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Even after the recent approval of the Greek austerity package, European authorities continue to scramble to prevent a default, and markets still fear the worst. Less than three years after Lehman Brothers collapsed, investors no longer have the luxury of assuming that the unthinkable is impossible.
But I don’t see another Lehman-style disaster in the making. In fact, the lessons that we’ve all learned from the failure of Lehman Brothers should make the impact of a Greek collapse severe, but manageable.
When Lehman went under, regulators had no playbook for managing the collapse of a global financial institution. Today, they know better. The European Central Bank is giving €100 billion of support to Greek banks. Meanwhile, the EU has committed €440 billion to the European Financial Stability Facility and is actively working on a second Greek plan, giving the country another three years to fix its finances.
While European leaders must cross a political minefield to secure a long-term plan, Greece’s determination to press ahead with austerity in the face of fierce public protests will compel the EU to cooperate. Everyone understands what a replay of the Lehman collapse could mean.
The good news is that banks everywhere are in better shape today than three years ago. Capital ratios are much higher, meaning there’s a bigger cushion to absorb the shock of a potential Greek default.
And investors are more vigilant. The biggest lesson from Lehman’s collapse was that visibility is crucial. So as the Greek crisis deteriorated, investors have made sure to get a good grip on the exposure of European banks to a potential default. In fact, new regulations that force banks to disclose more than ever before give investors much more information to act upon.
Broadly speaking, we think that European bank exposure to Greece is manageable and that market prices reflect exaggerated assumptions about the likely impact of a sovereign default. The risk depends on how much exposure a bank has to Greek bonds when compared with its tangible equity. For example, if an institution has 5% of equity in Greek bonds, we calculate that in a default it would lose half of it—or about 2.5%—before tax. After tax, the loss would be about 1.5%.
That would be unpleasant to digest but not a disaster. Yet European banks are currently trading at very depressed valuations of about 1x tangible book value.
Take Societe Generale, which has returned to a respectable level of profitability over the last year and has modest Greek bond holdings. SocGen controls Geniki Bank in Greece, but the unit accounts for only 1% of SocGen’s total loan book. Yet the stock is trading at 0.9 times tangible book value. In a Greek sovereign default, we estimate SocGen’s tier 1 capital ratio might drop from 8.8% to 8.5%—hardly a catastrophe for investors.
There are many more banks like SocGen out there, with solid earnings prospects and limited exposure to Greece. So although Greek banks themselves look like a value trap, I think the market’s worst nightmare is creating select opportunities to snap up European financials at bargain prices.
Kevin Simms is the Global Director of Value Research at AllianceBernstein
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio management teams.
