Strange to be pitching the idea of buying European banks in general. One of my more famous or infamous pieces was my SOM that argued for shorting European banks back in summer of 2011. That pitch got me on the front page of the WSJ (not a great experience btw). However, the core of my framework then and is now is to pick the best long or short. I believe the case for buying European banks is a compelling one, just as the case was for shorting them at the beginning of the crisis. European growth is accelerating, imbalances in the GIIPS and banks have been addressed, while the NPLs cycle is likely over. So, the asymmetry looks compelling. Basically, normalization means upside for European banks and European equities in general. My pitch for buying Greek banks and GGBs is an extension of this theme. (the figures in this commentary are from my SOM piece that can be viewed by subscribers on my web site, www.SOMMACRO.com)
My fundamental economic framework for Greece is at the core of my trade strategy. Greece was Europe’s subprime problem. Greek’s economic growth shot up after they joined the EMU driven up by access to external credit that supported a bubble in internal credit. Credit dried up in the aftermath of the election 2009. The Greek economy implodes and NPLs shoot up. For Greece that means their economy has gone through a “Great Depression” scenario. Driven by the EU/IMF reform programs, Greece closed its many imbalances (see graph below).
Now against a backdrop of accelerating growth in the EMU particularly from Germany, the Greek economy appears to be stabilizing at levels last seen before their entry into the EMU, while the NPL cycle seems to have crested.
Further after two reform programs, Greece is now close to getting a third program that if the IMF gets its way this program could finally mean debt relief. This the point of the discussions today between the EU and IMF. This is the catalyst for GGBs yields to converge to other GIIPs yields.
Now back to the Greek banks. This strategy is based on a similar pitch I used aa few years ago for regional US banks that had large NPL problems. The idea then as it is now is that economic growth stops the NPL creation cycle that in turn increases earning by reducing provisions. Then loan loss reserves get turned into real capital as actually losses are substantially less than assumed losses. Both factors would drive up bank valuations from trough levels. Yes, Greek bank NPLs are large on percentage basis at over 35% of loans. However, so to is their loan loss reserve. So, if the NPL cycle has stopped, Greek bank valuations should appreciate as the power of their underlying earnings engines emerge as provisioning ebbs. Also, their large loan loss reserves should be more than sufficient to deal with write downs still leaving extra for excess capital to be given back to investors (see figure below). BTW this is same idea for buying Italian banks as well.
So, don’t be put off by the recent rally in GGBs and banks, still much more left to go.
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