[Author's note (November 12th, 2012): The 0.93 P/B ratio number that the bank would have after the recapitalization was used accidentally. The correct P/B ratio number is 1.25 which changes the calculated potential target prices for the worst. The numbers below have now been changed accordingly.]
National Bank of Greece (NBG) had quite a run in the past two weeks, surpassing $1.98, which was the post June 6th Greek election high, and closing at $2.58 yesterday. In my opinion, which is based on available facts, the stock is a prime short candidate at these levels with almost no risk of permanent capital loss.
An investor short the stock at current levels could expect a profit in the range of 76%-95% depending on which of the two events mentioned below will occur. All numbers below are in euros.
Event A: Orderly recapitalization of Greek banks
Greek banks which have been labeled as systemic are to be recapitalized by the Hellenic Financial Stability Fund. The HFSF has already advanced to the banks the first tranche of capital needed and will advance the second tranche as soon as Greece gets its own next tranche. The terms on which the banks have received the first tranche of capital are not yet known and will be decided when the second tranche will be given.
National Bank of Greece has negative equity and needs between €7B and €8B of new funds to reach the minimum 9% core capital ratio required by the Bank of Greece by September 2012. The above amount may be somewhat lower than the actual needs because it takes into account a study of the bank's loan book by Blackrock Solutions which started almost a year ago.
Since then, the deterioration of the Greek economy has been a lot greater than expected with GDP falling 6.8% and the bank's non-performing loans reaching 14% (page 4 in the presentation) of its total loans. The total new funds needed may be as much as €10B if the economy doesn't deteriorate even further. I will use a figure of €8Β for my calculations.
Recently, the Secretary General of the Hellenic Bank Association appeared before the parliamentary economic committee which was discussing the recapitalization of the Greek banks. There, he stated that the Greek banks which are going to be recapitalized by the HFSF will see the Greek state becoming their largest shareholder owning 85%-90% of the common shares outstanding (4th paragraph from the end).
It is planned that the HFSF will contribute 90% of the funds needed. Assuming that the Greek state will own 85% of the outstanding shares of National Bank of Greece after contributing 90% of the funds needed, then the offering price of new shares should be €0.49 as calculated below.
€8Β new funds / €0.49 new share price = 16,326Β new shares
16,326Β new shares + 0.956B old shares = 17.282B total shares
€8Β new funds * 90% HFSF participation = €7.2B HFSF funds
€7.2B HFSF funds / €0.49 new share price = 14.69B HFSF shares
14.69B HFSF shares / 17.282B total shares = 85% HFSF holdings
When the process is completed and if the price is at €0.49, the bank will have a P/B ratio of 1.25 at group level.
As of this moment 25 Eurozone non-Greek banks with over €80B in assets have a 0.58 mean P/B ratio as calculated by Thomson-Reuters.
If National Bank of Greece trades at a similar P/B ratio, then its potential stock price could be €0.22.
Recently Cyprus Popular Bank had to receive financial aid from the Cyprus state, since it had huge losses and negative equity. The capital increase was done at €0.10 per new share which was also the current market price. Right now the stock is trading at €0.043 with a 0.75 P/B ratio. A similar P/B ratio for National Bank of Greece would give a potential trading price of €0.30.
Event B: Greek Eurozone exit
If Greece exits the Eurozone, my assumption is that Greek bank stocks will stop trading for a period of several days to several weeks. When they resume trading their prices will decrease to €0.10 and below.
In case of event A, the potential return is 76%-88% (€0.22<P<€0.49).
In case of event B, the potential return is 95% (P<€0.10).
Timing and technicals
It is reported that the final terms of the recapitalization which are the catalyst for "Event A" will be announced before the end of this month. If the announcement is delayed the stock may continue higher.
Based just on technical criteria the stock has shown some signs of momentum weakness. However, it has crossed the 200SMA and can move at least 17% higher before finding the next resistance point.
Conclusion and risks
In order to suffer permanent capital loss from the above investment operation, the issuance of new shares must be done at an unduly high level compared to the bank's value. Unfortunately, governments in general are known to make bad investment decisions time after time. This is something the investor must have in mind and proceed carefully.
Disclosure: I am short NBG.