%
Total:                                  100%                               +3.79%

Tuesday, December 26, 2017

Greek Bank Core Profits

When it comes to Greek banks everyone seems to be stuck on one subject: Non-performing loans.  While this is a very serious issue since bad loans comprise around 45-50% of total loan portfolios, it obscures what is happening under the surface of red ink: strong core profits.

A good example is Alpha Bank, Greece's largest bank by market capitalization (2.47 billion euro as of Dec.23).
 
*2011 provisions exclude losses from the Greek Government Bond haircut
2017e are 9m results annualized

As you can see from the chart, core earnings (revenues minus expenses) bottomed out in 2012 and have been rising since. This year they are likely to reach pre-crisis levels, or even higher if significant mark-to-market gains from its Greek government bond portfolio are included - 2017 has been a banner year for GGBs.  Furthermore, core earnings are now exceeding loan provisions and write-offs, producing net bottom line profits for the first time in six years.  

Profits are driven by high net interest margins and lower operating costs, which are being slashed as the Greek banking industry consolidates drastically. Just four banks now  account for 97% of all banking assets, a level of concentration far above the EU average.

I expect the rise in core profits to continue as the economic recovery gains momentum in 2018-19 and costs are reduced  further by more staff reductions and branch closures.  I also expect to see some top line gains from a slight pickup in credit expansion and the gradual shift of government borrowing from the official sector to bond issuance.  And I would  not be surprised if the capital controls imposed in 2015 are lifted entirely towards the end of 2018, bringing back deposits now hidden under mattresses.