Banks are a hot item
Barring listed Greek companies thought to be in the target list of various foreign private equity funds rumored to scan the local market for potential targets, Greek banks are the next hot item in town. Analysts working for well-known international investment banks have been competing over who is going to give the highest target price for Greek banking stocks, feeling confident that they will continue to deliver strong earnings going into 2008. But few, if any doubt, that the ECB (European Central Bank) will continue to gradually tighten monetary policy in the months and the quarters ahead, something the majority of analysts consider a minus for banks in general. Is this the case with Greek banks? We would not say so if the ECB rate hike stops at 2.75 percent this year. European Central Bank President Jean Claude Trichet indicated last week that a 25 basis point rate hike is likely in March, following a similar move in early December which brought the ECB’s official intervention rate to 2.25 percent. So, there is little doubt in the markets that the central bank of the eurozone will set it at 2.50 percent next month with more hikes in the quarters to come. The yield on the three-month Euribor futures contract due December 2006 eased to 3.09 percent on Friday from 3.15 percent a week earlier, showing market participants still bet, although more hesitantly, that the ECB’s official rate will be at 3.0 percent at the end of the year. It is noted that the futures contract settles to the three-month Euribor (the three-month interbank offered rate) which has been 15 basis points higher on average than the ECB’s official rate since the launch of the single European currency in 1999. It makes a great difference whether the ECB ups its key interest rate to 3.0 percent or 3.5 percent by the end of the year, especially to those who have taken floating rate loans rather than fixed rate loans as well as the financial institutions which rely on wholesale funding rather than their own deposit base to finance these loans and have large fixed coupon bond portfolios. Little impact Moreover, the level of interest rates is known to affect the demand for loans by households and corporations. In this context, a gradual increase in the ECB’s rate to 2.75 or 3.0 percent by the end of the year will have had a much lesser impact on loan demand than a bigger increase to 3.25 or 3.50 percent by year-end. This is the case especially in Greece where most mortgage loans are based on the ECB’s key rate, the three-month Euribor or the so called base loan rate set by local banks, a remnant of another era. A hike in the ECB’s key rate to 2.75 percent will have little impact on local retail loan demand but borrowers will start feeling the pinch if it went up to 3.0 percent or more. This despite the fact that Greek inflation is expected to average between 3.0 and 3.5 percent this year and GDP growth is seen between 3.4 and 3.8 percent which, theoretically speaking, sets the so-called neutral or break-even level of interest rates much higher between 6.4 percent and 7.3 percent for Greek borrowers. This contrasts with the eurozone, where the break-even interest rate, which leaves borrowers indifferent to taking out loans, is thought to be between 3.5 and 4.0 percent. So, assuming the ECB tightens in a gradual way to 2.75 by year-end, local demand for consumer and mortgage loans is not expected to be materially affected. This is important because most Greek banks work with higher margins than in the EU and a more severe than anticipated slowdown in loan growth would have led to increased competition among banks and a faster erosion in spreads, hitting their earnings. In addition, Greek banks may see their earnings being boosted under such a mild interest rate scenario, especially the National Bank of Greece, the Agricultural Bank and the Postal Savings Bank, because of their relatively low loan to deposit ratio, accounting between 70 and 80 percent in the case of National Bank. But their loan base is not just large. It is also relatively cheap, a characteristic shared by other large banks with a much larger loan to deposit ratio. This low cost of funding, the result of current and saving accounts accounting for a great deal of their total deposit base, makes them more vulnerable to rising interbank interest rates. Vulnerability The fact that most of them are well capitalized with core Tier I above 7.5 percent gives them a great deal of flexibility as well. A look also at the maturity structure of their balance sheet shows that interest rate exposure is skewed towards the short-run, meaning they are able to reprice a significant portion of their assets and liabilities in a period of less than three months. This in turn translates into their net interest income being sensitive to interest rate increases. Assuming that most of them have at least partially hedged their fixed bond portfolios against further increases in the euro interest rates, it makes them less vulnerable to the ECB’s tightening cycle, whatever shape this may take. The fact that local banks have reduced the size of their bond and stock market portfolios in the previous years adds more credence to our assumption. All-in-all, most large Greek banks may even end up gaining from the expected ECB rate hikes, further boosting their investment story contrary to what many people may have expected. The only threat to their story from the ECB may come only from sizeable interest rate hikes with the potential of hitting hard domestic credit growth. But this is not the most likely scenario given late economic developments, such as a drop in the French industrial production, in large eurozone countries.
