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Greece on the cusp of default


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I know Greece is a small country, but I'm completely amazed at how the situation which is deteriorating so badly, hasn't even but a dent on the stock market rally.

 

As of last night, the yield on a 2 year Greek government bond hit a record 13.52%. I don't know of any sovereign government in the world that is currently paying those yields, let alone a Eurozone member! The serious risk in Europe at the moment is that if Europe bails out Greece, other Eurozone members like Portugal, Spain and Ireland could be further weakened, which could trigger more sovereign debt problems. If Europe does nothing, Greece will certain default, but so too might other Eurozone countries.

 

To me at least, it's like fall of 2007 all over again. We're seeing the first rain drops of the storm, but for some reason the markets seem to think it can all be contained. I still think that the Euro, in its current form, will no longer exist within 2 years.

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I've been watching this Greece situation with great interest.  At what point is the risk over stated?  I fully recognize that Greece will end up defaulting at some point in the next 5 years, but with the IMF/EU bailout is it really that likely to occur in the next 2 years?  Also, when sovereign debt does default, it normally takes the form of either a delay in interest payments, or perhaps a delay in interest payments followed by a hair-cut.

 

If two-year debt is yielding 13.5%, it strikes me that there is already a significant hair-cut built into current prices.  And, as I suggested, it is not at all clear to me that Greece's problems will come to a head over the next two years given the existence of a bailout package.  This feels a little like GMAC bonds from a couple years ago... 

 

SJ

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I think its overblown. Germany will cave eventually. German and French banks hold alot of Greece debt so they have double the incentive to help out. The sticking point is they want Greece to pay market rates. That will not work. They will end up paying a decent spread over the German rate when its all said and done.

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You might want to look at the better of the PIIGS, particularly in the 4-6yr range, & where there have also effectively been bank nationalizations. Then ask;

- Why is it that their economic condition today can only get worse?

- Why do you need the coupon?

- Why would the sovereign not try to extend maturities with zero coupon bonds, at favourable terms?

- Why do you need to repatriate the investment on maturity?

 

If you bought the bond today at 65, & it got re-termed in 2 yrs into a zero-coupon 7 yr maturity at 1.65:1 (165 of ppl on maturity vs todays 100 & bi-annual interest payments), you would have 165 (& a 254% return) in 9 yrs. Would the average residential property in that country have appreciated by as much when their economy was this bad? If you then bought a residential property in that country with your 165 (on maturity), does the FX risk really matter? And if this were your intent; haven`t you really bought that future house today (without the upkeep, & taxes etc) at 40c in the $?

 

SD

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"To me at least, it's like fall of 2007 all over again. We're seeing the first rain drops of the storm, but for some reason the markets seem to think it can all be contained. "

 

One thing I have learned the hard way during the crisis about this macro stuff is to look at what the stock market is doing relative to it. Value investors such as myself tend to work in a vacuum and to ignore what the market is doing, but we cannot dismiss that the overall amount of knowledge that drives the stock market is greater than what is known by any individual.

 

Back in the fall of 2007, the market made a new high following quite a hiccup in August following the collapse of two hedge funds managed by Bear Stearns. However, if you take a bird eye view and look at a 5 year chart of the S&P, you will see that despite this new high that 2007 showed nowhere near the uptrend of 2005 and 2006. The market was going more or less sideways. So you can say that the market as a whole was growing uncomfortable with the decline in housing which was apparent since early 2006. We were also many years into a rebound following the 2001 recession.

 

If you look at the chart today, the uptrend is extremely strong. This seems to indicate that the collectivity must be seeing improvements in earnings and in the economy strong enough to offset Greece and other sovereign issues. I am not saying that this will remain like that forever, but at the moment, it would seem dangerous to bet against the crowd based on that. I would wait for the market to at least trade within a sideways channel for 3 to 6 months before betting against it.  

 

This may sound like complete garbage for bottom up value investors, but if the level of the market starts to influence your capital allocation decisions: you sell or don't buy cheap stocks because you think that the market is high at the moment or that some macro issue like Greece's debt will drive it down, you may come to regret your decision because the current trend is clearly up and will continue until it shows clear signs of fatigue.

 

We may get a double dip recession, we may be into a "V" shape recovery, I just don't know like I could not tell in early March 09 if we where into a depression. All I can say is that IMO there are still enough attractively priced stocks out there on an absolute basis to fill a portfolio and the market seems to indicate that the earnings trend for the economy is up.

 

Cardboard

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It is impossible to predict the timing but I can see this snowballing when it does happen.  It looks like the US could briefly become a safe haven again.

 

http://www.ctv.ca/servlet/ArticleNews/story/CTVNews/20100427/debt_loonie_100427/20100427?hub=Canada

 

TORONTO — Canada's dollar plunged more than a cent in less than 30 minutes Tuesday after traders turned to the U.S. dollar amid new worries about Greece's debt.

 

The loonie dropped to as low as 98.47 cents US shortly before noon, down 1.39 cents from Monday's close.

 

It rallied briefly but fell even further to 98.21 cents US in the early afternoon, down 1.65 cents US.

 

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Also, any banks that held Greece debt are now required (as of today's downgrade to junk) to replace that debt or find other capital.  We know from the previous sub-prime crisis that the economy is more global now so the banks affected will not be limited to Europe.  I suspect this will  have an impact on market liquidity.

 

Do the US banks disclose the amount of soveriegn debt they hold?

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I was looking at NBG (Nt Bank of Greece) to see if it will survive the crisis without too much dilution. I noticed that in Vancouver NBG loaned lots of monies to the Greek community who wisely used it to buy westside apartments and commercial buildings which have risen 20 to 40 fold and land back in Greece which has risen substanially as well. NBG has thereby accrued considerable bank loyalty. And I take SD's point that many want to retire in Greece. I was pleased to see that they have as much deposits as loans with far less than the usual long term loans vs. short term deposits and that they have good earnings in Turkey. This bank doesn't believe in levaraging deposits 20 to 1 or more! Their loan book will suffer continued losses in Greece of course but they are in a position to increase the rates they charge on loans so I suspect their customers will suffer more than they will (if the loan rate exceeds the government bond rate their interest margin is pretty good if they borrow at 1%). I am unsure how to value the $8B Euro Greek Government bonds which they hold (plus considerable loans to Greek government agencies etc. 9B of 70B loans). If the Greek government debt defaults would I value it at $4B assuming a 50% discount in a debt exchange, or, is it fair to leave it at full value since presumably they could use it at full value as reserves or use it to pay their taxes owed to the Greek government or some other use I have not thought of. It seems to me that Greek government debt is worth more to a Greek bank than to others. In the Argentina default some chose to hold out for full payment by turning down the proposed debt exchange and perhaps a strong Greek Bank could do so? Further, the Greek government would presumably want to bail out the strongest Greek bank and presumably they would find a way to repay their debts to the Greek bank in full. Has any one else done this sort of analysis and determined whether such debt should be discounted or not? Has anyone else ran a stress test on NBG?

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Also, any banks that held Greece debt are now required (as of today's downgrade to junk) to replace that debt or find other capital.  We know from the previous sub-prime crisis that the economy is more global now so the banks affected will not be limited to Europe.  I suspect this will  have an impact on market liquidity.

 

Do the US banks disclose the amount of soveriegn debt they hold?

 

This article suggests that US banks in the aggregate hold $16.4b in Greek debt.

 

http://ftalphaville.ft.com/blog/2010/01/29/137341/whos-selling-greek-cds/

 

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Just because ...

 

Keep in mind that the sovereign needs to reduce its funding shortfall & debt service requirement, when nobody wants to lend new money to it; therefore it can only squeeze existing debt holders (1) On maturity take 80c - or rollover into a low coupon 12yr bond guaranteed by the EU (2) On maturity take 80c - or rollover into a higher yield zero coupon, callable (at a % of the IV), sovereign 10 yr bond.

 

Most sovereigns finance at an average 5-7 yr term; if they get into trouble they extend the average term to 9-12 yrs. Assuming a 10yr term that zero would issue at between 46-56, if the yield were between 8-6%.

 

You would be unhappy, but you’d take the zero because it matures sooner, you don’t need the coupons, & there’s a chance it could get called earlier; but you’d also sell it if you could. Assuming an average 25% liquidity discount these things would trade in the secondary market at around 35-42 Euro + accumulated interest.

 

Because this threatens the integrity of Euro land, & the Euro, most would also expect additional Euro depreciation. If its 10% you’d actually pay 90c in the $, & there would be no repatriation FX risk if the proceeds from the maturing euro bonds were spent anywhere in Euro land (ie: a villa).

 

On day 1 you’d actually buy the zero for 31-38 (46*(1-.25)*(1-.1)=31). If it got called the next day you would make at least [50%] 15+ (46+call premium-31). If it’s called 5 yrs hence you’d get more, get the proceeds when the economy is turning (otherwise the sovereign wouldn’t call), & would be reinvesting when property prices were still low.

 

..... Gives a whole new meaning to property management.

 

SD

 

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"Earnings: Dow Chemical (DOW, Fortune 500) reported earnings of 41 cents per share, coming in well ahead of the 30 cents EPS that was expected by a consensus of analyst opinion from Thomson Reuters."

 

Analysts are still way behind on earnings from cyclical companies (big ones, not under-followed companies) and the market turns higher whenever these positive earnings show up. When the market no longer responds positively to good news then you should question yourself about Greece, Portugal and other macro stuff.

 

Here is an article that I read yesterday that is in line with my current thinking, talks about 2007 and that does a better job explaining what I mean.

 

http://www.gold-eagle.com/editorials_08/swanson042610.html

 

Unless you can't find or don't hold cheap stocks, going to cash now because of various fears seems premature. The trend is still up and at worst could turn flat. Also, there are no signs of a 1987 crash. This should remain a good market for stock pickers (buy low, sell high, repeat).

 

There is a reason why Prem is only hedging 25-30% of his stock position at the moment and he is more vulnerable than a small stock picker: his liabilities and related payment terms remain constant while market swings could hurt his capital base and cash availability. Unless you are levered, you don't have this disadvantage and you are able to take advantage of market swings IF they occur by selling cheap stocks for cheaper ones.

 

Cardboard

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~Buy when there's blood in the streets~

 

Coca-cola Hellenic Bottling Company SA (CCH) held steady during the last couple of weeks

 

Hellenic Telecommunications Org SA (OTE) dropped from ~$6.50 to ~$5.50, but was back up to ~$6.00 today

 

National Bank of Greece SA (NBG) is down from ~$4.50 to ~$2.50, but back to ~$3.00 today

 

Is NBG a double to $6.00 in three years?

 

 

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I think you're mad to be talking about buying opportunities when the situation is still deteriorating, falling knives and all that.

 

http://www.reuters.com/article/idUSTRE63R1CD20100428

IMF chief Dominique Strauss-Kahn told policy makers the aid package for debt-crippled Greece would be worth 100-120 billion euros ($133-160 billion) over three years, against the 45 billion pledged to date by the IMF and euro zone.

 

Germany in particular has been dragging its feet over moves to prop up crumbling Greek finances, and it was not immediately clear how governments planned to raise the additional money for Athens, or whether they could secure support for the move.

 

After meeting the German politicians, Strauss-Kahn declined to comment when asked if the Greek aid package could reach 120 billion euros.

 

However financial markets, which have fallen precipitously this week on fears of a Greek default and contagion through the EU fringes, immediately bounced on word of increased aid.

So the assistance package required has now tripled from €40 billion to €120 billion.
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I agree that the knives are still falling. I have been watching the NBG.A preferred which traded at its 52 week low on February 8th, when this was a $30-40b problem, not a $120b problem. I think the bank will survive even if the governement and its euro participation does not. You are likely going to be able to acquire the common of NBG lower than its current price and I would not buy the NBG.A preferred as it is non-cumulative and there is the chance that a dividend would be suspended at some point.

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I agree that the knives are still falling. I have been watching the NBG.A preferred which traded at its 52 week low on February 8th, when this was a $30-40b problem, not a $120b problem. I think the bank will survive even if the governement and its euro participation does not. You are likely going to be able to acquire the common of NBG lower than its current price and I would not buy the NBG.A preferred as it is non-cumulative and there is the chance that a dividend would be suspended at some point.

 

Yeah, I am guessing that NBG is not exactly the Wells Fargo of Greece.

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Unless you're Greek, or well versed in Greek property and lending standards then I would stay the hell away from any Greek banks. Remember that Warren Buffett lost $240 million on Irish banks in 2008. From his annual report.

 

I made some other already-recognizable errors as well. They were smaller, but unfortunately not that small. During 2008, I spent $244 million for shares of two Irish banks that appeared cheap to me. At yearend we wrote these holdings down to market: $27 million, for an 89% loss. Since then, the two stocks have declined even further. The tennis crowd would call my mistakes "unforced errors".

 

Basically, Irish banks lied through their teeth about the quality of their loan books. The Irish Financial Regulator and the Irish Stock Exchange were complicit in condoning, and even covering up in this deception. Buffett obviously only read financial statements and wasn't aware of the political and regulatory shenanigans that were going on behind the scenes until it was too late.

 

Maybe NBG is fine, I'm just saying you would really want to know your stuff before you went anywhere near it.

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Although, in the final analysis it may not matter. I am sure there is someone much smarter and wealthier than me who really understood Chrysler bonds right to the point that the government wiped him out. My belief is that this comes down to how much is Europe, and by extension of the IMF the U.S., willing to pay to preserve the failed experiment of the EMU. NBG will be around when this is over but you may getting your dividends in drachmas.

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If there's a run on NGB, who backstops?  The sovereign cannot backstop in my humble opinion unless supported by other Euro countries.  That's a high impact risk and non-zero.

 

-O

I don't know about NBG specifically, but i have read that the some of the largest sellers of Greece default protection have been the Greek Banks themselves.

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If there's a run on NGB, who backstops?  The sovereign cannot backstop in my humble opinion unless supported by other Euro countries.  That's a high impact risk and non-zero.

 

-O

I don't know about NBG specifically, but i have read that the some of the largest sellers of Greece default protection have been the Greek Banks themselves.

 

Just think of the counter party risk on Greece Sovereign CDS sold by a Greek Bank.  And nobody knows the true exposures. No one knows who all the participants/counterparties are. This will weigh on the entire European banking sector, and has the possibility of creating another CDS domino effect. When are they finally gonna ban these things?

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