|Shares Out. (in M):||1,544||P/E||0||0|
|Market Cap (in $M):||3,258||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
What if I told you, you could buy a bank at 0.37 tangible book with 17.2% fully loaded CET1, leverage ratio of 13.5% and price to pre-provision income of 2.7? Sounds great, right? You would be less excited if I told you it is a Greek bank. But things are changing.
Investing in distressed Greek banks is not new. Many well-known investors like current Secretary of Commerce Wilbur Ross or John Paulson or David Einhorn invested in various Greek banks 2-3 years ago. They got burned really badly! Their investing thesis had only one flaw - they were too early. They have underestimated severity of Greek economic woes and political instability which resulted in and caused further economic problems. Now, 3 years later, Greek banks have sufficient capital, CET1 is at the highest rate in recent history, deposits have started to grow, NPLs to fall; Greece has done additional restructuring and is finally poised to a secular growth.
Investing in distressed securities, especially banks is always a risky business so allocation size should be set accordingly.
It is impossible to consider investing in Greek banks without some insight into the macro environment.
With 27 percent drop and 10 years long depression Greek economy probably set some kind of a record. You won’t find many peacetime drops of this magnitude, for sure. As NYT headline said “Seen from Greece, Great depression looks good”. Greek unemployment reached 28%, with youth unemployment hitting 60 percent. With its own currency, rebalancing would have gone much smoother and less painful but that water is under the bridge now. Sunk costs are too big at this point. 2010 or even 2013 was the time to leave euro but now, after all the suffering, it doesn’t have much sense any more. The Greeks have managed to rebalance their economy in a big way. The average and minimal salaries are about a quarter below their pre-crisis levels while enormous current account deficits (15% in 2007 and 2008) have all but disappeared. The Greeks are finally living within their means.
Real estate prices are recovering form their 40% drop since 2009, while the unemployment rate has dropped to 21.7%. With the total contribution to GDP close to 20%, tourism is extremely important to for the prosperity of Greece. All evidence suggest that this is going to be a record tourist season so unemployment rate is expected to continue to decrease.
Increased competitiveness of Greek workforce toward Germany didn’t lead to higher exports so far. That shouldn’t come as a surprise. There is always a time lag. In the first phase it’s the imports that fall and subsequently, after some investing, exports pick up. Only recently, after nearly a decade of negative growth, Greek fixed capital formation turned positive. The only issue that still prevails is a large government debt, close to 180% of GDP. Even on that front the Greeks have made a tremendous progress. In 2016 they managed to produce fat primary surplus of 3.9%( IMF: 4.2%), far above targets set by the creditors. It remains to be seen whether this will be enough to avoid new austerity measures. But imposing new austerity measures shall certainly not result in as disastrous outcome as it did before. More balanced and competitive, economy should be more resilient to similar shocks.
Greek banking sector
This is mostly a macro story and improved macro environment is going to lift all banking boats. I have chosen Alpha Bank since it has somewhat protected downside with the highest level of regulatory required capital and the high level of total coverage, yet it is still quite cheap on P/TBV basis. In the most optimistic scenario for the Greek economy, Piraeus shares should probably perform the best but if things don’t go as planned it would be the weakest link among Greek banks. Alpha Bank is one of the 4 Greek banks that control roughly 95% of the total banking market. The concentration of Greek banking industry is a direct result of financial and economic crisis which hit that country badly. Prior to the crisis 4 largest banks: Alpha, Piraeus, National Bank of Greece and Eurobank Ergasias held about 65% of the Greek market but after the wave of consolidation, Greece banking sector has become the most concentrated in the Eurozone. Greek banking industry is a textbook example of oligopoly (which comes from Ancient Greek ὀλίγος and πωλεῖν).Needless to say, such a large concentration implies better NIMs, ROAs and ROEs, other things being equal.
Furthermore, Greek banking industry has become very efficient. Numerous branches have been closed and a large number of employees has been laid off. In 2008, there were 4098 branches of domestic institutions with 66 thousand employees which fell to 2332 branches and 43 thousand banking employees in 2016. Reduced operating expenses over the past few years has made Greek banking one of the most efficient in the EU on the cost/income basis as the picture below shows.
NPEs represent the most significant challenge for Greek banking system and a big drag to Greek economy. Greek banks entered the crisis with total outstanding number of NPEs of €14.5 billion which has ballooned to €108 billion or 45% of total exposure. To settle this burdening issue there are currently a number of initiatives which are aiming to remove impediments for NPEs resolution. Greek authorities have recently passed several important legislations related to this matter. For instance, as a result of activist groups that are on a daily basis opposing foreclosures and interrupting proceedings as well as abusing notaries, only few hundred auctions have gone ahead out of thousands planned last year. To avoid further obstruction from anti-eviction groups in courthouses, the property auctions are going to be carried out on line from September this year. Also, out of court settlement of business debt has been approved by the parliament. Those legal changes should speed things up considerably.
In cooperation with the Bank of Greece and SSM, operational targets have been set to reduce NPLs and NPEs in a three years period. They plan to reduce the NPLs approximately by half until the December of 2019.
Alpha Bank holds about 22% of all Greek deposits and a quarter of all the loans. It is the fourth largest bank in terms of assets and deposits in Greece. Alpha is the bank with the largest tangible book value, it is best capitalized under Basel 3 rules, has the highest pre-provision income and the second highest level of private ownership. There are 1.5 billion shares of which 11% are owned by special purpose vehicle created to stabilize Greek banking sector, HFSF. They issued warrants with the rights to purchase shares from HFSF but being deep out of the money (strike price is going to be € 27.72 on the next exercise in December) they are worthless now. Alpha doesn’t have preferred shares or convertible bonds at this point.
Alpha has 692 branches of which 505 are in Greece and the rest in Cyprus, Romania and Albania. They were also present in other neighboring countries but sold the subsidiaries off with Serbian subsidiary being the latest disinvestment earlier this year. While they were pulling off from South Eastern European market, they increased their presence in Greece by acquiring Emporiki Bank S.A. from Credit Agricole followed by acquisition of Citibank’s Greek Retail Operations. The bank significantly improved its operating efficiency over the past few years. Since 2013, the workforce has been decreased by 5 thousand and number of branches by approx. 400, representing a decrease of 25% each. Combined with freezed or cut wages, cost to income has dropped nearly 20 pps to 46% making Alpha Bank best in class in operating efficiency. As of Q1 this year Alpha has €64 billion in assets of which €44 billion are in net loans. 43% of loans are medium and large business loans, 34% are mortgages, 11% are SBL and the rest are consumer and credit card loans. The largest part of loan portfolio, wholesale is split between industry (23%), trade (21%), construction (16%), and real estate (8%), tourism (8%), shipping (6%) and others.
Despite being the smallest among the 4 systemic banks it has been the leader in the revenue generation and profits before provisions for loan losses. TTM PPI is €1.2 billion, head and shoulders above the peers. It is a result of high net interest margin (3%) and the lowest cost to income ratio.
As with the case of other Greek banks, Alpha has a considerable non-performing exposure. Current NPE is €32 billion and more than half is in the business segment. NPLs stood at €23 billion at the end of Q1. The most problematic loans are SBL and consumer loans where NPL ratios are 76.2% and 42.1%, respectively, far above the average NPL ratio of 38.1%. A good thing is that from the current levels they can go only down which has already started to happen. Alpha SSM targets are in line with system targets announced by the Bank of Greece. Respective targets for Alpha are 36% reduction of NPEs and 48% of NPLs until the end of 2019. These targets are based on 1.5% GDP growth in 2017 and 2% growth in 2018. The management did not provide the precise trajectory of NPL/NPE reduction but on the last quarter’s conference call Alpha Bank Deputy CEO Artemis C. Theodoridis has said “I can tell you that the plan that we have submitted and agreed is lighter on the first couple of quarters and heavier towards the last couple of quarters of the year. And also, a lot heavier towards 2018 and 2019.” He also stressed that for significant improvement legal changes should have to take place but so far they didn’t. He was referring to electronic auctions that have become a law of the land and they expect tangible improvements in the 4th quarter this year when electronic auctions become a common practice.
2017 should represent an inflection point in terms of NPEs. Q1 was the first quarter when NPE formation turned negative. NPLs have already declined in 2016 but now they are declining at twice that rate.
The NPLs and NPE are very high but total coverage ratio, which includes provisions and collateral, stands at 124% for NPLs and 105% for NPEs (which is the reason I prefer Alpha over Piraeus). Given the high LLP level (15.9 billion euros) there is a good chance that in the next few years a part of reserves is going to be released and added to the tangible book value.
Even before the crisis loans to deposit ratio was very high. During the never ending depression it got even higher due to: a) collapse of disposable income and huge unemployment due to which Greeks had to eat up their savings and b) financial panics. The deposits have been falling at the rapid rate in two periods across the board: a) from 2009-2012 and b) 2015. Alpha’s deposits reached the bottom in 1Q 2016 at 31 billion, a fall of nearly 30% in a bit more than a year. But things are changing for the better as of late. They have been on a steady rise since 1Q 2016. Higher level of deposits should improve margins given the fact that the funding gap has been bridged with more expensive Eurosystem funding sources. The deposits should continue to grow with the help of improved macro conditions and decreased risk of a new default. There was a slight decrease earlier this year due to delays in the 2nd review but after successful completion of the review, deposits continue to rise.
With FLB3 CET1 of 17.2% Alpha Bank is the best capitalized bank in Greece. Also, it has by far the smallest percentage of DTA among the Greek banks.
What could go wrong?
The typical explanation for such a low price is uncertainty related to the bailout program. I find it strange that 3 years ago people were willing to invest at more than a double of the current P/TBV multiple. So many investors have been burned over the last decade during which the market became overly cautious when it comes to Greek banking shares. But depressions don’t last forever. Also,3 extra years have considerably improved chances for exiting depression and starting long run growth.
The biggest risk is a new default and the repetition of 2015. Many US investors have invested in the Greek banks in 2014 and 2015 under the impression that the worst for Greece is over but the political unrest, new left-wing government, bailout referendum, default, risk of leaving the Eurozone, the bank runs and the capital shortfall led to huge losses for them. I believe that market fears about repetition of 2015 are exaggerated. Currently, banks are sufficiently capitalized and frankly how much more austerity measures Greece could take or creditors could demand? Many reforms had already been taken; fiscally it is one of the most frugal countries in the world right now. The largest reform than will be carried out going forward are going to be pension cuts. Pensions are expected to fall on average of 12%.When ongoing bailout program ends in summer 2018 there is a possibility of fourth bailout but I think there is only a small chance that jitters from it will be nearly as bad as in 2015. Firstly, Syriza which won election on anti-austerity policies embraced austerity measures almost identical to those adopted by previous governments. The anti-systemic rebels are now part of the system and there is no new force in sight that can cause mayhem of the previous magnitude. So whatever happens at the end of current bailout program should go smoother than the last time. Besides, completion of the 2nd review and Greece recent issue of 5 year bonds are certainly a signs of stabilization.
Second risk is related to the banking industry specifically. If in the forthcoming quarters banks don’t show improvement in reducing NPLs, it could trigger regulator’s reaction for a new wave of recapitalization since high level of NPLs undermine capacity of banks to lend and that way represent an obstacle in effort for economic recovery. So far, there have been Greek banks that have done a better job reducing NPLs than Alpha. Most notably National Bank of Greece which is the bank with best metrics but it is also more expensive. But it is still too early in the game. The management of the Alpha bank is confident it will meet its targets.
Alpha bank operates in one of the least competitive environments for banks in the world. When the dust finally settles, 15% ROE should be the standard for the Greek banking industry and Alpha has proven itself as the leader of the group so far in terms of profitability. I expect this to happen over the next five years. Right now, large US banks are trading at 1.4 to 1.8 to tangible book. There is no reason not to see Greek banks at those multiples in a few years. During that period cost of risk should considerably fall, making Alpha more profitable which should, in turn, further increase its tangible book. Even €5.7 in TBV per share vs. current price of 2 euros looks attractive. Add some released reserves and 5 years of cumulative core earnings and it will look even better. And that doesn’t even count in the premium to the book value.
Alpha Bank has all characteristics of a great business: high industry concentration, high barriers to entry, low and declining operating costs and increasingly favourable legislative framework. It is only political instability that casts a shadow over Greek banking industry, worrying shareholders as well as savers. But all the back and forth play between Greek government and Eurogroup ( i.e. Germany) is in my opinion just a posturing, at this point. No one can afford a new default now, and least of all the Greek government. They are ready to sign almost ANYTHING now and Euro ministers are ready to except signed reforms that will take place in a few years.
After 7 lean years Greece is at the dawn of economic recovery of which the banking industry is going to be the greatest beneficiary.
Record breaking tourist season, falling unemployment rates, positive GDP results
Successful completion of the third bailout program
Inclusion of Greek bonds in ECB buying program