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How Much Fallout From a Greek Default?

Mon, 12 Sep 2011

Morningstar analysts Erin Davis and Maclovio Pina discuss the inevitability of a Greek default and which banks are most exposed to Greek debt.

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Video Transcript

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

The Greek sovereign debt crisis continues to roll on. I'm here with senior analysts Mac Pina and Erin Davis to take a look at the situation and see what it could mean for the European banks.

Thanks for joining me today.

Erin Davis: It's good to be here.

Glaser: So, Erin and Mac, can we just start off by giving an overview of exactly what's happening in Greece right now? Why is this crisis flaring up again? Can you just give us some background about the situation?

Davis: Well, George Papandreou just survived the vote of confidence, but very narrowly, and now the government is considering some austerity measures that are necessary for the next round of EU funds. There's been a lot of talk about people being opposed to them, but I think ultimately, they're going to pass.

Glaser: So, if we're able to get these austerity measures passed and able to bring the Greek budget deficit down a little bit, does that actually solve their fundamental structural problems? We hear a lot of about this as just kicking the can down the road. Could this really avoid a default of Greek debt? Is there a way to avoid this default?

Davis: Ultimately, I'm afraid that you're right, that this won't solve the problems in a really fundamental way. I think that they're just extending Greece's payout schedule, but the real underlying problem isn't a liquidity problem. It's not that Greece doesn't have enough money to pay the debt right now. The problem is that Greece is never going to be able to repay this debt.

So, ultimately, I think that the EU and the debtholders are going to become tired of extending the bonds, and that Greece is going to have to pay market rates eventually, and then, when that happens, it might be two or three years from now, but then, Greece is going to default.

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Glaser: So, we see this default, I guess the question on everyone's mind is, who holds this debt? Is this something that's held by a lot of European banks? Is this going to be a Lehman moment with the default? Is there going to be a lack of confidence in the financial system? Or are the European banks going to be able to survive a big sovereign default?

Maclovio Pina: So ... it's really tricky to really track down exactly who holds how much debt. We do have a good idea of which of the banks under our coverage are most exposed to Greek debt. National Bank of Greece, which is Greece's largest bank, is the obvious choice for being the most vulnerable to any type of restructuring. It doesn't have to be outright default, but any type of restructuring will make them take marks off of their Greek debt securities that they are holding on their books, and that can entail tremendous equity raises if they need to continue as a going concern as they've done so far and keep their equity base as they have it.

There are other banks that still have a good amount of Greece government securities as a percentage of their equity. Dexia is the next one on our list. After that it can really be not too important, but the thing is that ... nobody really knows exactly who holds what and then there might be other securities like CDS securities written against this debt, and nobody knows who's holding what. So, one thing that at least this will accomplish is let banks prepare better to that eventual event, but there are definitely some banks in trouble in our view.

Glaser: So, kicking the can down the road might seem like a folly, but really what it does is it lets everyone buy time, prepare their balance sheets to get ready for the moment, unlike something like Lehman, which happened very suddenly.

Now, one of the questions that comes up a lot is about contagion, that if Greece defaults then everyone is going to be focused on Portugal and Ireland, and maybe even on Spain.

Do you think there is way to build the firewall around Greece and to really isolate the problems there, or do you see it spreading across the continent?

Davis: That's a very hard question to answer. I think that, if the problems spread to Ireland and Portugal that that might be manageable. I think that we are ultimately less worried about Spain. I think that its problems are less structural, and that ultimately it's not going to default. I think that if Ireland defaulted, that would be a problem for some U.K. banks like Lloyds and RBS, even though they are not Irish banks. They still hold a lot of Irish assets.

Glaser: So, it sounds like the sovereign debt situation, at least for the banks, that they could see a few failures, but for the most the banking system will be able to take this pain.

Pina: Yes.

Davis: I think that that's exactly right.

Glaser: Erin, Mac, thanks so much for sharing this with us today. I will definitely talk to you guys again soon for an update.

Davis: Thank you. It's good to here.

Pina: Thank you very much for having us.

Glaser: For Morningstar, I'm Jeremy Glaser.

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