Quarterly Investment Guide

US investors getting burned on Greek bank bets

By Nasos Koukakis, special to CNBC

Renowned fund managers who invested hundreds of millions of dollars in the troubled Greek banks are trapped in uncertainty caused by the political developments in Greece and global financial turmoil.

A pedestrian passes a graffiti damaged sign at the entrance to a main branch of the National Bank of Greece in Thessaloniki, Greece, on Wednesday, July 1, 2015.
Konstantinos Tsakalidis | Bloomberg | Getty Images

John Paulson, Prem Watsa, Wilbur L. Ross and other funds, such as Brookfield Capital Partners, Capital Research & Management, Mackenzie Cundill, Schroder Investment Management and Wellington Management are among those who invested more than 10 billion euros ($11.3 billion) of capital in the Greek banking system over the past couple of years.

Many of them saw the $6.7 billion worth of investments in Greek banks that they made in February 2014 evaporate just a year later, under the . Although they lost their initial bet on Greek banks, last November they dared to put an additional 4 billion euros ($4.45 billion) worth of funds into the Greek banking system.

Until recently, these foreign investors argued their investments in Greek banks were promising, as their stocks traded at a third or less of their tangible book value. They were confident that as the Greek economy would start to grow, bank reserves and earnings would improve pushing up Greek bank stock valuations. The same investors saw great value in the portfolios of nonperforming loans of Greek banks and believed that 20 percent of these bad loans could be recovered.

A man withdraws cash from an ATM outside a National Bank branch in Athens.
The $400 billion ripoff that could destroy the Greek bailout

But this bet has been disastrous: three months later they lost 61 percent of their initial investment. Greek bank shares have plunged as uncertainty over yet another stalled bailout review weighs on the country's economic recovery prospects.

This development contradicts fund managers' expectations that things could turn around after the harsh pain of bank recapitalization. Alarmed at their loss, the heads of Paulson & Co and Fairfax Financial Holdings met 10 days ago, in late January, with the Greek Prime Minister Alexis Tsipras to discuss the prospects of the Greek economy.

The investors reportedly stressed to the Greek prime minister that the completion of the review of Greece΄s adjustment program will have a major impact on the economy. Therefore, time is a crucial parameter: The earlier it is completed, the faster the economy will recover. Tsipras assured investors of the government's determination to proceed with the necessary reforms, privatizations and creation of an attractive environment for investments. He also told them the bailout review will be completed by the end of March.

The situation changed after the recent visit of the IMF, EU, European Central Bank and European Stability Mechanism executives in Athens, as the progress in reforms appeared to be less than satisfactory. The dramatic plunge in Greek bank shares can be attributed to the uncertainty generated by the never-ending negotiations between Athens and its creditors, public opposition to the Social Security reform, the farmer blockades and the talk of another snap election.

All this, combined with the strained external environment, led to an investor exodus. Since the start of 2016, the Athens Stock Exchange has sunk 28 percent.

Brokerage sources note that Fairfax, Capital Research, Wilbur Ross, Fidelity, Mackenzie and Brookfield, who recently participated in the capital increases of the Greek banks, did not sell their shares, despite suffering losses of more than 55 percent on their investments.

In contrast, KKR, Wellington and Credit Agricole sold their Greek banking stocks en masse over the last two weeks, with damages in relation to the purchase price. These sales, among others, resulted in the precipitation of the Greek stock market.

Is it Cyprus all over again?

The president of the Hellenic Capital Market Commission, Charalampos Gotsis, told CNBC that the Greek stock market decline is due to the activation of many stop-loss orders, especially for bank shares. "A stop-loss order is designed to limit an investor's loss on a position in a security. If, for example, the sale order is related with the possibility of a 20 percent share drop — if that will happen — the sale is executed automatically," he said.

Greek bank shares are pricing the probability of a new round of capital injection later this year as a result of an ongoing political and economic uncertainty. If the Greek banks find themselves in need of another recapitalization, this time it will be done with bondholder and depositor money, just like in Cyprus in 2013. Should that be the case, then it is expected that mergers and financial resolutions will follow.

Under pressure from profit decline, the only option for Greek banks is to proactively management bad assets. Danièle Nouy, chair of the supervisory board of the ECB's Single Supervisory Mechanism (SSM), visited Athens this week to meet with Greek banks administrators. Talks focused on the state of the banks following their recapitalization, governance issues and management of nonperforming loans. Nouy told bankers to intensify their efforts, noting that the reduction of 108 billion euros ($121 billion) in bad debts will undoubtedly be a "long journey."

Taking into account that Greek business and household deposits amount to 123 billion euros ($138 billion), it becomes clear that the challenges for the Greek banking system in relation of the credit risk are high. Any deterioration of the economic environment for political or other reasons can be fatal, both for the banks and their investors.

— By Nasos Koukakis, special to CNBC.com