ECONOMY

The effects of the US subprime mortgage crisis on local banks

Greek bankers and government officials are proud to proclaim that local banks have negligible exposure to the US subprime market. They are right. This does not mean though they do not feel the pinch from the strain on financial markets emanating from the subprime debacle. This is more so for the smaller banks which are bound to come under more pressure as liquidity becomes more valuable. Ever since National Bank sold its subsidiary Atlantic Bank of New York, the presence of Greek banks in the large but distant US banking market has fallen to its lowest point ever. Piraeus Bank is the only other major local bank with a worthwhile presence in the New York market, via Marathon Bank. This was unavoidable, following their strategic decision to put emphasis and deploy resources in Southeastern Europe. Of course, they had no idea that by doing this they would avoid being directly affected by the so-called subprime mortgage crisis in the USA. The offspring of the bursting of the housing market in the biggest economy of the world, the subprime crisis demonstrated itself by homeowners inability to meet their loan commitments, resulting in a rising number of foreclosures. The inability of some major US subprime mortgage lenders to cope with the situation has led to shutdowns that had an adverse effect on the stock prices of banks, financial companies and others. The crisis was felt globally because many subprime mortgages had been packaged by bankers and money managers into securities and sold to financial investors such as hedge funds worldwide. The most popular instruments were CDOs (collateralized debt obligations), a type of asset-backed security which provided exposure to a portfolio of mortgages, among other assets. The riskiest parts of these CDOs, which were created in 1987 by bankers at now-defunct Drexel Brurnham Lambert Inc which was the base of junk-bond king Michael Milken, were comprised of subprime mortgage loans. Luckily, Greek banks had not invested in such CDOs and other synthetic credit products but for a few which had invested a tiny portion of their portfolio. Even Postal Savings Bank, which admitted to have placed some -40 million in CDOs, has said they were in the most senior tranches, rated AAA, which are regarded as the most safe. So, the subprime mortgage crisis caught local banks with a reduced physical presence in the US banking market and with a tiny portion of their assets invested in CDOs and other securities hit hard by the subprime financial crisis. Although not advertised, the Greek banks could not avoid the other effects of the financial crisis caused by the bursting of the US house market bubble. Their stock market holdings got hit in August as global bourses fell before starting to rally as the US Federal Reserve and the ECB (European Central Bank) started pumping liquidity into money markets to normalize conditions and the hopes of a Fed interest rate cut revived. At the same time, Greek banks found out, like others abroad, that liquidity was a valuable asset and regulatory capital was back in the spotlight after a multiyear period of rising leverage. The sizable increase of money market interest rates on the euro interbank market despite the injections of liquidity by the ECB could not be ignored. Especially by local banks which borrow on the international markets to fund their strong loan growth. The 3-month Euribor interest rate rose by some 0.60 percentage points above the levels seen before the subprime financial crisis became evident in July and hovers some 0.70 to 0.80 points above the ECB’s intervention rate, left unchanged at 4.0 percent in September and October. Other markets, such as the securitization market where Greek banks had increasingly resorted to raise liquidity by securitizing portion of their loan and credit card portfolios, came to a standstill. Moreover, the commercial paper market, where some banks used to borrow short-term funds up to nine months, became very expensive in addition to becoming less liquid as many investors sought not to buy these securities. The higher funding costs for banks whose loan-to-deposit ratio exceeded 100 percent, such as EFG Eurobank, Alpha Bank, Piraeus Bank, Marfin Popular Bank and other smaller banks, was bound to lead to lower profits if no changes to their loan and deposit policies were made. National Bank of Greece, Postal Savings Bank and ATEbank were not adversely affected because their deposits still exceed their loans. Euribor option Sensitive about the effects on their earnings, banks reportedly responded by offering new adjustable rate mortgage loans based on Euribor rather than the ECB official rate and even asking that old loans based on the ECB official rate be based on Euribor to better mirror money market conditions. They also started offering deposits with higher interest rates, sometimes above 3 percent, to attract new customers. This is because the cost to them is higher than borrowing on the interbank or other markets. Although this is a situation which affects all banks with relatively small deposit bases compared to their loan portfolios, one should expect tough days ahead for the small and medium-sized banks. This is because the Greek central bank has tightened the screws, asking them to report their liquidity ratio more often than before. Banks were required to do so at the end of a quarter. It is no secret that some banks, especially small ones, with small deposit bases, managed to satisfy the two liquidity ratios by borrowing on the last few days of every quarter. If more frequent, weekly, reporting of their liquidity position is not enough, the central bank has asked them to apply some stress liquidity tests to see what the impact of adverse developments will be on their capital adequacy ratio, liquidity and bottom line. This means some banks will have to take more steps to enhance their liquidity, which in turn translates into higher funding costs. This is because these banks are usually those which have limited credit lines and have no option but to attract customers by offering even larger deposit rates. So, although the Greek banks have nearly no exposure to the US subprime market and its credit products, they are feeling the consequences of the financial crisis in terms of higher funding costs on the interbank market. Although money market conditions appear to be getting back to normal, banks with relatively small deposit bases, especially the small ones will fell the pinch more in the coming weeks and perhaps months.