If analysts are right, 2008 will not be an easy year for banking stocks in Europe and the US but the large Greek banks, especially National Bank of Greece, have the characteristics to outperform. We think they are right. It is very likely that major local banks will post double-digit growth in 2008 and at least confirm their current guidance for similar levels of profit growth in 2009 and 2010. At the end of 2006, the pundits predicted that 2007 would be another good year for the large Greek banks which are on the radar screens of foreign institutional investors. It turns out they were partly right. Bank earnings are set to post double-digit growth based on nine-month results, although most of their stocks did not meet expectations. The major banks, that is, National Bank of Greece, EFG Eurobank, Alpha Bank and Piraeus Bank, saw their earnings grow in line with or better than expectations in the January-September 2007 period. The credit crisis did not hurt them, unlike banks in Western Europe and the US which were exposed to the US housing market and credit derivatives tied to subprime mortgages. Only Greece’s Postal Savings Bank was hit because of its portfolio investments in CDOs and other financial instruments whose prices nosedived after July. The good profit results undoubtedly helped the Greek banking sector come out almost unscathed from the credit crisis and the ensuing stock market turbulence since it did not suffer the declines of other European banking shares. On the other hand though, it did not produce the kind of returns expected by investors at the beginning of 2007. The shares of National Bank gained more than 25 percent in 2007 while Eurobank and Alpha Bank shares closed with very small gains. The shares of Piraeus Bank fared better, gaining more than 10 percent last year while Cyprus-based Marfin Popular Bank (MPB) saw its shares rise more than 8 percent. Emporiki Bank was the worst-performing stock among the large banks, as its shares fell more than 10 percent on the heels of declining earnings, partly due to higher loan loss provisions as the subsidiary of Credit Agricole (CASA) sought to improve the quality of its loan portfolio. However, Emporiki was the best performer with gains of 0.7 percent in the first week of trading in the new year with MPB the worst after its weekly 6.77 percent drop. According to market consensus (FactSet), Emporiki Bank will see its earnings per share (EPS) rise 48 percent this year compared to 2007 and more than 18 percent in 2009. Since it is a purely domestic operation, deriving no significant revenues from abroad, analysts see Emporiki Bank actually benefiting from an increase in retail lending, a more favorable year-on-year comparison in provisions and access to cheap funding due to its high credit rating as a member of the CASA group. The other major banks are also expected to post strong earnings growth in 2008 and 2009 with an increasing portion coming from abroad. National Bank of Greece, the flagship of the domestic banking sector, will see its profit rise by about 19 percent this year and 20 percent next year, getting strong help from Finansbank, the Turkish bank whose acquisition became a hotly debated political and economic issue in 2006. EFG Eurobank, which saw its share fall more than 4 percent in the first week of trading in 2008, is expected to post an increase in profit per share of 16 percent in 2008 and more than 24 percent in 2009. Consensus figures put Alpha Bank’s EPS growth at 11 percent in 2008 and about 10 percent in 2009. Analysts expect a stronger performance by Piraeus Bank with earnings rising 15 percent year-on-year this year and 28.5 percent in 2009. So, consensus analyst estimates are quite bullish for the major Greek banks despite an expected slowdown in domestic loan volumes and another small contraction in the spread they earn on their loans and deposits. Obviously, the investment community is betting that strong growth from their foreign operations, mostly in Southeastern Europe will more than compensate for the earnings fatigue at home. However, all banks are not the same. Even though the capital position of the major Greek banks is strong, following two successful share capital increases by Eurobank and Piraeus Bank in excess of -1 billion in the second half of 2007, they are not all in the same position as far as funding is concerned. This is important in a period when money markets are gradually returning to normality, following an unprecedented cash injection from the European Central Bank and the Fed, for the securitization market has basically frozen and wholesale funding – generally speaking – has become more expensive. It is known that National Bank of Greece enjoys a comparative advantage on that front. Its loan-to-deposit ratio is below 100 percent, meaning it can fund its loan growth via its large deposit base at home. This is not true for other large banks such as Eurobank, Alpha or Piraeus Bank, whose deposits are less than their loans. These banks will have to fund part of their strong asset growth by raising money in international capital markets where the cost has risen. This means they have no option, assuming the situation does not normalize, but to pass on the costs to their customers and risk a further slowdown in their loan growth volumes or absorb it and see their spreads declining more than expected. It should be noted that the reference 3-month Euribor in the interbank market currently stands at 4.68 percent compared to 4.20 percent before the onset of the credit crisis in July, with the ECB’s official rate at 4 percent. Moreover, with the exception of National Bank, Alpha Bank and Emporiki Bank, which is not really of any great interest to foreign investors, the other Greek banks are expected to have negative free cash flows in 2008. Free cash flow is defined as net profit minus ordinary dividends and capital expenditures which includes M&A spending. This is not necessarily bad as long as their profits keep on rising, meeting or beating consensus expectations but it is something worth noting during a period of crisis. Of course, mergers and acquisitions could also play a role in 2008 and there are reasons to believe that the opportunities for corporate actions involving large banks are on the rise. However, it may be small banks such as Attica Bank and Aspis Bank that set the ball rolling. All in all, the major Greek banks look set to deliver another set of strong financial results in 2008 but the performance of their shares may not follow suit if stock markets do not recover. However, their shares should once again outperform their Western peers with National Bank standing above the rest.