Friday, 26 August 2011

Markets - Liquidity? The IV Greek Credit Therapy

"Intravenous therapy or IV therapy is the giving of substances directly into a vein."

This week analogy directly relates to the news that Greece has been forced to activate emergency funding, because of collateral issues that is acceptable to the ECB.

Greece forced to tap emergency funding - Louise Armitstead - The Telegraph

"In a move described as the "last stand for Greek banks", the embattled country's central bank activated Emergency Liquidity Assistance (ELA) for the first time on Wednesday night."

"The ELA was designed under European rules to allow national central banks to provide liquidity for their own lenders when they run out of collateral of a quality that can be used to trade with the ECB. It is an obscure tool that is supposed to be temporary and one of the last resorts for indebted banks. So far it has only be used in Ireland.

By accepting a lower level of collateral the debt in the ELA is, in theory, supposed to be the responsibility of Greece. However, since the Greek state is surviving on eurozone bailouts and Greek banks are reliant on ECB funding, in practice the loans are backed by the eurozone. The terms of lending and other details are not disclosed publicly."

Mr Raoul Ruparel of Open Europe said according to the article: "Though the ELA is meant to be a temporary emergency solution, we know from Ireland, where the programme has been running for almost a year, that once banks get hooked on ELA they rarely get off it."

Hence the analogy to IV Therapy for "zombie banks".

What is a zombie bank:
"A zombie bank is a financial institution that has an economic net worth less than zero but continues to operate because its ability to repay its debts is shored up by implicit or explicit government credit support. The term was first used by Edward Kane in 1987 to explain the dangers of tolerating a large number of insolvent savings and loan associations and applied to the emerging Japanese crisis in 1993. Zombie institutions face runs by uninsured depositors and margin calls from counterparties in derivatives transactions." - Wikipedia

In my post "Zombieland 2...The Sequel...", I described it further:
"Zombie banks often have a large amount of nonperforming assets on their balance sheets which make future earnings very unpredictable."

In essence, Greek banks are suffering the same fate as their Irish counteparts, namely becoming "Zombie banks" in the process.

Deutsche Bank on the 24th of August, published an interesting paper: "Greek and Cypriot Banks - Estimated capital shortfall."
Between the 29th and the 30th of August, we will get Quarter results for Greek banks, so watch closely the results.
What I have learned from the report so far:
"Operating profits are set to decline for as long as Greece remains in recession and global activity slows down, affecting inter alia the course of interest rates (ECB hikes)."

No surprise there given the economic outlook for Greece.
We know for a fact that following the EU summit of July 21st that the need of raising capital has been communicated by the Greek governement.

Deutsche Bank have "increased" their "impairments estimates" due to higher NPLs (Nonperforming loans). On the 22nd of August the Greek Finance minister in Bloomberg Finance stated that the recession in Greece could exceed 4.5% and stand between 4.5% and 5.3%, which is 100-200 bps worse than the latest EC forecast:

And Deutsche Bank to add:
"Greek banks continue to face the same challenges. Deposits outflows in combination with the reduction in value of collaterals placed with the ECB continue to stretch their liquidity. ECB funding spiked in May and June to E103bn (collaterals at 148bn) from E87bn in April. If banks cannot use the new E30bn state guarantee liquidity tranche, then any new liquidity needs will have to be met by the central bank's ELA facility."

There you go, it is ELA time, as indicated at the start of the post. The IV Credit line is now well in place for Greek "zombie banks".

Previously, I wrote the following, whereas in Ireland, banks sunk the government finances and the country, the Greek profligacy and their banks being overloaded with Greek government bonds sunk their financial system.

So, how are Greek banks supposed to grow their profits when lending growth is falling? They can't:

And what is happening to Greek deposits in Greek banks? They are melting away:

Greek Banks' Liquidity Is Suffering As Nervous Clients Withdraw Savings - WSJ - Philip Pangalos

"The consequence for many Greek banks is a growing shortage of liquidity that is increasing their reliance on emergency funding from the European Central Bank and forcing them to further cut lending to businesses. That, in turn, is deepening Greece's recession, making it harder for the government to narrow its gaping budget deficit."

We already know from the European Banking Association Stress tests from July 15th, that two Greek Banks failed the test: ATE Bank and Eurobank EFG.

Additional points from the Deutsche Bank report in comparison to Ireland:
"Loans/GDP for the Irish banks stood at c.6.5X versus 2.2x for the Greek Banks."

"The L/D (Loan/Deposit) ratio of the Irish banks tested stood at 180% as of 2010, while the L/D of Greek banks stood at 122%, according to the Bank of Greece."
Not as bad as Ireland, for Greek banks.

Greek banks as of 2012, will have to maintain a minimum Tier 1 capital of 10%, as per the central bank.
Deutsche Bank adds in relation to Greek Banks:
"The government can directly inject capital into any bank it owns if it cannot privatize them first".

They estimate the capital shortfall needed so far to be in the region of 5 billion euros.

The Hellenic Financial Stability Fund, set up in October 2010 to provide capital support has 10 billion euros in capital to support its financial sector. Its duration is set until 2017. The HFSF 10 billion reserves come from the 110 billion euros rescue package provided by the EMU and IMF.

Following the 21st of July meeting for the second rescue package of 109 billion euros (which has yet to be approved by the members of the Euro zone), the firepower of the HFSF will be increased to 30 billion euros.

The worrying trend for Greek banks is not only the lack of loan growth directly tied to the poor economic situation but to some extent, a noticeable increase in the NPL ratios (Nonperforming loans). Below are three examples:
Alpha bank:
NPL ratio for FY 2009: 5.7%
NPL ratio for FY 2010: 8.5%
NPL ratio for Q1 2011: 9.3%
Deposits fell from 42 billion euros in 2009 to 37.6 billion euros in Q1 2011.

Eurobank (failed the EBA stress test on the 15th of July):
NPL ratio for FY 2009: 6.68%
NPL ratio for FY 2010: 9.60%
NPL ratio for Q1 2011: 11.40%
Deposits fell from 46 billion euros in 2009 to 40 billion euros in Q1 2011.

ATE Bank (failed the EBA stress test on the 15th of July):
NPL ratio for FY 2009: 7.6%
NPL ratio for FY 2010: 9.60%
NPL ratio for Q1 2011: 14.5%
Deposits fell from 46 billion euros in 2009 to 40 billion euros in Q1 2011.

So what is the solution to some of these increasing issues? The Greek financial system will have to go through consolidation to survive.

Remember, the name of the game is access to credit and liquidity:
"The recent significant increase in credit spreads for many financials have been driven by the markets concerned about the ability of the weaker players to access credit at reasonable rates."

Basically a game of survival of the fittest.
By consolidating its banking sector, according to the same report from Deutsche Bank, Greek banks could achieve Core Tier 1 ratios between 9% and 10%, reaching therefore the 2012 objective set by the Bank of Greece:
"Our main conclusion is that based on the synergies and value creation potential M&A would make economic sense. Moreover, the creation of bigger entities could facilitate the banking system in re-accessing debt markets, although we believe will primarily depend on the fiscal performance of the sovereign and less to the size of the banks in Greece. In a nutshell, consolidation should help the banks in becoming more efficient and could even be triggered by their need to raise capital in the future. But it may not be enough to make them operate like normal banks again for as long as the sovereign risks remain high."

Conclusion: we have zombie banks in Greece, like in Ireland, and the fate of the Greek banking system now depends on ELA IV support. It is entirely depending on the outcome for Greece as a sovereign and, given 2 years Greek notes are currently yielding close to 45%, the prospects for survival aren't great at the moment, particularly with the ongoing dissents in the European political space:

So yes, the correlation between sovereigns and financial sectors is indeed very strong.

One thing Greece must address is tax cheats who represents 30 billion euros, or 12 per cent of GDP, every year. Another American solution to European woes would be, for Greece, to tax its citizens on their worldwide income, similar to the US. It would be a very efficient way to stabilise its ailing banking system and deposit outflows given one third of its funds withdrawn have gone abroad for fear of a crackdown on tax evasion. By imposing Greek citizen on their worlwide income like US citizens,, and with the help of Luxembourg authorities, Cyprus, Switzerland and the United Kingdom, the outflow could be stemmed and vital tax receipts could rapidly help close the gap on the very acute budget deficit, but that's another story...

Stay Tuned!

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