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How to Trade Moody's Downgrade of Greek Banks

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Moody's Investors Service downgraded 8 Greek banks on Friday, citing the banks' exposure to Greek government bonds and a worsening Greek economy.

Earlier this year, all of Greece's major banks agreed to a government bond swap that resulted in them reporting billions of euros in losses, which hurt the banks' bottom lines but did little to reduce talk of a Greek default.

Despite already losing billions of euros from their Greek government debt holdings, those losses could rise further in the event of a default. Greek banks are also facing the difficulty of operating in a weakening economy in which non performing loans are on the rise.

Moody's said in it's report that the main factors behind its downgrade of Greek banks were:

"(1) The impact of recent impairments of Greek government bonds (GGBs), and the increasing risk of significant additional impairments of GGBs, on banks' capital levels. (2) The expected impact of the deteriorating domestic economic environment on non-performing loans (NPLs) and potential additional provisioning costs from the upcoming diagnostic asset quality study, initiated by BoG and to be conducted by external consultants (BlackRock). (3) Declines in deposit bases and still fragile liquidity positions, as illustrated by limited remaining eligible collateral for funding from the European Central Bank (ECB) and the recent activation of Emergency Liquidity Assistance (ELA) by the Bank of Greece (BoG)."

A number of events that have been in the news recently support Moody's Investors Service's decision to downgrade Greek banks.

Greece is due to receive an 8 billion euro installment from its bailout fund from the International Monetary Fund (IMF), European Central Bank (ECB), and the European Commission (EC). However, Greece's creditors haven't been satisfied by its efforts to implement austerity measures aimed at reducing the country's deficit. German Finance Minister Wolfgang Schaeuble recently warned that bailout funds would be withheld if Greece didn't convince its creditors that it was complying with all the agreements that it made in order to receive the bailout money. If the 8 billion euros are withheld, Greece could default within weeks.

Further complimenting matters is the deteriorating situation inside Greece. The economy is falling deeper into recession and unemployment is rising. Much of the Greek Capitol of Athens was at a standstill yesterday as transit workers went on strike protesting the latest round of austerity measures, which include raising taxes for many of Greece's lowest paid workers. Prime Minister George Papandreou has vowed that Greece will not default but the intense pressure he is facing from the Greek people could eventually force him to break his promises to international lenders.

If the downgrade of Greeks biggest banks by Moody's Investors Service is the latest indicator that a Greek default is coming, investors might want to move their money into safe haven currencies like the Swiss frank or the Japanese yen. The CurrencyShares Swiss Franc Trust (NYSE: FXF) or the CurrencyShares Japanese Yen Trust (NYSE: FXY) ETFs allow investors to easily make this FOREX play and move cash into these two currencies that often see inflows during times of global financial turmoil.

A default by Greece could lead to defaults in other troubled eurozone countries like Portugal, Ireland and Italy. If such a domino effect were to occur, it could be the end of the euro. Investors who feel that this is a likely scenario could buy the ProShares UltraShort Euro (NYSE: EUO) or the Market Vectors Double Short Euro (NYSE: DRR) if they are looking to profit from an eventual collapse of the euro.

Investors who think that Greece will be able to get through this difficult period without defaulting might want to buy shares of one of the banks downgraded by Moody's, National Bank of Greece (NYSE: NBG). Although Greek banks are risky plays, they also have huge upside potential. Many traders believe that a Greek default is going to happen in the near future, so the stock of any financial institution with much exposure to Greek debt has already been driven down. If Greece avoids a default, National Bank of Greece could see its share price soar.

Investors who want to trade on the belief that Greece will avoid a default may want to consider the iShares MSCI Europe Financials (Nasdaq: EUFN) ETF if they'd prefer a security that is less risky than an individual Greek banking stock. Many European financial institutions have a great deal of Greek government debt in their holdings, so they have also seen their share prices falling. The iShares MSCI Europe Financials ETF allows investors to buy an assortment of European financial stocks. This ETF should also move significantly higher if Greece avoids a default, without as much possible downside as the National Bank of Greece ADR.

 

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