This is an extract from August 2020 edition of The European Long View, a monthly product focussing on banking system top line data in key regions. It supports our idea generation process as it provides a clear analytical framework to corroborate existing and identify new trends.

  • Banking assets as a % of GDP has risen across Europe.  Whilst the swell in banking assets will initially lead to higher income, the Eurozone bank return on assets should actually fall as this balance sheet growth is due to greater holdings of low yielding sovereign bonds and new loans. The ability to generate inflation and have higher rates in time will depend on the persistence of this rise, which in our view is likely to be transitory as much of the new lending is unproductive (current rather than capital spending).
  • There has been strong Non Financial Corporate loan growth across Europe due to drawdown of credit facilities and government guarantees, particularly in France and Spain.  Who will ultimately bear the loss? It is hard to envisage a situation where losses are only borne by the state and not bank shareholders.
  • Banks in France have seen a collapse in lending rates from c.150bps pre-crisis.  This appears uneconomic for any banking system.
  • In Spain, Portugal and Italy, the most recent data suggests the contribution of non-mortgage household lending to overall growth is now falling, a trend we expected post COVID-19.  If this persists, it is potentially a very significant structural trend reversal for NII in these regions. 
  • Portugal’s collapse in household non-mortgage loan growth – non-mortgage loans have buffered the top line of banks since 2012.

Banking assets as a % of GDP has risen across Europe.

Investment implication: We are as yet unsure of the likely medium-term consequences of this for European banks. The swell in banking assets will initially lead to higher income.

That said, the Eurozone bank return on assets should actually fall as this balance sheet growth is due to greater holdings of low yielding sovereign bonds and new loans (front book rates have declined sharply in many regions).

From a stock performance perspective, the rise in banking assets could also ultimately provide an inflationary impulse and a catalyst for a change in the rate environment. However, our initial reaction is to remain cautious on the sustainability of this prospect. For this to happen:

  1. The banking assets to GDP ratio would have to rise persistently (the move in 2020 might prove to be a transitory impulse);
  2. Many of these new loans are unproductive (current, not capital spending) which implies firms may seek to quickly repay once the economy normalises; and
  3. If the latter does not occur and NPEs rise, the allocation of losses between the state and the banks will most likely become a political issue (despite the presence of guarantees). This may have long-term implications for bank earnings power (and their ability to lend productively). 

Strong NFC loan growth across Europe due to drawdown of credit facilities and government guarantees, particularly in France and Spain.

Investment implication: Whilst immediately beneficial to the top line, the quality of this lending and who will ultimately bear the loss is somewhat unclear. It is hard to envisage a situation where losses are only borne by the state and not bank shareholders. The evolution of this debate is covered in our monthly Insights report.

France: NFC loan rates remain significantly below year-end levels. The banks in France were lending at front book rates of c. 150bps pre-crisis, but this has collapsed. This appears uneconomic for any banking system.

Investment implication: Persistence of this will be negative for the banking business top line of French banks.

The customer spread in Italy is also collapsing. 

Spain, Portugal and Italy: Increased importance of non-mortgage household lending.

Investment implication: Non-mortgage lending is cyclical and shorter duration (1-2 years) and this has aided the top line of most banks in these regions since 2012. Most recent data suggests this contribution to overall growth is now falling. We had expected this trend to emerge post COVID-19 as detailed in prior reports. If it persists in the coming months, it is potentially a very significant structural trend reversal for NII in these regions.

Portugal: Collapse in household non-mortgage loan growth.

Investment implication: Loan growth in this area has buffered the top line of Portuguese banks since 2012. A weaker growth rate going forward will be negative for the NII of BCP.