I KNOWZ, A MERGUR WILL FIX IT! PART 2

The rate at which posts on this blog end up spawning sequels never ceases to amaze me.

Readers will, by now, have read about the planned (and presumably done) deal to merge two of the largest Greek banks, EFG and Alpha. You can also check out my friend @mstevis' take on the deal here. My tongue in cheek suggestion for EFAGA to be the name of the merged bank is not gaining much currency but hey, I can't have it all.

I must first refer you to my original post, back when NBG tried to buy Alpha. Like anyone not entirely bonkers I rained shit on that parade because the proposed merger returned an under-capitalised bank in all respects but this time around it really is different. I still don't like bank mergers but as I've discussed before they are necessary and this one is going ahead.

I've crunched the numbers on the capitalisation of the proposed merged bank based on the Stress Test results for EFG and Alpha, plus details of the announced deal. You can check out the results below:

I believe that the new bank will be seen as secure by the markets, achieving the objective of the merger. My guess is that it will probably turn out to be most beneficial for the Alpha shareholders as, at a time when the market should really only be valuing worst-case Core Tier I, Alpha is way under-priced.

What will it take to elevate the merged bank beyond contagion? I'd say Core Tier 1 at over 7% even if Greek bonds take an 80% haircut. How much will that cost? EUR6bn. Hell they will probably draw that much in deposits, post-merger.

This is probably good news. You don't hear me say that very often, now do you? It's good news because, assuming the new bank tries to keep to a 7% core tier 1 capital ratio, it can in theory lend an extra EUR13bn in risk-adjusted loans. By the same calculation, Alpha could only add a measly EUR3bn and the benighted EFG would have to actually reduce lending by a net EUR15bn. So we go from a net reduction of EU12bn to a net increase of EUR13bn. Now I don't expect all of this will materialise in the current climate but an extra EUR25bn in spare lending capacity out of nowhere is nothing to be sneered at, it's about 10% of the total outstanding loans to domestic non-financial institutions.

Then again I do wonder whether EFAGA won't also start drawing deposits from other Greek banks as opposed to deposits previously moved abroad. It's very likely; after all, most of the country's savings aren't with the super-mobile ultra-rich, whatever defaultniks would have you believe. It could be that this is a winner-take all game in which the first couple of banks to reach good capitalisation take the pot as both depositors and investors flock to them. If I'm right, then the pressure on the rest of the Greek banking sector is about to become unbearable.

PRIMARY DEFICIT ENTERS THE TWILIGHT ZONE

Readers will remember my little naive model for the primary deficit, the one that kept warning that the public finances are becoming unstable. I called it naive in my last post on the matter in order to indicate that it's fitted to a simple pattern with little basis in the actual economics of the Greek state.

Well as with all naive models it has just been blown to shit by the facts. You see, the model as of June 2011 looked like this:

 Now that the figures for July have come in, it looks more like this:

When the data no longer fit one's model, it's the model that has to go. But I think you'll agree with me that we're in uncharted territory here in more ways than my own failed predictions can demonstrate. I will set the model aside for now then and just show you the facts.

July was a surplus month as expected. But whereas July 2010 returned a primary surplus of EUR730m, July 2011 returned a much smaller primary surplus of EUR385m. We've now exceeded the 2010 primary deficit every month since April, as per the graph below:

All in all, we're already EUR1.8bn off last year's primary deficit figures. Mind you, that year's ytd spending figures have been mysteriously revised upwards by EUR340m, and the June figures by EUR240m, so it's hard to know what really happened last year until this year is over. All I know is that at this rate we're on track to achieve a primary deficit of EUR8bn if all following months exactly mirror those of 2010, or EUR9.4bn if the current trend persists.

Is this due to the deeper-than-expected recession, as both the Ministry of Finance and its critics claim? Well, according to the Ministry's figures revenues are down by EUR1.9bn year on year while primary expenditures (including, as I always do, public investment) are down by a mere EUR113m - and that's only because the public investment budget has been slashed by another EUR1.6bn. Otherwise, public expenditure has risen (yes, risen) in 2011 so far. Cutting public investment is the worst way to cut the deficit and the IMF knows this.

So why they are allowing it is beyond me.