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Some of the biggest of Greece's debt-laden banks may be headed for nationalization, particularly if debt restructuring becomes more aggressive and investors continue to dump their shares.
Hostage to about 40 billion euros of toxic government debt on their books in the form of deeply discounted bonds, their fate is inextricably tied to the outcome of the crisis, which many analysts feel will end with a Greek default.
Private creditors, including Greek banks, have agreed to take a 21 percent "haircut" - a loss on the face value of the debt they hold - as part of a second, 109 billion euro bailout deal agreed by Greece and its international lenders in July.
But a consensus is building among economists, politicians, and investors that without a bigger, 50 percent haircut, Greece will still stumble under its 350 billion euro debt load and lose its emergency funding.
"The prospect of a larger haircut has got bigger. Certainly the CDS market sees a larger than 90 percent probability of such an event happening within 5 years," said analyst Niall O'Connor at Credit Suisse in London. "It is possible and could happen within a year, I would not rule it out."
On Tuesday, German and French government advisers joined the debate, arguing that Athens needs to halve its debt burden and calling for more support to recapitalize banks with large exposures to Greek bonds.
Greek media reported on Wednesday that the discussion over the size of bondholder losses has pushed more investors into agreeing to the 21 percent haircut in which they would swap bonds maturing up to 2020 with safer, longer-maturities.
Bankers have also suggested they would be open to another round of write offs later if the first amount is insufficient to stop a default that would trigger much deeper losses.
If that speculation becomes reality, the impact on banks' equity base would be too big to repair in a depressed market and lenders would have to turn to a state Financial Stability Fund - and nationalization - or collapse.
"The banks would (need to) be immediately recapitalized and obviously nationalized because the owners would not be able to supplement the capital gap," said Yannis Papantoniou, a former Greek finance minister and the architect of the Mediterranean state's entry into the euro.
"So the state should come in."
Battered by shrinking deposits and rising bad loans amid a deep and protracted recession, banks are deleveraging and cutting costs to shield their balance sheets and meet the 10 percent minimum core capital ratio demanded by the central bank.
The big five banks - National Bank, Eurobank, Alpha, Piraeus and Hellenic Postbank have already taken a 4.3 billion euro hit on the debt swap plan that Athens wants to conclude next month.
Greek bank shares have shed 64 percent year-to-date and 72 percent in the last 12 months. Once the Athens bourse's locomotives, they have sharply underperformed the broader market.
For the big five, the implosion in market value in the last 12 months was 10.7 billion euros, almost 5 percent of GDP, an amount that would only grow if banks turned to the FSF for funds.
"The money to be raised would be multiples of their current market cap, rendering equity issues highly dilutive, vaporizing shareholder ownership," said an Athens based analyst on condition of anonymity due to the sensitivity of the issue.
"Given the size of the needed equity injections, the most likely outcome would be to turn to the FSF."
The FSF already has 10 billion euros to recapitalize and largely nationalize the Greek banking system.
That amount should grow to 30 billion once euro zone parliaments ratify the EFSF safety net created to prevent the Greek crisis from spilling over into other countries like Spain or Italy and triggering a new global economic downturn.
Under the scheme, banks would issue common voting shares, which the FSF would buy, giving the state large equity stakes in the banks. It would buy the shares far below market prices so taxpayers stand a chance to make a capital gain when the economy returns to growth and the government can privatize the stakes.
Such a model would resemble the TARP plan executed by U.S. policymakers following the collapse of Lehman Brothers in 2008 and the nationalization of two of Sweden's top banks in the early 1990s, long cited by economists as one of the most successful bank rescue operations in modern history.
But while in both of those cases governments managed to divest their shares and return their banking sectors to health, economists warn Greece has suffered a far deeper economic contraction, while the state has also proven a poor steward of sectors that traditionally thrive under private ownership.
"This of course would be a negative thing, because state-owned banks in a country like Greece would be a disaster in terms of management, financing, and everything else," Papantoniou said.
An obvious parallel is Ireland. After a series of bailouts, two of the six domestic banks were closed and the government forced mergers and balance sheet cuts, leaving two banks virtually state-owned and only Bank of Ireland in majority private hands.
CORE CAPITAL HIT
Greek banks have been losing deposits since the debt crisis erupted in the start of 2010 due to outflows and recession-driven cash burn. Business and household balances had shrunk by 50.3 billion euros, or 21.2 percent, to 187 billion by July.
If Greek banks were to take a 50 percent haircut on 40 billion euros of government paper, it would mean an after-tax writedown of about 16 billion euros.
Subtracting this writedown from an aggregate Core Tier 1 capital - a measure of banks' financial strength - of about 24 billion for the big five banks would leave them with just 8 billion euros in equity.
Analysts say that, measured against 200 billion of risk weighted assets, the remaining equity would translate to a capital ratio of just 4 percent, far below the 10 percent minimum required by the central bank.
To claw their way back to the minimum ratio, banks would need to raise at least 12 billion euros when the combined market capitalization for the big five is only 4.3 billion euros, a near impossible prospect in such a troubled market.
While in theory some banks could generate capital through deleveraging and asset disposals, analysts say this would be a long shot given the time pressure to restore their financial strength and reassure depositors.
While underwriting rights issues would be a tough call, finding a deep-pocketed willing investor cannot be entirely ruled out.
Alpha and Eurobank unveiled a merger deal in August that included a capital injection by Alpha's Qatari shareholder Paramount, which will pump in half a billion euros through a convertible bond issue.
But analysts said the prospect of buyouts from foreign peers looks dim as long as sovereign debt default fears persist. Potential investors looking for cheap prey would probably wait until Greece's economy stabilizes and cherry pick from the FSF, which will be looking to divest stakes in two years' time.
"It is highly unlikely that a foreign bank would come in and inject capital in a Greek bank as long as the risk of default is so alive," said Deutsche Bank analyst Dimitris Giannoulis.
"The FSF remains the only option for banks," he said.