My Response to David Einhorn’s comments (Part 1)

What a surprise: David Einhorn responds!

As some of you might have noticed, David Einhorn has commented on my post and responded to my arguments. This is a big surprise and I have no clue who told him about my blog. Needless to say, I feel flattered that my analysis aroused his interest. From what I can tell, he seems to have written it himself and, given that it is a lengthy two-part response, he must have put some time into it. Wow!

Although I had planned not write extensively about Piraeus bank again, since I have already spent quite some time on a stock I do not plan to own, David’s response compelled me to have another close look at the matter. To make a long story short: it is always a pleasure to engage in a discussion with a smart and dedicated opponent.

In order to make it easier to follow the arguments, I have copied in his comments and italicized them before responding. Comments which yield similar answers have been grouped together in order to save space. I have split the post into two parts.

David Einhorn:

  1. Greek Employment is improving. It was 28% in Sept 2013 and been flat or better every month since and is now below 26%
  2.  Greek GDP just did turn positive in Q3 (+1.7%). The 6 year recession appears to be over. While growth forecasts across Europe have disappointed, Greece has had a series of beats. Coming off such a depressed level, it is quite possible that there will be more beats in the future. But, like any forecast, time will tell.

Viennacapitalist (VC)

There is obviously no point disputing the numbers and I too have stated that I believe the Greek economy has gotten more competitive at the margin. Since we are grown-ups we are not going to discuss about GDP-forecasts. Just do not expect any miracles: Greece lives in an economically weak neighborhood (EU, Balkans and Middle East) something very few people talk about, but no less a real problem.

David Einhorn

  1. I never said that Greece’s high debt load is “not an issue”.

I would argue that it is much easier to have all your debt basically with a single entity. Particularly when you owe that entity so much that there is little to nothing that they can do but make it easier for you over time – or of course risk that you suddenly default on all of it and leave a giant black hole in the EFSF. You can see how this has already played out with the bailout loans already having reduced rates of interest and longer maturities applied. Plus in any event of default on public debt the ECB will obviously be involved, as like last time, as they own it too.

  1. Greece does not have a material budget deficit.


Ok, you did not say “not an issue,” but you fail to discuss the impact of the sovereign burden on the Greek economy – at least, that’s what I inferred from the absence of any slides on that topic. To be fair: I might well be you discussed it at the conference and did not put it into the slides.

The fact that the Greek government owes most of its debt to a single (non-economic) entity (actually it is a few supranationals that are involved here) certainly seems favorable at first, as they have an incentive to “pretend and extend” and make uneconomic loans just as you describe. And Piraeus bank through its cosy relationships with the Greek central bank certainly can profit from that – just look at the negative goodwill, which, if correctly booked, means taxpayers have handed over quite some assets. But once we factor in the second and third round effect the picture looks different: uneconomic loans enable the uneconomic structures to persist (think: Japan’s Zombie corporates) hampering “creative destruction!” Without creative destruction there cannot be growth, something which the whole developed world is being reminded of, after the bail-out orgies of the past few years. And economic growth is what you need for this investment to make sense in my view.

Loans by supranational organizations (IMF, EU) have historically provided local demagogues with a convenient scapegoat thereby increasing political tensions. Not for nothing will you find very few adherents of IMF programs in countries that have “enjoyed” these “uneconomic” loans. And this is not without substance: usually a few profit, whereas the rest suffers higher prices as these loans are inflationary at the margin. Objectively, the effect of debt programs on growth is questionable as well: there is empirical evidence that IMF programs have, ahem, a mixed record creating sustainable growth. Most fail. Bureaucrats rarely know where to invest. The same is true, by the way, for foreign aid (I very much recommend this book).

Indeed, Greece’s primary balance is forecast to be positive by the EU Commission – my primary reference mentioned in the post. Nothing to quibble about that. But I observe the political tensions are nevertheless growing between the troika and the government. This week’s Bloomberg article  hints at heavy fights behind the scenes about the true deficit figure (emphasis mine),

(…)Troika representatives are furious because the Greek government has failed to come up with any concrete measures to plug the fiscal gap since euro-area finance ministers warned earlier this month about a lack of progress in Greece meeting its commitments, one person said. With the government in Athens refusing to concede there is a funding hole, the standoff means Greece may miss a Dec. 8 deadline for agreement on the steps required to unlock the aid and what comes after it, both said (…)

Seems there is a gap after all. Well, if even they cannot agree on whether there is a deficit or not… 🙂

David Einhorn

  1.  You ask how the debt services is so low absent a restructuring. Here’s how:

Debt service is obviously a reflection of interest payments paid on the debt and he doesn’t seem to have thought about that – I never suggested the total debt amount was decreasing as it is not. Greek debt used to primarily GGB’s paying a market rate of interest back in a time where interest rates were not zero. Now the vast amount of the debt is borrowings owed to the EU and the IMF. Total debt is €320bn. Of that, €154bn is owed to the EFSF and the IMF as part of the second bailout. This carries no cash interest payments at all until the decade long grace period is over in 2022. The €53bn EU loan related to the first bailout pays interest at Euribor + 150bps, down from the original loan fee of Euribor + 400bps. In total Greece owes €245bn to the EU, ECB and IMF and pays cash interest on this of just over €2.5bn. They also pay zero interest on their €15bn of GTB’s (covered by ECB guarantee). The €30bn of restructured GGB’s pay 2% interest. All of this data is readily checkable on Bloomberg and the internet

You suggest 4.3% of GDP interest expenditure, which implies 8 billion of payments on 320 billion of debt, or 2.5%, yet we can see above that only a small portion of the debt carries and interest cost above that rate. I suspect the EU forecast may include accrued interest on the 154 billion bailout loans that are adding up during the grace period. Even this is questionable as the EFSF loan does not have a fixed rate of interest chargeable as far as I can see. In any case, I was referring to cash debt service costs, and I stand by my presentation.


Again, the 4.3% were NOT suggested by me, I took them from the EU Commission’s autumn forecast, as this seemed a natural way to start. I personally very much appreciate that you made your own calculation in a bottom up fashion. Still, given the complex and sometimes (deliberately) opaque nature of the bail-out deals it is easy to miss something.

I say this not because I have found your reasoning faulty, but because your slide (debt-service as % of GDP) puzzles me: How can your forecast for 2014 be substantially lower than your own 2013 figure? Your 2013, figure (4%), by the way, is perfectly in line with the EU Commission’s data. Why the divergence between your data and the EU data from 2014 onwards? Why this dramatic change from 2013 to 2014 in your OWN data? As far as I know there has been no dramatic new bailout benefit effective 2014 – the bulk of the restructurings took place in 2011/12. This is why the interest burden on your slide decreases substantially from 2011 (7%) to 4% in 2013 – fine! However, why there should be another substantial decrease from 2013 to 2014 I do not understand, but maybe there is an explanation  – the 250 bp. decrease on the EUR 53bn that you mention can’t account for that as this amounts to “only” 0.6% of GDP.

On the EU Budget figures: GDP accounting is usually a far cry from double entry bookkeeping and is mostly cash flow based which is exactly why it is so easy to fiddle with the numbers (ask GS). Even if the difference were due to accruals as you suggest, this still would not alter my conclusion that the debt load of the sovereign is still among the highest in the Euro zone: accrued interest increases the debt burden just as much and liquidity constraints for the sovereign are anyway not an issue with the ECB lending freely against Greek government bonds and even without collateral – think ELA.

David Einhorn

  1. We do not believe that the Greek banks we own have high direct sovereign exposures.


Agree! In my original posts I came up with EUR 3 bn. of direct sovereign exposure – not much. However, I was primarily referring to the indirect (growth and political) risks arising from the sovereign debt overhang, as described above and I believe they are important to the story.

Note, however, that the direct sovereign exposure could increase by another EUR 3 bn. if the DTA are converted into a loan to the sovereign, as is being planned by the periphery countries. Curious if this will be deficit increasing, clearly the sovereign debt would rise. This measure is necessary because under BASEL III DTAs will be deducted from capital and the Greek banks will need to come up with more – see discussion on Basel III in the second part of my response.

David Einhorn

  1. Regarding the issue of “moat”: I presented a thesis for 2017. I think it is extremely easy to suggest that there will not be any foreign banks in Greece again by then. And presumably if there are overseas banks that enter Greece, it is because the thesis has already worked very well. It’s hard to see why they would decide to allocate capital to Greece again unless the incumbents were earning outsized returns and they thought there was the opportunity to do the same.


Agree: in 2017 there will be little foreign banking activity in Greece. However, a moat is a long-term concept. Sustainability is important. A few years of outsized returns will not do much to your P/B multiple if they are perceived to be cyclical. In 2017 people better believe that the moat is permanent, otherwise no premium. Last time I checked, most commercial banks in the Euro zone traded at a discount to book value…

I have to concede, however, given that nowadays companies are rewarded by buying-back overvalued stock, it might well be that short-terminism has won out and such considerations do not matter anymore…

David Einhorn

  1.  Neither Dexia nor RBS were bailed out due to failures of their local banking franchises.

Dexia was a liquidity problem, where it lost wholesale financing and included massive Sovereign bond exposure to peripheral Europe into the peak of the crisis. It’s core Belgian operations have earned excess returns throughout.

RBS had its own problems (ABN deal, US real estate, over stretched balance sheet). It’s core UK business earned an ROE between 16-18% from 2004-2007 followed by 11% in 2008, and 3% in 2009, before returning to the teens in 2010. By 2012, with less competition, it hit 24% and was 30% in H1 2014.

We aren’t expecting anything that great in Greece, but it is illustrative of concentrated banking markets can yield excess returns, especially in a post-crisis recovery.


I know it is popular and best practice to distinguish between solvency and liquidity problems. However, I have found this distinction too fuzzy for practical purposes. Would Dexia have earned outsized returns if it had better matched its balance sheet? Probably not! Would the “business model” exist at all? Hard to know for outsiders. For a lot of these municipal finance companies (like Dexia) the “raison d’etre” was levering tiny spreads with maturity mismatches. Looks great as you need little (regulatory) equity and as long as the yield curve is steep. If there is a run, however, they fail that rapidly that not even the ECB can get together in time to save them – doesn’t sound like a good business to me. Certainly, the capital losses suffered by the shareholders during the bailout need to be deducted from the other banks’ ROEs if we want to talk about the “banking system” profitability of a specific country from a top-down perspective as you did in your presentation.

Now, I had to make myself familiar with RBS. For starters: RBS is a collection of different businesses and as a group its performance has been disappointing. Berenberg Research forecasts a negative (-1.1%) Return for 2015. In the table below (Berenberg research) you have all ROE figures per business segment.


I think your ROE refers to UK PBB with a return on tangible equity (ROTE) forecast of 32% – impressive, but just about 20% of RBSs business. What about the other segments, such as Commercial and CIB, the bulk of which is UK based? (About 1/3rd of their total exposure is ex UK according to the annual report). Returns are not that impressive, especially considering that we are still on the very nice side of the credit cycle. Why does the benefit of concentration not accrue to these segments? Is it, for example, because the international competition in these segments? I do not deny the existence of banking franchises, but the drivers of their performance have to be understood at the micro-level and such an analysis for the Greek banks I have not seen.

More importantly, and this is valid for your comment about Dexia’s core business as well: in my experience, it is very difficult to carve out the true performance of a segment of a complex banking group – much more difficult than for other businesses. Providing accurate figures is itself a very difficult task for multinational banks. Just take the RBS table above as an example and look at the horrible losses in what is labelled the “other” segment. Can you be sure that overhead costs have been properly allocated to the respective business segment? Or, could it be that the business line managers are lobbying internally to dump everything into that basket which doesn’t belong to anybody, so they can look good – politics not performance brings bonuses!

Now, it is the first time I look at RBS and I am no means an expert, but the fact that all clearly identifiable businesses perform nicely and, at the same time, the group is suffering losses doesn’t increase my confidence in their transfer price policy and their business line figures…

David Einhorn

  1.  We used 15% ROE in our estimates for a recovery. Other markets have done better. But, I won’t quibble over 14%. Should that be achieved, I don’t believe the Greek banks will trade anywhere near the current discounts to book value. for example, Komercni, the listed Czech bank, trades at 2x TBV for its 14% ROE.


Well, none of my arguments apply to Komercni: They are not in the Euro, which means if you are a foreign bank, you have additional currency risk. Plus, all non-Euro CEE countries have their own regulator and local regulations that can be very different from Basel II applicable across the Euro zone. These are all potential deterrents to would be entrants. It is much easier for the local regulator to refuse a banking license in the Czech Republic than for a regulator in the Euro zone – the ECB has no say in the Czech republic.

The macroeconomic (and indeed the historical and cultural) backdrop could not be more different from the situation in Greece:

For one, the Czechs have low government (48%) as well as low private debt (83%) which makes a (debt) growth story much more plausible. Second, they are a nation of savers which is why its loan-to-deposit ratio stands at fantastic 72% vs. 109% for Piraeus – a huge funding advantage. Last but not least: the Czech Republic is the most industrialized country in Europe, i.e. there are plenty of economically sound customers to choose from. This is not a coincidence, but a historically grown state of affairs: the southern and western part (Bohemia and Moravia) of the Czech Republic was the industrial “rust belt” of the Habsburg Empire – no such economic structures exist (or have ever existed) in Greece.

Conclusion:  the cost of capital for Czech banks is (and should) be lower than for Greek banks and its loan growth prospects better – Komercni deserves to trade at a significant premium to Piraeus. If you think Komercni’s TBV is justified, Piraeus should trade way lower (given 14% ROE).

In the next post I will respond to David’s second comment. Patience is required, as I am currently busy helping friends raise VC-money. I hope I will find time to post by the end of the week…


One comment

  1. Congratulations, well deserved, for having gotten the attention of David Einhorn and thank you for this most sophisticated debate. You know my own assessment of Piraeus Bank. In terms of sophistication, it is lightyears away from yours and, of course, David Einhorn’s. Instead, it is in reminiscence of what my bosses at one of the large American money center banks told me in my first year of training almost 45 years ago: “No matter how good the financials of your borrower, if you don’t have full confidence in the personal integrity of the people involved, stay away from them!”

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