Greek bank woes pose new risk in debt crisis

ATHENS/VIENNA (Reuters) - They did not cause the debt crisis but Greece's banks may soon become its victims, and increasing pressure on their balance sheets could add another chapter to Athens' fiscal tragedy.

Greece's downgrade to speculative status by ratings agency Standard & Poor's on Tuesday was also applied to Greek lenders, a move that simultaneously hit the value of government bonds in the banks' portfolios and their own ability to raise credit.

That added to a bleak environment of more possible downgrades by other agencies, an economic downturn expected to squeeze earnings and push up non-performing loans, and a rising worry among analysts that Greece may restructure its debt.

If this last possibility happened, it would be a major blow to Greek banks, which hold around 40 billion euros in debt on their books, and raise the specter of capital hikes in a market that has seen foreign investors flee as the debt crisis intensifies.

Analysts agree the Greek banking sector is relatively well capitalized and has a comparatively low loan-to-deposit ratio, and they are not yet predicting a banking crisis.

But the crux of the issue remains whether a multi-billion-euro aid package Athens is trying to secure from euro zone states and the International Monetary Fund will tide it over long enough to cut a bloated public sector and tackle a 300 billion euro debt pile.

Markets have not passed final judgment, but see that as increasingly unlikely, with Greek five-year credit default swaps briefly rising to a record 911.6 basis points on Wednesday, indicating an implied default rate of 52.6 percent.

Such a development would also ratchet up pressure on public finances despite the government having already imposed a raft of painful austerity measures to save itself from bankruptcy.

"If the situation really deteriorates sharply and with it systemic risk for the Greek bank sector, I don't think the Greek government has any money left to support that or any other sector of the economy," said Diego Iscaro, a senior economist for IHS Global insight.

DEFAULT RISK

Analysts say default or restructuring could shave anywhere from 20 to 50 percent off the value of Greek debt, a major part of the portfolios of Greek banks.

National Bank has the biggest exposure with 17.9 billion euros or 16 percent of total assets and 223 percent of equity, followed by Eurobank with 7 bln euros, and Piraeus with 6.5 billion.

According to UniCredit, even a 20 percent haircut would chop NBG's equity Tier-1 capital to 4.7 from 10 percent, Piraeus' to 4.1 pct from 7.7 pct, and Eurobank's to 5.1 pct from 7.9 pct, making recapitalizations necessary.

Other drags for the sector, which has shed 37 percent of its market value since the start of the year, is the upward pressure on funding costs and government deficit-cutting measures expected to deepen last year's recession into 2011.

Greek two-year government yields spiked to almost 16 percent this week, posing problems for banks looking for funding in the market, while domestic competition for deposits will become more fierce, compressing profit margins.

With other European banks staying away, Greek lenders have been using liquidity facilities offered by the European Central Bank for short-term financing, but that too faces some uncertainty.

Under ECB rules, if S&P rival Moody's also cuts Greece to speculative level, Greek banks would receive 5 percent less cash when they use Greek bonds as collateral, exacerbating tight borrowing costs.

Economists also expect a 3-5 percent economic contraction and a jump in unemployment to over 12 percent this year, which will boost non-performing credits, squeeze borrowing demand and prompt lenders to shut their vaults to consumers and businesses.

"We expect Greek banks' asset quality to remain under pressure in 2010 as the country's economy is expected to undergo an even deeper recession than in 2009," Standard & Poor's said.

MORE FUNDS?

Other issues include public confidence, after domestic non-government deposits fell by nearly 9 billion euros, or about 4 percent, in January and February, a figure analysts said was not alarming but also not insignificant.

Greece's government has guaranteed deposits and, earlier this month, said it would release 17 billion euros -- 7 percent of gross domestic product and more than the entire amount the government hopes to cut from last year's fiscal gap -- remaining from a 28 billion euro support scheme launched in 2008.

Either guarantee, if tapped, would put further pressure on Athens' strained public finances, and investor aversion to Greek assets would mean any capital hikes would require more state cash.

"If it was the case that they needed capital, it probably would probably have to be government who would pay, so once again would have further nasty implications for public finances," said Ben May, an economist at Capital Economics.

(Writing by Michael Winfrey; editing by John Stonestreet)