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Negative bond yields could mean short-term pain, long-term gain for Greek banks

Greece became the latest country to issue negative-yielding state debt, selling €487.5 million of government bonds with a yield of minus 0.02% on Oct. 9, in a move that surprised analysts and industry pundits.

With the sale of the three-month bonds, Greece joins European countries including Sweden, Germany and Spain in selling government debt with a negative yield.

This development may cause some pain for Greek banks in the short term, although it may have some indirect positive effects further down the line when it comes to working through the huge volumes of nonperforming loans that Greek banks still have on their balance sheets, according to Jakob Suwalski, an analyst at Scope Ratings covering Greek banks.

A helping hand for securitization

Treasury bills are an "easy and stable" source of income to the banks that hold them, so negative yields diminish that income, Suwalski said in an interview.

"For Greek banks, the immediate impact on profitability is negative. Greece has regularly auctioned 52-weeks T-bills since March 2018 and those yields could also turn negative," he said.

Greek banks held a combined €11.77 billion in their own country's sovereign bonds of the end of June 2018, out of a total of €18.16 billion of sovereign bonds on their balance sheets, according to the most recent data from the European Banking Authority's stress testing exercise. Three-month T-bills, the shortest-dated form of government debt, make up a relatively small part of Greek banks' holdings of their own country's sovereign debt, at €986 million.

But there could be benefits for Greek banks in the longer term, because cheaper debt for the government will indirectly make it easier for banks to offload bad debts via securitization, according to Suwalski.

"Lower financing costs for the government are reducing the cost for investors of buying protection, via credit default swaps, against possible default on Greek government debt," he said.

This is relevant in the context of Greece's proposed asset protection scheme, Project Hercules, which was given the green light by the European Commission on Oct. 10, Suwalski said.

Project Hercules is similar to Italy's GACS scheme and would allow banks to use state guarantees to back the securitization of NPLs. Under the scheme, banks would be able to transfer bad loans to a special purpose vehicle that would issue bonds, with a government guarantee for the senior notes.

"Thanks to narrower Greek CDS spreads and the recent abolition of capital controls — which eliminated transfer risk and reduced political intervention risk — we expect the gap between prices offered for Greek NPL assets and prices sought by Greek banks to narrow significantly," Suwalski said. "In other words, the negative yield on T-bills and associated lower CDS prices will help Greek banks make use of the securitization process to reduce their exposure to NPLs swiftly."

In the long term, this will help banks to clean up their balance sheets and free up capacity for new lending, all of which will help to drive banks' profitability, he said.

Greece lifted the last of its capital controls on Sept. 1 this year.

Securitization has already proved a useful tool for Greek banks working to flush out bad debts: Eurobank Ergasias SA securitized and agreed to sell €2 billion of nonperforming mortgage loans in June this year.

Greece's "big four" banks are still struggling with high levels of bad debts; the country has the highest NPL ratio in Europe at 41.41% as of the first quarter of 2019, according to the European Banking Authority, while its NPL pile totaled €84.3 billion.

A quirk of the markets

For Spyridoula Tzima, senior financial analyst - global sovereign ratings at DBRS, the negative yielding bond issue is a vote of confidence in the Greece from the international markets.

"From a sovereign perspective this partially reflects the favorable environment in the international bond markets," the analyst said. "But also the growing confidence on the Greek economy after the election of a government that aims to boost economic growth by removing impediments to investments, while remaining fiscally prudent."

New Democracy unseated left-leaning Syriza in Greece's snap elections in July. New prime minister Kyriakos Mitsotakis has promised to cut taxes and push through pro-business reforms.

But other Greek economy-watchers are quick to point out that Greece's negative-yielding bond is more of a quirk of the current financial markets rather than a vote of confidence in the Greek economic recovery.

"I don't think this has anything to do with investor perceptions of the soundness of the Greek government or economy," George Kessarios of Exclusive Capital, a Cyprus-based asset manager, and a regular commentator on Greek financials, said in an interview, adding that the negative-yielding bonds were more the result of the huge amounts of money flowing into the bond market globally.

Nikolaos Antypas, lecturer in finance at Henley Business School, University of Reading, agreed.

"This seems to be more of an artifact of the current financial markets than the progress Greece has had with respect to the financial health of the banking sector and the overall economy," he said in an email.

"In general, I am still optimistic about the improvement in the Greek banking sector, but I would be worried if a recovering economy is treated as if it is a fully developed, mature market," he added.