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By Jason Stipp | 09-13-2011 05:10 PM

Herro: Market's Big Mistake on European Banks

European banks have been sold off in lockstep, despite critical differences in quality, says the Oakmark manager.

Jason Stipp: I'm Jason Stipp for Morningstar. As concerns grow over a possible Greek default and sovereign European debt concerns broadly, we're checking in today with David Herro, Oakmark International manager, and also named Morningstar's Manager of the Last Decade. He's going to tell us a little bit about his take on the European situation and how his portfolio is positioned today.

Thanks for coming in, David.

David Herro: Happy to be here, Jason.

Stipp: So, I'd like to talk about the potential for the Greek bankruptcy and the knock-on effects. You have several European bank holdings in the portfolio, and I think a good way to talk about this is to talk about your holdings.

As you're thinking about the possibilities that could unfold in Europe, how are you thinking about the potential for those holdings right now and the risks for those holdings?

Herro: Clearly, we do believe, there is a high degree of risk that the Greeks will not be able to pay most or all or any of their debt. Who knows? Probably they could pay for some of it, but clearly, they cannot pay for the nominal value of their debt. There's $400 billion in debt, 14 million people. They haven't shown propensity to go through austerity. By the way, we have seen this in places like Ireland, where they quietly have done the things necessary to get through their economic crisis. So, Greece is a problem.

However, the rest of the PIIGS countries, if you look at Italy, Spain, Portugal, Ireland, we do not view as major problems. Portugal has to be watched, but recently, their new government passed measures. So, that is the overview.

So, our main concern is the exposure to Greece and Greek debt among of the banks and the financials that we own. At this stage, if we look through all our holdings--and our biggest holdings in Europe are companies like Intesa Sanpaolo, Credit Suisse, Santander, and BNP Paribas, the French bank that's in the news today. None of these financial institutions have a major exposure to the Greek problem.

BNP has around $3.5 billion worth of exposure to Greece. However, pre-provisioning profits for that institution are over $20 billion. So they've already written down probably a third, 40% of their exposure. So we think they are in very good shape. BNP is very well capitalized, and we don't think there's real issue with them in Greece.

However, what happens is, because Greece is problematic, people have automatically extended this to all the other peripheral countries, and I think this is the big mistake. The other countries are not in the same situation as Greece, and the market is lumping them all together, and there lies an opportunity as well.

Stipp: So you mentioned BNP there, and it has some exposure to Greece. When you are thinking about that bank and all the bank generally, do you have a sense of what would be a best-case scenario, a worst-case scenario from the situation, and then also what do you think is the most likely scenario to come out broadly and also specifically in how it could affect those banks?

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