Prospects of Local Lenders in Greece - The Best from Greece

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Posted on: 10/Nov/2009

Greek banks retain luster as efforts turn to cost efficiency
Lenders will see boost to bottom line after spike in nonperforming loans

The 2003-2007 growth story of banks in Greece and Southeastern Europe may be over but the prospects of local lenders are not poor, as reflected in increasing stock prices on the Athens bourse.

Burgeoning growth in Greece and Southeastern Europe helped local bank stocks outperform most of their eurozone peers during the period from 2003-2007 but turned out to be a big burden in 2008 when the credit crisis turned into a global economic recession. With most economists forecasting another year of recession or anemic growth at best for Greece, the prospects of local banks look poor. Is this the case? Don't bet on it.

Credit institutions relied on high credit growth rates in Greece and in neighboring countries underpinned by strong economic growth to see their profits skyrocket during the period from 2003-2007 and even in 2008.

They did not hesitate to advertise this growth to institutional investors in Europe, the USA and even Asia who were hungry for higher returns, attracting billions of euros in new investments which helped to propel their stocks to all-time highs. This, in return, generated millions of euros in bonuses for executives and middle to upper management, providing incentives for less prudent lending practices in mortgages, consumer loans and credit cards, in some cases.

The collapse of Lehman Brothers helped to undermine confidence among credit institutions and froze interbank and capital markets, creating a liquidity crunch that hit Greek shores in the second half of September 2008. With the help of the European Central Bank (ECB) and the state, local banks were able to overcome the liquidity scare in a few months' time. However, it took many more months to heal the wounds of high interest rate time deposits which, combined with a significant slowdown in loan volumes, hurt their profits. This deceleration in loan volume growth continues, compressing their interest and commission revenues while the number of households and companies that fail to pay their installments after 90 days continues to rise, albeit at a decreasing rate. This has forced banks to set aside more money for provisions against doubtful loans, which is hurting their earnings while investment and loan writeoffs keep on eating into their rich capital ratios. Banks are generally considered a so-called cyclical play but the prospects for economic growth for Greece and neighboring countries, with the exception of Turkey, do not look good next year. This is particularly so after the election of a socialist government which seems determined to deprive them of some of their sources of easy money. So it is reasonable to wonder whether local banks have lost their luster.

The answer should be a resounding «no» although there are reasons for many to be concerned. There is no doubt that nonperforming loans should continue to rise in the next few quarters, peaking in the second or the third quarter of 2010, and forcing banks to set more provisions aside. Also, one should not expect any significant boost in revenues from a mild pickup in lending in 2010, which means the old growth story will not be a factor next year. However, there are some positives. Greek banks now pay greater attention to cost efficiency than before and should be expected to continue to do so in the next couple of years, bringing expenditures under control. The likely rise in the ECB's main refinancing rates will make it more imperative to borrow at higher rates on world markets, making their cost of funding more expensive. On the other hand, banks have managed to increase the spreads they charge in their loan books, which makes them less vulnerable to the anticipated increase in the official euro interest rates.

Nevertheless, the biggest advantage for local banks in late 2010 and 2011 will be what is their main weakness today, namely their high provisions. Once nonperforming loans as a percentage of total loans begin decreasing, banks will be able to reduce their cost of risk, that is, their provisions as a percentage of total loans. Even if provisions for bad loans come down to higher levels than seen in good old 2007, this will unleash hundreds of millions of euros in profits. The latter explains to a large extent the outperformance of their stocks since early March and helps to limit their downside potential in a likely stock market correction. All in all, the smaller provision story by Greek banks holds the promise of being the catalyst for their stocks in the next year or two, just like the previous growth story before the international financial crisis. Of course, this assumes that Greece and its neighboring economies do not fall into any protracted recession in 2010-2011.



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