Greece and Banks
David R. Kotok
May 23, 2012
“Europe’s banks, sitting on $1.19 trillion of debt to Spain, Portugal, Italy and Ireland, are facing a wave of losses if Greece abandons the euro. While lenders have increased capital buffers, written down Greek bonds and used central-bank loans to help refinance units in southern Europe, they remain vulnerable to the contagion that might follow a withdrawal, investors say. Even with more than two years of preparation, banks still are at risk of deposit flight and rising defaults in other indebted euro nations.” Bloomberg, May 23, 2012
Susan B. asked: “Do you not think most banks are already prepared for more Greek downside?”
Oh, Susan the question is a good one but to answer we need to ask another question for clarification. Which banks are you talking about?
1. Small and mid-sized Community banks in the United States?
Answer: no exposure to Greece. If they have any, their board members need to fire the president and send him to a psychiatrist.
2. Larger regional banks in the United States?
Answer: some may have a little exposure to Greece because of portfolio diversification that includes the Eurozone or because of trade financing with certain customers who are Greek-connected. US regional bank exposure directly to Greece is quite small. Indirect exposure may be bigger if contagion occurs. We own the regional banks and do not anticipate any negative issues in that subsector. We use the ETF whose symbol is KRE.
3. The very large US banks (the big 6)?
Answer: there is definite exposure to Greece but it is manageable. The large US banks have had several years to structure themselves to address this developing risk. The amount of hedging and the defensiveness needed are now in question because of the Jamie Dimon revelations. Markets have marked down the value of the large US banks as if there is going to be another systemic shock. We think this is over done. We are scaling into the large US banks. We will not name the ETF selections until the trading is complete. There are many ways to structure a rebalancing into ETFS and the financial sector. The ETF space is filled with options. The combination of them makes the portfolio selection challenging and opportunistic. See our new book “From Bear to Bull with ETFS” for how financial ETFs work in bull and bear markets. Links to all book vendors (e-book or paperback) are found in the flyer on the Cumberland website, www.cumber.com .
4. Larger banks in non-periphery countries in Europe and particularly in the euro zone?
This is murky which is why the market has re-priced these bank shares to the downside. They definitely have direct exposure although they have been adjusting it lower at every opportunity. French, German, Dutch and Finnish banks can manage this risk. A Greek exit from the Eurozone or a Greek default beyond what has already occurred will definitely cause them to take more losses and to mark down the present value of assets. We do not own them except where they are a part of a broader ETF. We are underweight Europe and only deployed in northern European countries. It is too soon to buy in this sector.
5. Banks in troubled periphery countries like Spain, Ireland, Portugal and Italy?
These banks are bleeding deposits and under stress. The best indicator of this stress is the credit spreads on sovereign debt of each country compared to the benchmark German “bund.” We post these spreads weekly on our website, www.cumber.com . The worse the country condition, the more the runs on the country’s banks accelerates. These banks are not sufficiently prepared. They cannot recapitalize themselves. They have lost the needed market access at a reasonable cost. They must have official intervention or the condition will worsen.
6. Banks in Greece?
Answer: private Greek bank ownership is dead. The banking sector is preserved ONLY because of the ELA. This is the Emergency Liquidity Assistance program that is administered by the central bank of Greece, not the European Central Bank. The ECB has passed this baton to the Bank of Greece for complex reasons having to do with the structure of central banking in Europe and with the strength of ECB claims in the event of a Greek government default or repudiation. Were it not for the ELA, banks in Greece would be failing like a sequence of falling dominoes. Without ELA, they would run out of cash. Anyone who can is moving his or her money out of Greece. Tens of billions of euro deposits have shifted to other places in Europe.
Susan, we are watching a contagion and banking crisis unfold in slower motion (the last few years). The speed is now accelerating. The longer it takes to resolution, the worse it will be for Greece, for the periphery and for Europe. We expect the ECB to move in very large size and inject another round of liquidity in order to try to maintain the weakening fence around Greece. Will they be able to insulate Italy or Spain? That is not clear and longer they wait, the harder it will be. Is Portugal the next Greece? We do not know but the markets have widened spreads so it seems that the market vigilantes are saying Portugal is next.
7. What is an investor to do?
If you think the contagion will spread around the world, sit in cash. Make that cash the US dollar, if you are American-based.
If you believe as I do, that there will be no global contagion, buy the US financials. We are overweight and scaling up using ETFs. Susan, for ten bucks, you can buy my e-book at the Kindle Store on Amazon.com. Read the appendix list of ETFs and the chapter on financials. Any profits from the book will go to the Global Interdependence Center, an organization holding a central banking, Europe-focused discussion in Poland this week.
Thank you, Susan, for asking the question. Stay safe and good luck.
David R. Kotok, Chairman and Chief Investment Officer