The large Greek banks repeated what they have done successfully since 2003. They, spearheaded by the National Bank of Greece, met or even exceeded market expectations by delivering another set of strong financial results in the first half of 2005 on the back of strong revenues from retail banking in Greece and Southeast Europe and the containment of personnel and administrative costs. If analysts are right, the large Greek banks will continue to offer handsome profits to their shareholders in the next couple of years, likely propelling their shares to new highs. Still, this story is based on a couple of critical assumptions. First, consumer, mortgage and small business loans will continue to thrive even at a slower pace. Second, Greek households and businesses will continue to service most of their loans so there will be no need for the banks to take higher provisions for non-performing loans, thus hurting their earnings. These two assumptions may be sound at this point, but there are reasons to believe the risks are not immaterial. A first look at the first-half results of the five large banks shows that consumer and mortgage lending portfolios expanded in double digits year-on-year. With the economy growing at 3.5 percent in the first six months of the year, underpinned by a more than 3 percent real increase in consumer spending, it is normal to have consumer volume loan growth exceed 20 and even 30 percent year-on-year in the same period, especially given the relatively low penetration of household lending as a percentage of GDP in Greece vis-a-vis the eurozone and the EU-15. Moreover, the strong rise in mortgages reflected the low Greek penetration of such loans to GDP, specific tax factors which are expected to add to the cost of new houses from the start of 2006 and the demand for bigger apartments or houses by the average household. Since Greek GDP is expected to expand at range of 3 to 4 percent next year with investment spending seen contributing more to growth as public, private and FDI (Foreign Direct Investment) projects start getting implemented and consumption less on the back of a less generous incomes policy, a slowdown should be in the cards. This slowdown may become more pronounced in 2006 if the central bank makes good on a recent statement by its chief and imposes tougher lending standards, limiting all monthly loan installments by an individual to 30 percent of his monthly income. High spreads It is understood that the more pronounced the loan slowdown in these two lucrative loan categories, the greater the risk of a rise in competition which would put pressure on lending spreads. It is noted that Greek banks enjoy some of the highest spreads in the eurozone. Most analysts expect these spreads to converge to the European average over time, emphasizing the greater the competition, the faster the convergence. Of course, competition could heat up even if the loan volume slowdown turns out to be mild – assuming a major player, most likely a foreign bank, spoils the party and goes for bigger market share. However, there are a few, if any, who believe in this scenario, since it is rather unlikely that a rational bank would act this way. Of course, some of the large banks can count on their expanding franchises in neighboring countries to increasingly support buoyant retail loan growth and hefty spreads at a group level. National Bank of Greece, EFG Eurobank, Alpha Bank and Piraeus Bank belong to this category. Moreover, they try to supplement their growth strategies with cost containment programs, including new voluntary retirement schemes to cushion any adverse effect from revenues on their bottom line. But Greek banks have yet to experience both a period of economic malaise and a noticeable deterioration in the quality of their loan portfolio, so it is not clear how they will react and what the impact on their bottom line will be. With the exception of Emporiki Bank, which has launched a rights issue to strengthen its capital base, the other major banks appear well capitalized to absorb a medium-sized hit. They all try to lower the ratio of non-performing loans to total loans and increase or keep provisioning coverage high. Although the significant growth in mortgage loans appears to constitute no threat since most Greek households behave prudently and tend to go to extremes to service their mortgage loans and preserve their houses, this is not the case with consumer loans and some corporate loans. In the case of consumer loans, banks have taken steps to improve their credit scoring systems and recover loans in arrears. Although there is no official household survey lately to confirm or deny the notion that some households, especially in urban areas, are heavily indebted, it is likely that this is the case. This, coupled with the underdeveloped culture of borrowing among Greek households, poses a threat to the asset quality of bank loan portfolio. On the other hand, it is likely that the majority of Greek households are generally under-leveraged, having taken no personal or consumer loans. In addition to consumer loans, banks may have to up their provisions in coming quarters to cope with a material rise in non-performing corporate loans. This is partly due to the «recognition» of essentially bad loans, dating back a number of quarters or years, which the banks rolled over, betting the company will recover and start servicing them again. It is also due to improvements in the loan administration departments, which have spotted potential poor credits relatively early on in the process. Of course, the liquidity squeeze felt by other companies has compounded the problem. However, the squeeze may be due to temporary factors, such as the seasonality of sales or the inability of clients, including the Greek state, to make prompt payments for completed projects, such as those in the construction sector. The second half results confirmed what most analysts suspected all along. Most of the large Greek banks offer an attractive growth profile along with a compelling restructuring story in the case of National Bank. However, the likelihood of a slowdown in domestic consumer loan growth along with a rise in non-performing consumer and corporate loans next year highlights a couple of risks to earnings. They may turn out to be manageable but they should not be ignored.