David EInhorn on Piraeus Bank: Now I know what he Thinks (Part II)

In this post I want to discuss some of the microeconomic, i.e. bank specific, arguments David Einhorn made during his presentation. I will only discuss Piraeus bank here, as I am already familiar with its financials due to my past blog posts. As in Part I, I will analyse his arguments one by one.

Similar to his macroeconomic analysis, Einhorn numbers improvements across all measures of bank performance and sees the potential for the share price to double over the next three years. The following slide neatly summarizes his view.

ReturnEinhorn

According to Einhorn, the stock price will be driven by the following three factors,

  • Cumulative “core earnings” due to increased profitability,
  • future releases of LLPs, due to over-provisioning in the past and, last but not least,
  • a re-rating of the stock: he expects the P/B multiple to double (to 1.5 x book).

Let’s have a look at each of these arguments…

Ad. 1.) Improved profitability

Einhorn has two slides that show various improving profitability indicators of which the most important one, at least to me, is the net income margin chart.

NetInterestMargin

The net income margin (NI margin) of a commercial bank is comparable to the revenue figure of an industrial company, i.e. it represents the top-line. It is the most important figure by which we should judge the long-term growth potential of any company. This is because for your typical industrial company, the top-line will be unaffected by one-time measures such as cost cuts that are unlikely to lead to sustainable growth in profits – not a perfect measure but a good start.

However, banks are somewhat different as the NI margin is not only driven by growth variables (costumers, loan pricing…), but also by an (important) cost variable: the cost of funds. Indeed, Einhorn mentions that the lower cost of deposits has been the main driver of NI margin growth.

Now, by how much more can the cost of deposits fall in Greece?

In order to answer that question, I have looked up the deposit rates Piraeus bank pays to its customers. Thankfully management has provided this table in its Q2 investor presentation

Time-Deposit_Piraeus

Current time deposit rates in Greece stand around 2% which doesn’t sound that high to me. As we can see, time deposit rates have come down quite a bit over the past 18 months falling by more than 200 bp thereby boosting the top-line. Another such boost is impossible. The fall in funding cost has of course mirrored the fall in the Greek government bond yield over the same period, see below…

greece-government-bond-yield

Note, that the second quarter 2014 marked the low for the 10-year Greek government bond at around 5% yield. Since then yields have increased substantially hitting 8% in November as the likelihood of another Greek default has increased. As I have argued in my previous post, given Greeks high sovereign debt burden and its high debt service costs, another restructuring is only a matter of time.

Given the already low deposit rates and the increase in Greek bond yields lately, it is safe to assume that the tailwind from lower funding cost is over. This leaves us with lending as the only driver for NI growth.

Yes, what about loan growth?

As always: facts first…

The table shows the evolution of the gross loan volumes of Piraeus bank in Greece, its most important market…

Piraeus_LoanGwth

Unsurprisingly, loan volumes have been falling across all segments, despite lower interest rates. I say unsurprisingly because this is what a de-leveraging looks like.

Question: what drives this de-leveraging?

Three possible explanations:

  • Piraeus bank doesn’t have enough capital to lend to costumers,
  • it doesn’t have enough liquidity to lend to costumers, i.e. it is overstretched,
  • it doesn’t find enough good customers who want to take out a loan.

Now, it is probably a combination of all three factors, if you ask me.

Although the bank looks well capitalized on a regulatory basis, I do have a few reservations about that book value – but more about that later.

Improving the liquidity profile certainly played a role as well, as the bank’s loan-to-deposit (LTD) ratio has come down substantially. This has, no doubt, to do with bank management being eager to get rid of the ECB’s “emergency liquidity assistance” (ELA) facility, an exceptional measure by the ECB to keep the banking systems of periphery countries afloat during the height of the sovereign debt crisis. This must have had high management and local regulatory priority. After all, an ELA-free balance sheet signifies a normal environment – and better negotiating power in Brussels.

But the most important factor – and, I think, true of all EU periphery countries – is the lack of potential and creditworthy debtors. What do you expect when a high double-digit percentage of the workforce lacks (official) income? And it is not exactly the case that Greeks are unfamiliar with leverage. The table below puts Greece’s total debt load (government, households and corporate) in perspective:

TotalDebtDevelopedMkts

Greece’s total debt load (Total ex financials, column e) at 304% of GDP is one of the highest among developed markets. Higher, for instance, than in the US (264%) and way higher than in Germany or Austria – not necessarily markets which are credited with high banking growth potential.

Actually, I think that it is more meaningful to compare Greece to other Emerging Markets. First, Greece suffers from many problems typical of emerging markets (high level of cronyism, inefficient state bureaucracy…), but also because it is EM that are seen to be “under-banked” which are usually touted as the next growth opportunity in banking circles. How does Greece  compare to your typical EM? Look at the following table for answers:

EMtotalDebt

Whether the “EM-are-underbanked-story” is sound or not, at least the bankers have a point: the average debt level (private + government) in EM is exactly half the Greek level (151% vs. 304%). Note that this is not just because of Greece’s high government debt: apart from Hungary (144%) and China (169%) no other EM has as high a private debt load as Greece (129%).

Summary: the fact that funding costs are unlikely to fall further and that there is limited loan growth potential due to the already high debt levels in the Greek economy, make it unlikely that the top-line of Piraeus bank will increase significantly from current levels. If there is growth potential, I would like to know where it comes from.

Ad. 2) Release of LLPs due to overprovisioning

According to the second argument, Piraeus bank has provisioned conservatively in the past and has potential to release some of these provisions thereby increasing profits and book value. Einhorn argues that, due to a law passed in 2008 which forbade foreclosures by banks, a lot of the NPLs are “strategic” in nature and will start paying once the law expires, i.e. next year.

I am not familiar with the details of this law, but many CEE governments have passed a similar law. For instance, Hungary and Ukraine with Austrian banks complaining. Usually, these laws are passed to protect retail creditors from losing their home – not corporate customers. Now, according to the Q2 presentation EUR 19.8bn out of EUR 28bn NPL of Piraeus are defaulted business loans. If it is indeed true that said law businesses from being foreclosed, I would be very worried about it, not bullish.

Why?

Because a bank’s assets are a collection of contracts that promise a certain cash flow. A contract’s worth is a function of its enforceability. The same goes for a pledge on collateral. In countries where rule of law is weak or enforceability is otherwise uncertain, as this law seems to suggest, we do not observe complex business models emerging. In these countries it’s mostly “cash and carry” business models that are successful. Put differently, such environments are not very bullish from the perspective of a prospective bank owner. As Klaus Kastner pointed out: the World Bank singled out the difficulty in “registering property” and “enforcing contracts” as the biggest challenge to Greek competitiveness.

(Note to Keynesians out there: there is much more to competitiveness than unit labour costs reductions as a result of currency devaluations.)

In short: I have my doubts on whether these NPL will start paying again…

Now, let’s look at the provisioning level of Piraeus bank. Einhorn provides the following slide.

ProvisionsPiraeusBank

Just eyeballing the coverage ratios (LLPs as % of NPLs) Piraeus doesn’t seem conservatively provisioned: 16% on mortgages after a massive drop in asset prices over the past five years doesn’t strike me as conservative. Of course, if you count the collateral then everything looks fine, i.e. a coverage of NPLs larger than 100% across all segments. But it is impossible to take comfort with the collateral values, in my view, before answering the following questions:

What type of do they count here? I hope it is not property, plant and equipment. How do they arrive at the figures? Transactions? Hardly possible in a depressionary environment. Estimated values (Appraisals)? If yes, how old are they? Are the values reported nominal values or haircut values? And how much is collateral worth in an environment where enforcement is legally difficult, anyway?

Most important of all: If collateral covers the net loans, why is the NPL ratio rising and standing at a record 38% of all loans, why are they not getting rid of these loans?

The answer, of course is that the book values of the loans don’t reflect the market value of these assets – otherwise the bank would have got rid of them a long time ago. They have every incentive to do so: it looks better on the balance sheet and it frees capital and liquidity. Also do not forget that in workout speed is everything, i.e. the longer you wait to enforce collateral the less valuable it becomes. Carrying the NPLs from, say, 2010 on your balance sheet doesn’t make them worth more, on average as a defaulted customer usually will delay capex as long as possible – with negative repercussions for pledged collateral values.

Fortunately, we have another indication of Piraeus’s asset quality: the recently concluded “Asset Quality Review” (AQR) by the ECB. The following chart (via Berenberg bank) summarizes the AQR findings on a country by country basis.

AQR_Berenberg
The figure above shows the additional provisions uncovered by the AQR, both, on an absolute and on a relative basis. Now, David Einhorn might find this surprising, but the Greek banking system was found to have the by far biggest issues, i.e. its book values the least reliable, with Piraeus one of the biggest hit (Alpha the second bank Einhorn talks about scores somewhat better).

This confirms my view: I do not see any scope for major releases here. Certainly the ECB has looked somewhat closer at the collateral values and has not taken management figures at face value – neither should anybody else.

Of course, the regulators managed to calm the markets by saying that the capital measures undertaken by Piraeus so far suffice for now, i.e. they fulfil current regulatory ratios – nobody needs another Greek banking crisis, after all. However, I want to emphasize the adjective “current” in this context, because starting from 2019 onwards, European banks are supposed to fulfill much stricter Basel III standards. In order not to overburden them, regulators have given European banks time until 2019 to prepare for the tougher environment. The ECB knows this and consequently also tried to assess the banks’ requirements under Basel III in a forward-looking way.

Shouldn’t we as investors be forward-looking as well?

I think yes, here are the results:

FullyLoadedBaselIII
This is interesting: under the fully loaded Basel III scenario Piraeus bank (line 116) ends up with a regulatory capital ratio (CET1) of  a negative (!) 1.5 percent – no doubt the doubious quality of Piraeus bank’s book value must have played a part.

I have no special information on how the ECB came up with that number, but if I interpret it correctly Piraeus bankwill have to come up with substantial equity in the next five years – it will be a long time before Piraeus can grow its loan book substantially, let alone pay dividends even if profitable.

Summary: the fact that the ECB AQR uncovered serious issues with Asset Quality in Greece and at Piraeus bank makes provision releases highly unlikely in the future. On the contrary, I would expect serious additional provisioning needs as the coverage ratios (without collateral) are not high, also compared to other banks in periphery countries. I repeat: this is no surprise, it is a well-known rule in workout management that the longer you wait the less you get back. The effect of Basel III is not even mentioned or considered by Einhorn – irresponsible.

Ad. 3) Multiple Expansion

If you follow Einhorn’s logic, golden Times are ahead for Greek banks and the economy, with growth prospects correspondingly high. He therefore goes on to assume that in three years investors will be willing to pay a premium to book value.

Apart from everything I have said so far about the dubious quality of Piraeus’s book value, it strikes me as strange that a so-called “value investor” is willing to speculate on the mood of “Mr. Market” in the future. Isn’t there supposed to be a margin of safety? If yes, where is it? This shows how far standards are  successively lowered in a bull market, even by those claiming to look for value (this happens often enough, read this Youngmoney post).

As is well-known, the P/B ratio is a function of the excess return, i.e. return over cost of capital, and the growth prospects of a company. Only for companies that can be expected to earn above their cost of capital one should be willing to pay above book value.

This relationship can be expressed with the following formula (derived from the “Gordon Growth Model“),

   P/B  = 1+ (ROE-r)/r-g)

where ROE is the return on (book) equity, (r) the cost of equity and (g) the growth rate. Note that, if (ROE = r) then the numerator is 0 and there should be no premium to book value. The nice thing about this formula: it offers us a possibility to back out Einhorn’s implicit expectations. I am interested in how much he expects this bank to earn three years down the road.

To do this, we first have to determine the appropriate value for the return investors expect when they invest in Greek banks, i.e. the cost of equity (r). I will not be overly harsh and argue that 12% is the minimum return investors demand for a Greek bank, although most investors probably would expect more in view of the macroeconomic situation.

Next, we have to settle for a long run growth rate. Given what I said about the comparatively high debt load of the Greek economy and the headwinds banks will face with Basel III, I believe it is very optimistic, if I assume a growth in profits of 5 percent per year.

Thus we get: (r-g) = (12%-5%)= 7 percent for the denominator

Plugging in a P/B of 1.5 and reshuffling terms yields an expected ROE requirement of 15,5%. This means that, in order to trade at 1.5 x book, Piraeus bank will have to earn 15.5% on book value on a sustained basis AND be able to grow by 5 percent per year – no “margin of safety” to see here.

But what does this mean in actual numbers?

Piraeus book value stood at around EUR 9.3bn at the end of the second quarter. Multiplying this figure with the expected ROE (15.5%) yields around EUR 1.5bn in expected net income (net income has been slightly positive YTD only if you include one offs) for Piraeus bank three years down the road. Note that this figure would be even 20% – 30% higher if Einhorn’s LLP releases materialize, as this would add to book value.

Is a net income of EUR 1.5bn realistic?

According to Einhorn’s slides, Piraeus bank’s pre-provision profit stood at around EUR 300 mln at the end of Q2 2014. That’s already significantly up from previous quarters due to the lower cost of funding and cost cutting measures. Annualizing this figure yields EUR 1.2bn pre provision profit, i.e. before deducting risk costs. Of course, risk costs are a real cost factor for banks even in normal years. Consequently, I assume that a bank of that size will have normalized risk costs of around EUR 100-200 mln per year. Deducting this from pre-provision profit leaves us with a normalized net income figure (we can ignore taxes due to high losses in the past) of around EUR 1 bn.

In other words: Pre-provision profits would have to increase by 50% over the next three years in order to meet Einhorn’s expectations AND risk costs would have to normalize rather quickly. This all has to be achieved taking into account:

  • no dramatic potential for further cost of funds reductions
  • limited growth prospect due to high debt load of households
  • the challenging demands posed by future Basel III requirements

And I repeat: Einhorn implicitly expects even higher net income, as he assumes book value will be higher!

Conclusion

This is a very weak investment thesis. The quality of the analysis is disappointingly low. Both his macro and his micro arguments are overly superficial, as he takes all figures at face value without trying to understand the drivers behind them. This makes him blindly trust the coverage ratios presented by management, or ignore the effect of known regulatory changes. He doesn’t touch the management topic at all, although there clearly are some issues such as a cosy relationship with regulators/politicians – in my experience not necessarily evidence of shareholder value driven ethics. Worst however, is the fact that he does not demand a “margin-of-safety” from this investment, but prefers to speculate on how much people might be willing to pay in the future.

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18 comments

  1. “Note to Keynesians out there: there is much more to competitiveness than unit labour costs reductions as a result of currency devaluations.”

    FYI unit labour costs do not fall when a currency devalues. If you look at the figures for ULCs and a country’s currency value they will be wholly independent of one another.

    Also, most Keynesians — at least the proper Keynesians that I would consider myself associated with — do not believe that devaluing a currency will improve a country’s trade balance. Keynesian economists like Anthony Thirlwall, Nicholas Kaldor, Paul Davidson and Wynne Godley write extensively on trade balances not responding to devaluations. Whether a devaluation will affect the trade balance depends on whether the Marshall-Lerner conditions are met. Often they are not.

  2. Agree, unit labor costs do not have to fall just because a currency devalues. This will depend on many factors such as relative bargaining power of labor in different sectors etc.

    Further, a change in the aggregate could also be just a statistical artefact: for instance, in Spain you have falling aggregate ULC (output/hour worked increases), but unemployment has been rising. As a consequence, it is difficult to know whether competitiveness has indeed risen or not, since the effect might well be due to the fact that marginally unproductive workers have been sacked and those remaining in the workforce (and “producing” GDP) by definition more productive. It means you can have falling ULC without any change in labor competitiveness whatsoever. At least not competitiveness as most people would understand it. Of course, you could define competitiveness as a fall in ULC and “solve” the problem 🙂

    As an Austrian, I do not consider thinking in terms of aggregate UCL useful at all – the aggregate hiding what is relevant to economic actors. What matters for employers and employees are specific prices at specific locations – not averages.

    As far as I know, most Keynesians subscribe to the theory of optimal currency areas where “flexibility” in devaluing its way out of problems is traded off against lower “transaction costs”. Devaluation is needed, according to Keynesians, because of “sticky wages.” All of Keynsianism relies on the “sticky” wages argument. And in this (very) short statement I was referring to this (mistaken) view. Take this article of Krugman, for example:
    http://krugman.blogs.nytimes.com/2012/06/24/revenge-of-the-optimum-currency-area/

    Keynes himself, by the way, has never disagreed with the notion that real wages have to fall for the labor market to clear. He just was not brave enough to tell the labor unions that nominal wages have to be reduced and thought they could be tricked into real wage reductions by inflation. Increasing “demand” by inflationary policies sounds much more acceptable, right. He also was an active advocate of devaluations for that reason (he could, however, just have had a financial interest, since I read he was long gold miners at the time and handsomely profitted when the US suspended convertibiltiy into Gold in the 30ies).
    Of course, nobody would admit not to be an intellectual coward which is why the brabble about naturally sticky wages and market failure comes in handily. Everyone knows that wages are not naturally “sticky”. I personally can give you lots of empirical examples, also in socialist Austria. Whenever they are sticky, like in the Euro periphery, it is due to government intervention, not market outcomes. I lived in Italy and could tell you horror stories.

    Devaluations do not help at all in restoring the trade balance which is why I think the theory of optimal currency areas is bogus. Only in the extreme, when nobody would lend cross-border (by nobody I also mean NOT the IMF) because of a rapidly eroding currency, would it hold in an indirect way (excluding remittances of foreign workers or other aid flows, since then you could have a negative trade balance despite the absence of cross border lending)

    Trade disbalances occur either naturally or as a consequence of distorted relative (!) prices which are, in turn, distorted by monetary policies. It is only the latter which is problematic. Whether devaluation reduces this imbalance depends on whether it has the effect of stopping said monetary distortions WITHOUT harming the natural effects (remittances a.s.o., seasonal variations). Has nothing to do with the “Marshall Learner condition” or what have you. These mechanics is also the reason why when yu try to measure it, it sometimes “holds” and sometimes it doesn’t as you would say. The ML condition is impossible to reliably measure ex-ante. Yes, sometimes cross-border lending slows down as a consequence of devaluation, sometimes it doesn’t. Cross border lending is a function of subjective risk appetities, not of demand elasticities: You can have any demand elasticity you want, if I do not lend you money, you cannot run a trade deficit.

    The Marshall-Lerner Condition, which is just a fancy way of comparing demand elasticities, is merely useful in describing something, not for theroretical understanding of phenomena. It just describes, after the fact, what happened. The symptoms, if you will. Might be useful from a historical perspective, but not for ex-ante statements.

    I am referring to prominent Keynesians, and have to admit I do not know the persons you cite. In best Austrian tradition I also do not distinguish between “Neo-classicals” and forms of Keynesianism. I use the term Keynesians for all non-micro founded economists, i.e. all Macro is Keynes for Austrians as they are methodologically identical (aggregates, logical positivists, empiricists).

    1. I can’t deal with all of that because much of it is statement of your opinions rather than a response to my comment but there are a lot of errors. Mainly stemming from confusing New Keynesians like Krugman from actual Keynesian economists. New Keynesians do use microfoundations (Krugman’s liquidity trap argument is microfounded, for example). Actual Keynesian reject microfoundations altogether.

      Also:

      “Keynes himself, by the way, has never disagreed with the notion that real wages have to fall for the labor market to clear.”

      I have no idea where you are getting this from. The whole of Chapter 19 of the General Theory argues to the contrary. It also argues that outside of a totalitarian system real wages will likely not fall even if labour accepted falling nominal wages. He writes quite explicitly and in no uncertain terms:

      “There is, therefore, no ground for the belief that a flexible wage policy is capable of maintaining a state of continuous full employment; — any more than for the belief than an open-market monetary policy is capable, unaided, of achieving this result. The economic system cannot be made self-adjusting along these lines.”

      https://www.marxists.org/reference/subject/economics/keynes/general-theory/ch19.htm

      Actual Keynesians do not recognise the ‘sticky wage’ argument as valid. They argue that even in a flexible wage regime the labour market would not clear unaided.

      1. Now, I am not sure I understand what you mean when you say I did not respond to your comment. Therefore I repeat:

        I agreed (and never said) that devaluation will lead to an improved trade balance. I tried to make my points with a few brief arguments and, importantly, without resorting to ML conditions and the like. Naturally I kept it brief and in no way laid out the full theory. This doesn’t mean there is no theory behind it and it is just “my opinion.”
        I made the original comment because out there there are people who believe that and I took Krugman’s article as an example.
        I also pointed out taking Krugman’s article that devaluations are considered beneficial by Keynesian (Macro) economists as they allow a quick adjustment in wages which they say cannot be achieved by market forces. All the newspapers in Europe are full with “economists” advising the ECB to devalue in one form or another (internal and external devaluations) – whose theory is this, if not Keynesian?
        This is the hallmark of Keynesianism old and new to my best knowledge. And it was with reference to this idea that I made the original comment – not because I believe it makes sense.

        So this should suffice to respond to your original comment.

        Further, in trying to clarify my position was briefly trying to lay out my issue with Keynesians, mainly by saying that I consider Macroeconomics bogus. And unit labor costs is a macro, not a micro, concept. And the founder of Macroeconomics was Mr. Keynes. You know very well that there is lots of theoretical critisism to non-micro founded economics. No need to repeat all that here. I think the critics are all right. Again, not just my opinion.

        Where do I take Keynes’s view from?

        Answer:

        From Hayek, who wrote about it in some of his papers. You can also watch this video below where he tells about conversations he had with Keynes and where he makes exactly this point.

        The whole episode is worth watching.
        Now you might say Hayek is a liar.
        This then would be just YOUR opinion.

        About your quote from the GT: this doesn’t mean we can conclude Hayek is wrong.
        After all, wasn’t it Keynes who said that when the circumstances change, he changes his mind? Hmmm…So we cannot take any of Keynes arguments in isolation, as he was actually proud of changing them as he saw fit. Right?
        Or can you prove that he didn’t change his mind afterwards?

        So to understand this quote, I think it is helpful to remember that Keynes was writing about a specific situation and he also was considering politically feasibility. Do not forget that the 30ies were a time of heavy market interventions and regulations. Might well be that Keynes political understanding made him think a free market order unachievable at the time. I think he might even have been right on that. Now, I might not think much of Keynes the economist, he certainly was a gifted political animal.

        Please note, that I do not say sticky wages do not exist in reality. This would be foolish amid heavy labor regulations and double digit unemployment rates in the periphery countries. I just say they do not exist in a free market, i.e. a market without unemployment benefits and labor union privileges as they exist in the European periphery. What do I mean with privileges? Now, it is possible in these countries for labor unions to kidnap the management (violence against body of property, ya know) of a company without anybody being prosecuted – happened in France see link.

        http://www.theguardian.com/world/2014/jan/06/french-workers-bosses-hostage-goodyear-amiens

        yeah, brutal capitalism that…

        I doubt that you and I would get away with this. Clearly, as long as the law is not applied equally to everybody one cannot speak of a free market. Period.

        Conclusion: in a free market, there are no sticky wages and no involuntary unemployment. This is not my opinion, it is based on micro-theory. all unemployment in the periphery would quickly disappear if you cut red tape and state benefits for idling and allowed companies to hire strike breakers. Ask yourself: why else is it, that the black market is booming in these countries?

        Because of a lack of “demand”? Does this make sense to you?

        Now, if I understand you correctly, you say that even under a flexible wage regime the labor market would not clear. And you New Keynesians have fully fledged micro-founded model with time preferences, budget contraints a.s.o. that shows this?
        In other words:
        A free market (free market in all factors of production not just labor) model, that needs constant government intervention? Is this correct?

        Never heard of anything like that.

      2. I just meant that your comment was rather long and tangential and so I didn’t feel the need to respond to every point. I would say the same for the above.

        So your source on Keynes’ views are Keynes’ rival’s opinions on Keynes’ views? Well, that’s fine. But you should probably be clear on that when you state it. I would imagine that most people would prefer primary source references. When I talk about the Austrian school I do tend to go to the primary sources. But that’s just me. 😉

  3. It is peculiar to me that debt overhang issues, both household and corporate do not loom large. What are the drivers of earnings growth? Lending ? To whom ? There is something called credit less recoveries also.
    It is also striking that the modes of failures of the banks in 2008Q4 – 2009Q1 have not been analyzed. The credit supply cutoff, from the liquidity crisis in 2008Q4 when Piraeus had a 135% loan/deposit ratio on an average of 120% for the baking sector, set off a deep recession (-3.x%) in 2009. The latter unraveled public finances and morphed into the disaster waiting to happen. Similar disasters had happened before from the Nordic crises to the Asian crises. In the Nordics drastic reshaping of the banks occurred, including their systems, managements and practices. The one that did not require bailout funds was Handelsbanken. That is also the one that keeps all board meetings minutes of their 140 years in a vault and managers learn from them. This I can understand as superior quality bank.
    Greece was heavily indebted, with a current account of -15%, high labor costs, loss of competitiveness, a puny export sector and a public administration structure in shambles, when the banking crisis hit. It had to support them now and on top lose growth, vital to make its debt serve payments. Greece got the two Irish crises, the one in the 1980s and the recent banking one, into one felt swoop. By the way, IMF programs never fail. They fail in derelict countries like Argentina. Is Greece the local Argentina?
    South Korea came out swinging and even Indonesia was better than before. Portugal was in better shape structurally than Greece when the global crisis hit because the IMF had fixed a few things y7ears before when it had imploded post revolution.
    The Greek banking sector was the least developed in the Eurozone and OECD EU pre-euro entry (read Patrick Honohan for a comparative analysis). Upon entry to the euro it just blew up from excessive credit growth, bad asset management (i.e. mutual funds, where the largest money market fund in the country collapsed in 2008Q4 and had to be supported because it was effectively short the Euribor-OIS spread via range accruals), and poor supervision. It had no risk management systems in place and no credit models. What has changed? They have been firefighting ever since.
    Greek banks were the worst failures with respect to assets, surpassing Ireland in required liquidity support. Thus, they get zero for management quality. It is all detailed in IMF Article IV surveillance reports since 2000.
    Ya think a foreign bank that knows this info (and other) won’t come in and clean house. Think again. And it will figure out the alpha drivers within the long used and abused local customer base.

  4. Well, Hayek who was an aquaintance of Keynes would be a primary source as well, don’t you think? You can never be sure when reading primary sources whether personal animosities are involved or not. It is the primary task of a historian separating facts from fiction. I do not find Hayek in any way malicious in the interview. Other personal accounts, for instance by Felix Sommary, are much more disadvantageous.
    And as I said, Keynes himself proudly said that he would change his views. If I were Keynesian I would have a hard time convincingly defending everything he once wrote because of that. But that’s just me. 

  5. On the previous post,

    P.S.: Piraeus had the worst capital ratio adjustment in the ECB/EBA stress test and had its ratio reduced by a whopping 3.7% from starting 2013 CET1 ratio of 13.7% to a 2013 ECB adjusted CET1 of 10%. So much for transparency. The best figures of true NPLs were Credit Agricole’s Emporiki (Commerce bank) local subsidiary, which it sold for 1 euro to Alpha bank after fully tanking it up with capital according to their NPLs of 33%. The Greek banks were showing at the time an average of 14% NPLs. That saved Alpha bank essentially.

    Also, the capital requirement numbers of the fully loaded CET1 adverse ratio should be noted for Greek banks in the EBA aggregate results. They are terrible. And the impact of the fully loaded CET1 adoption, which has Greece sticking out as a sore thumb, should be noted in the ECB aggregate results. Certain common sense assumptions are made for the rate of depletion of tax loss carry forwards (from the Greek debt restructuring or PSI) and for DTAs resulting from conversion of provisions to actual loss.

    Greece is the most delayed country in the EU in adoption of the CRD IV nad it will be a toip priority for the SSM, the single supervisor of bank in euro land to deal with this. According to calculations (in the ECB report) the number of years for Greek banks at projected profitability to take advantage of the tax carry forwards and DTAs-tax credits converted is off the charts.

    The law that converts DTAs to tax credits payable by Greek bonds was not accepted by EBA and ECB because it recreates the bank-sovereign adverse loop. This means that tax credits once created and left over from any tax use offsetting flows are payable in hard, cold cash and not in kind. This implies a fiscal burden and those funds that are earmarked as a buffer for bank recap needs, and which the Greek politicians want to use to get rid of the tight monitoring by the EC/ECB/IMF by claiming they do not need a precautionary credit line, are poof out of sight out of reach.

    Some of the references to excessive credit creation in Greece (aside from the IMF Article IVs) are:

    “Identifying excessive credit growth and leverage,” Alessi and Detken, ECB, 2014; “Liquidity Shocks and Asset Price Boom/Bust Cycles,” Adalid and Detken, ECB, 2007; ”Global Banks and International Shock Transmission: Evidence from The Crisis,” Cetorelli and Goldberg, Federal Reserve BNY, 2009.

    Aisen and Franken, “Bank Credit during the 2008 Financial Crisis: A Cross-Country Comparison,” 2010.

    The horrid state of the Greek banking sector on the eve of euro entry:
    Patrick Honohan, “Consequences for Greece and Portugal of the Opening-up of the European Banking Market,” 1997.
    IMF, “The Portuguese Banking System: Feeling its Pulse on the Eve of EMU,” October 9, 1998.
    Leaven and Levine, “Bank Governance, Regulation, and Risk Taking,” Journal of Financial Economics, 2009, which finds that Greek banks were the most unstable in the EU proper before euro entry.

  6. Alfred, agree with much of what you said, unfortunately David Einhorn doesn’t discuss managment at all – although supremely important, as you point out.
    Did not know about the Handelsbanken minutes you mention. Would be extremely interesting to parse through them and see how banking has changed over the years.
    Not sure, I agree about the effectiveness of IMF programes, though.

    1. Yes, Handelsbanken is an exceptional bank. Here is the intro from FT,
      http://www.ft.com/intl/cms/s/0/4f4d6894-5a82-11e2-b60e-00144feab49a.html?siteedition=intl#axzz2KKkjw2BQ
      If you chart it against the S&P, it has creamed the latter. It is up there with the top 5 Canadian banks (RBC, TD, BMO, BNS, CIBC).
      Other sources: Andrew Haldane, “A leaf being turned,” October, 2012.

      Jonung et al, “The Great Financial Crisis in Finland and Sweden: The Nordic Experience of Financial Liberalization”, 2009 (It has a section on corporate governance, whereby good banks exert stewardship and active ownership on Swedish corporations by seats on their boards. Particularly important for Greece as many debt loaded firms need mergers and operational restructuring.There is no point in debt restructuring without operational restructuring, which also entails debt to equity conversions and active ownership, If the banks have their own corporate governance problems, then this get transmitted down the already greasy line. Also, Greece was the last to liberalize haphazardly and without proper supervisory mechanisms in place its banking sector and it was coincidental with easy euro funding, thus all hell broke lose.)

      Lars Jonung (DG ECFIN), “The Swedish model for resolving the banking crisis of 1991-93. Seven reasons why it was successful,” 2009 (with a lot of lessons for Greece, and in fact when the Asian crisis erupted, countries from the region sent over reps to learn how to deal with debt overhang and business restructuring. Korea excelled as a student under the IMF program).

      Stefan Ingves (the current Swedish Central Banker and Technical Advisor to the ESRB prior, among other positions), “The management of the bank crisis – in retrospect.” 1996 (designed the program in Sweden, was head of the IMF program in Indonesia, where the crisis started as a banking crisis with a lot of similarities with Greece as the interbank wholesale markets froze and sparked a liquidity crisis and a fight for deposits that had bank funding costs skyrocket).

      IMF, “Indonesia: Anatomy of a Banking Crisis, Two Years of Living Dangerously 1997-99,” May 2001 (one of the key participants from IMF’s financial sector department or MCM headed the financial sector related IMF programs in Greece and Spain and averted the ridiculous attempt by Greco politicians to merge NBG with Eurobank and pile on further disaster on an unfolding disaster). Again, problems stemmed from clueless financial liberalization in an environ of nice, healthy corruption. 16 banks were in dire solvency straits, all politically connected to the Suharto family. The largest private bank, BCA, with 12% of the sector’s liabilities suffered massive runs by depositors. BCA had an asset side that was more sound and was eventually US Farallon Capital of SanFran bough a controlling stake in 2002. Farallon installed a Chairman and management members and made reforms during 4 years, selling in 2006. After the remake and sale, other institutional investors started looking at Indonesia, as the clean up of the largest bank created positive externalities. A far cry from the topical investment tactics discussed, where the uptick is a bet on a nebulousness comparative advantage.

  7. Alfred, will read some of your interesting links.
    What just worries me about HB now is the Swedish housing market which I consider to be in a bubble-surely that would affect HB as well, as least I do not see how it would not.

  8. Haldane rocks. He has other interesting pieces on how banks RoEs bunch together during a credit spree, more so than any other economic sector, as they herd together and take correlated exposures on both sides of the balance sheet, and have they give up all their gains as the credit boom turns do a bust.

    On the issue of BCA, it had a 17% loan/deposit ratio when the Farallon consortium bought the controlling stake. It brought in Deutche Bank personnel to train staff on risk management, credit assessment and operational processes. These were gaping weaknesses, as the bank was operating as a retail deposit taking unit on the liability and as Treasury unit of the Salim Group on the asset side, making money of government bonds. There was plenty of room to grow once turned into a real bank and once the economy stabilized and turned a leaf. The same operational and risk management weaknesses plague the Greek banks.

    The analysis does not take into account the Japanese lost decade effect, the result of balance-sheet distress, with large parts of the economy unable to spend thanks to excessive debt and the “extend and pretend” problematic loan bank practices. High debt was also the reason for the Great Depression. Thus, funds for targeted infrastructure development from the Eurozone are needed to improve general creditworthiness. BY infuriating the EU/ECB but not delivering on structural reforms, which will lift potential growth capacity of the economy anyway, the Greek government is shooting itself in the foot for the nth time. And of course infrastructure funds should not be delivered to the hands of the local oligarchs, who would extract a nice rent, but to proper monitoring and technical engineering groups. Vested interests have stakes in much of the press and TV outlets and exercise pressure. This is the reason that Greece has the most papers in circulation than any other country in Western EU but no objective news coverage. Take a look at “Greece’s Triangle of Power” by Reuters (http://www.reuters.com/article/2012/12/19/us-greece-media-idUSBRE8BG0CF20121219).

  9. agree: foreclosure, or extend and pretend by banks is the main reason economies such as Greece are not recovering. I hinted at that in my analysis by referring to creative destruction. Due to lack of time/space I did not write a full analysis of the topic – saved that for some future post.
    Do not think, however, that EU funds are the solution. I think honest accounting, more flexible markets are the way. Funds were never a problem in Japan, it nonetheless never recovered.

  10. will be interesting to see how the Australian Banks will deal with the looming recession. They are famed for thei high ROE due to concentration…I feel their high ROEs have more to do with the commodity credit bubble…

    1. Australian banks are in the top global Universal banks league along with Canadian banks (Universal banking includes banks with 3 main business lines: retail and commercial lending – including facilitating capital markets access for large corporation in the form of debt or equity issuance, asset management/insurance. It does not include large scale investment banking operations that form over 40% of profits, as some journalists mistakenly present vis-a-vis a simple S&L or Credit Union).

      Point well taken on the commodity issue. One has to look at their retail operations to analyze risks.

      Aussie banks have done some amazing things in customer-centric tech innovations and transformation of branches to a “consulting and servicing format” (like Umpqua and Commerce Bank in its heydays).

      DEFAULT or wild market premia (bonds, equity, liquidity) gyration risks of Greece: Not factored in Einhorn’s analysis.The Greek yellow media stoke the fire of lunatic fringe protest vote political groupings more than in any other EU country. Vested interests use the outlets to put breaks on structural reforms that affect them. If a fringe group, inflated by the vote of the discontented, disillusioned and unemployed throng, gets elected in 2015Q1, then a conflict with the EU/ECB/IMF will materialize.

      The role and practices of Greek media are accurately described in a 2006 cable from the US embassy in Athens, released by Wiki Leaks :
      https://wikileaks.org/cable/2006/07/06ATHENS1805.html

      The IMF has the largest rescue program exposure in its history in Greece. A conflict will jeopardize repayment and will annoy significantly its largest stakeholder.

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