Second take on asset quality as local conditions weaken
Greek banks have been feeling the heat of the international credit crisis mainly, and thus far, in the form of higher funding costs. However, higher lending rates, along with a slower-growing domestic economy, higher risks in neighboring southeast European countries and the central bank are bound to force them to take a closer look at their credit asset quality. The likely deterioration may spell trouble for their future earnings and even capital adequacy ratios in some cases. The local credit institutions have been lucky. They have been able to expand their retail banking franchises and boost their profits in a broadly benign domestic macroeconomic environment characterized by strong gross domestic product (GDP) growth rates, declining unemployment and rising personal disposable income in the last 12-13 years or so. Greek banks also benefited because this period coincided with Greece’s EU convergence and entry into the eurozone, the accompanying sharp drop in interest rates and the full liberalization of the Greek banking sector. So they have yet to live through a full business cycle, comprising of an economic upturn and a downturn. This means they have no experience as to how the declining economic activity affects their assets, namely loans given to households and companies. Although Greece is expected to weather the economic storm better than most of its eurozone peers, the economic slowdown is substantial if forecasts of GDP growth in the area of 2.5 to 3.0 percent next year materialize. Moreover, there are signs of economic fatigue, coupled with current account imbalances, in neighboring countries ranging from Turkey to Romania, Bulgaria and others where large local banks have been busy building their branch networks. In addition, money market rates in euros have been rising steadily due to the global financial crisis. The three-month Euribor, which is the base rate for many mortgage, consumer and business floating rate loans, surpassed the 5.10 percent level last week which is the highest since the euro’s inception in 1999. In this kind of environment, it is generally the case that banks’ asset quality deteriorates, albeit with a time lag: As the economy slows, unemployment and interest rates rise, hurting more and more households and businesses. There is no doubt that Greek banks have become more sophisticated in applying advanced risk management techniques and are more effective in collecting loans in arrears. The fact that the improving prospects of sectors such as construction, which recorded a higher proportion of non-performing loans (NPL) as a percentage of total loans in the past, has also helped their credit quality. Based on first-half results, the large local banks, namely National, Eurobank, Alpha Bank, Piraeus Bank, Marfin Popular Bank and ATEbank, have managed to reduce their NPL ratio compared to a year earlier. This was partly due to Bank of Greece’s pressure for higher write-offs of bad loans to bring the sector’s NPL ratio closer to the eurozone average of 3-3.5 percent. The central bank is expected to press local banks further in coming weeks to clean up their loan books by making more provisions for non-performing loans and proceed with higher write-offs even if this means they will have to boost their capital. This would be quite challenging at a time that large foreign banks are facing big difficulties in raising fresh capital. At this point, the provisioning rate of the sector is lower than the average rate during the 2000-2008 period, according to UBS calculations. It stood at 64 basis points at the end of June, compared to a period average of 90 basis points and an average 68 for the European banking sector. Of course, there are differences among local banks which reflect their different asset mix, i.e. mortgage and small business loans versus consumer loans. Also, there are sharp differences between the portfolio mix of Greek and Cypriot banks now and in the past. Still, the evolving deterioration of economic conditions in Greece and abroad and the central bank’s likely pro-active stance is likely to force banks to up their provisions, hurting their earnings and writing off more bad loans, eating into their capital base. It is better though to be prudent than imprudent at times of market turbulence.
