Greece: the end of bailout program

To facilitate the transition and soothe market concerns about Greece’s debt sustainability, the end of the bailout program was accompanied by a couple of debt relief measures, including the deferral of interest and principal payments on European Financial Stability Facility loans by 10 years, and the transfer of profits from the ECB’s purchases of Greek government bonds. However, these relief measures are conditional on Greece’s commitment to fiscal discipline and to the structural reforms introduced.

This conditionality shall help reduce the risk of a significant policy shift, in particular also ahead of next year’s general elections. Centre-right New Democracy party is leading in the polls, which would imply a confirmation of a pro-EU and more market friendly policy stance. Overall, we thus see limited risks of a reversal into fiscal profligacy and unwinding of structural reforms.

This said, the economic situation in Greece remains challenging, and it will still take years to tackle the country’s most arduous economic and social issue, the high unemployment rate (which is down from the 28% peak in 2013, but still close to 20%).

On the positive side, though, there are signs that the reforms from the past years are finally bearing fruit: after several years of contraction (2008-2013) and stagnation thereafter, the Greek economy expanded by 2.3% in Q1 this year, the fastest rate in a decade. In the coming years we expect growth rates slightly above the 2% mark.

Substantial challenges remain: the banking system is strained by a bulk of non-performing exposure (NPE) of € 92.4 bn or 48.5% of the total, and the IMF reckons that in an adverse scenario, Greek banks may still face a capital shortage of € 1.3-1.9 bn or 10% of the capital base. As such, reducing the NPE exposure will be a critical policy task in the years to come. Another key concern is the very high level of public debt (189% of GDP), which will clearly limit the fiscal leeway for Greek governments going forward, also after the expiration of the bailout program.

Greek government bonds have reflected the support from international institutions and the improvement of the underlying economy.

Ten years yield is stabilizing just above 4%: although this is the lowest level since the beginning of the crisis, it still offers an important pick up versus other Eurozone sovereign issuers, while its weaker rating is partially compensated by the fact that most of the debt is now in hands of supranational & official creditors.

In particular, we find attractive the Greek TBill market, albeit illiquid, where extra yield versus other Euro denominated money market instruments is very interesting particularly if considered that, even in a new adverse scenario of debt restructuring, TBills are traditionally excluded from these event.

We see some appeal in the Greek equity market. Local equities have underperformed the euro area year-to-date despite the improved earnings growth and economic environment, and we think they can better handle the negative spill-overs from external shocks over the medium term, although we recognize that they may remain exposed to volatility in the short-term, especially due to the Turkish lira woes (we avoid companies exposed to Turkey).

While relative equity valuations have reached an attractive level due to their gap with peers in the rest of the Euro area, investors have to be extremely careful with their stock picking, as performance dispersion is very high amongst stocks and sectors.

We favour domestic-focused companies as we anticipate private consumption will finally take off after 10 years of weakness (retailers, infrastructures, stock exchanges and ports will be positively impacted), and we also like family-owned firms with a strong track-record in terms of management, cash-flows generation and use.

On the other hand, we have a negative view on some sectors and stocks. For example, we avoid Greek banks, which account for almost 25% of the general Athens Stock Exchange index, as we believe they will need capital injection in the near future due to their extremely high NPE ratio, that is close to 50% in a context where the ECB is pushing banks under its supervision to lower non-performing loans (NPL) ratio – currently above 30% - at around 10%. Home repossession process in Greece has been inefficient so far (e-auction could help to a degree in the near future), and NPL reduction is coming more from write-offs than from anything else, as no Greek bank has proved to be able to recover NPL significantly so far. This might trigger, again, capital increases for the weakest banks in the country. Our calculations show that additional capital requirements could range between €1.2bn and €8.1bn for those banks (hypotheses: 20% NPL ratio, 50% coverage, no NPL recovery).