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Run with the wind

18 November 2013 By Hugo Dixon

Greece has been the markets’ whipping boy for most of the past four years. But in the last few months, sentiment has changed and international investors are bottom-fishing – in particular for banking assets.

This gives the country a double opportunity: lenders can use it to clean up their balance sheets by selling non-performing loans; and the state can privatise its stakes in the banks. Both should grab the chance while it lasts.

Greece’s banks have been in a terrible mess as a result of the crisis. Not only were they loaded up with government bonds, which got haircut; even the big four that survived are weighed down by about 65 billion euros of non-performing loans, equivalent to around a third of GDP.

But a 40 billion-euro recapitalisation and restructuring of the sector, financed mainly by bailout money, has helped change investor perceptions. Several hedge funds – including Paulson & Co – have invested in the banks.

Last month Piraeus Bank placed 494 million euros of its shares and warrants with investors after BCP, the Portuguese lender, decided to sell out. Meanwhile, investors are heading to Athens looking to buy packages of non-performing loans on the cheap.

Investors believe Greece is close to turning the corner after years of recession. There are also few opportunities for high returns in the rest of the world, given that the love affair with emerging markets has soured. This is why Athens now has an excellent chance to clean up its banks and privatise them.

Although the banks have been recapitalised, their non-performing loans are clogging up both their balance sheets and the economy. Zombie companies, which have borrowed too much, are dying a slow death. Even healthy companies struggle to get credit because the banks are preoccupied with managing their existing bad loans.

The classic answer to this problem – adopted recently in both Spain and Ireland – is to create a “bad” bank. Non-performing loans are sold to a separate institution at a discount. The bad bank then restructures the loans. In an ideal world, it divides the sheep from the goats: companies with viable business models but excessive debt get their borrowings cut, maybe by converting them into equity; those that aren’t get liquidated. Meanwhile, the good banks focus on lending to both healthy businesses and restructured ones.

Creating a bad bank may be part of the answer for Greece. But the investor interest means there are other options. One is for the banks to sell packages of loans to vulture funds. A second is to set up special purpose vehicles with investors, allowing the banks to share in any upside. A third is for the Hellenic Financial Stability Fund (HFSF), the organisation established to manage the state’s stakes in the banks, to create a bad bank and get international investors to provide most of the equity funding for it.

One problem is that the banks would have to sell their bad loans at a deep discount to face value – perhaps at only a quarter of it, according to various guesstimates doing the rounds in Athens. Given that they have only taken provisions for about half face value, they would have to take further big writedowns of maybe 15 billion euros or more.

This, in turn, raises the question of where they will get the capital. There are two main answers: get another capital injection from the HFSF, which still has an unused pot of 11.3 billion euros; or sell shares in the market, the route chosen by Eurobank, which plans to issue 2 billion euros of stock early next year.

Meanwhile, Athens should crack on with selling its stakes in the big four banks – Alpha Bank, Eurobank, National Bank of Greece and Piraeus – the value of which is now over 20 billion euros.

This would have two benefits. First, it would increase the free float, allowing the banks to operate as commercial institutions with international shareholders. This would be an improvement on the bad old days when they were controlled by a coterie of local business interests.

Second, the funds from privatisation could close the funding gap in Athens’ bailout programme, which the International Monetary Fund puts at 10.9 billion euros. At the moment, there is no plan for how to fill this hole, which will emerge in the middle of next year, and Greece’s European partners are reluctant to lend it more money.

It would be better if Athens raised the money itself, as it would then gain credibility with its lenders who have been berating it for the slow progress it has made privatising assets. Instead of being seen as a laggard, it would exceed expectations – reinforcing the view that it was turning the corner.

Before Greece can privatise its banks, it needs to neutralise some warrants outside investors received when they bought shares earlier in the year. This is because it would be foolish to sell its bank stakes only to find it has to buy them back at an exorbitant price if and when the warrants are exercised. But this is something a bit of corporate finance ingenuity could solve.

Greece knows a lot about vicious cycles. Athens and its international rescuers should capitalise on optimistic market sentiment while it lasts to give a positive twist to what could hopefully become a virtuous one.


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