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Developments in the retail banking market the bank analyst’s perspective

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European Retail Banking –
the Analyst’s perspective
Leigh Goodwin
+44 (0) 1883 331135
+44 (0) 7970 057578
leigh_rookcottage@yahoo.co.uk
March 2012
2
European Banks: Challenging Times, pre 3yr LTRO
Equity Valuations Dropped, US and Europe Converged
–
European and US bank multiples both dropped below 1x tangible book in Aug
-
2011 for the first time since 1Q09.
US, UK and Eurozone Bank Valuations Converged
–
Anomalously, US banks, typically valued at a premium, traded in line with European banks. For most investors, US banks appear more attractive given (1) fewer funding & sovereign concerns, (2) better economic growth, and (3) greater divergence from its long term valuation trend.
Record Valuation Dispersion
–
the ratio between the highest and lowest rated quintiles of European banks (by P/TBV) spiked well above previous peaks; for some time contradicting the historic ‘Buy Value’ signal.
Credit Spreads Blew Out
–
Recent trends in credit markets have been worse than in equity markets. CDS spreads were worse for European banks than in 2008
-
09 crisis. Cash markets have largely been frozen.
Capital Raised But Enough?
–
European banks added around €
300bn of core Tier 1 capital 2008
-
11, an increase of over 50%. But as bank share prices showed, sovereign risk fears can outweigh increased capital levels.
Economic Outlook Worse
–
Global economic prospects continue to worsen sharply and we expect shrinkage for many peripheral Euro countries in 2012. Consensus earnings downgrades will continue, in our view.
3 Year LTRO Averted Near
-
Term Disaster, but Time For a Funding Re
-
Think?
–
Central bank action means we are not worried about short term liquidity. But longer term funding for Euro banks is more worrying. Euro banks have changed a bit, but likely not enough. Significant balance sheet restructuring is necessary.
Global Credit Crunch? –
Western European banks account for c50% of global bank assets, but just c25% of equity. Euro ex
-
UK banks are deleveraging and withdrawing from EM banking. In Asia the rise of the rest should offset this, but CEE could be vulnerable.
7
US vs Europe –
P/TBV
European banks still trade below book value; US banks around book value
For most investors, US banks appear more attractive given (1) fewer funding & sovereign concerns, (2) better economic growth, and (3) greater divergence from its long term valuation trend
8
US Banks More Profitable
Note: Historicals: 1984
-
2010; Estimates: 2011E
-
2012E
9
‘Quality’ Banks Trading at Record Highs
The valuation dispersion within the European banks sector –
ratio of highest P/BV quintile vs lowest –
reached levels in August 2011 that historically represented a ‘BUY’ signal (and ‘BUT VALUE’) signal.
However, the ‘quality’ banks continued to outperform until the ECB announced the 3 year LTRO programme in December 2011.
This has prompted a ‘Dash for Trash’ as in 2Q09; but beware –
that rebound lasted 6 months, then reversed over the subsequent 2 years. The market figured out that the problem banks hadn’t really been fixed
10
TMT vs Banking Bubble
11
European Banks: Challenging Times, pre 3yr LTRO
Equity Valuations Dropped, US and Europe Converged
–
European and US bank multiples both dropped below 1x tangible book in Aug
-
2011 for the first time since 1Q09.
US, UK and Eurozone Bank Valuations Converged
–
Anomalously, US banks, typically valued at a premium, traded in line with European banks. For most investors, US banks appear more attractive given (1) fewer funding & sovereign concerns, (2) better economic growth, and (3) greater divergence from its long term valuation trend.
Record Valuation Dispersion
–
the ratio between the highest and lowest rated quintiles of European banks (by P/TBV) spiked well above previous peaks; for some time contradicting the historic ‘Buy Value’ signal.
Credit Spreads Blew Out
–
Recent trends in credit markets have been worse than in equity markets. CDS spreads were worse for European banks than in 2008
-
09 crisis. Cash markets have largely been frozen.
Capital Raised But Enough?
–
European banks added around €
300bn of core Tier 1 capital 2008
-
11, an increase of over 50%. But as bank share prices showed, sovereign risk fears can outweigh increased capital levels.
Economic Outlook Worse
–
Global economic prospects continue to worsen sharply and we expect shrinkage for many peripheral Euro countries in 2012. Consensus earnings downgrades will continue, in our view.
3 Year LTRO Averted Near
-
Term Disaster, but Time For a Funding Re
-
Think?
–
Central bank action means we are not worried about short term liquidity. But longer term funding for Euro banks is more worrying. Euro banks have changed a bit, but likely not enough. Significant balance sheet restructuring is necessary.
Global Credit Crunch? –
Western European banks account for c50% of global bank assets, but just c25% of equity. Euro ex
-
UK banks are deleveraging and withdrawing from EM banking. In Asia the rise of the rest should offset this, but CEE could be vulnerable.
13
Capital Increase: European Banks
16
Top 2011E Dividend Payers
Source: Company data, CIRA estimates
European Bank Sector –
Top 10 Dividend Payers 2011E
(% of Dividend Pool)
Global Bank Sector –
Top 10 Dividend Payers 2011E (% of Dividend Pool)
17
Look Back At The US & TARP –
liquidity mattered more than capital
18
Unsecured Markets Have Shut Down
Significant financing needs of European banks in 1H12 necessitated ECB action with 3 year LTRO programme announced in December 2011
19
European Banks -
Short Term Funding
20
European Banks: Challenging Times, pre 3yr LTRO
Equity Valuations Dropped, US and Europe Converged
–
European and US bank multiples both dropped below 1x tangible book in Aug
-
2011 for the first time since 1Q09.
US, UK and Eurozone Bank Valuations Converged
–
Anomalously, US banks, typically valued at a premium, traded in line with European banks. For most investors, US banks appear more attractive given (1) fewer funding & sovereign concerns, (2) better economic growth, and (3) greater divergence from its long term valuation trend.
Record Valuation Dispersion
–
the ratio between the highest and lowest rated quintiles of European banks (by P/TBV) spiked well above previous peaks; for some time contradicting the historic ‘Buy Value’ signal.
Credit Spreads Blew Out
–
Recent trends in credit markets have been worse than in equity markets. CDS spreads were worse for European banks than in 2008
-
09 crisis. Cash markets have largely been frozen.
Capital Raised But Enough?
–
European banks added around €
300bn of core Tier 1 capital 2008
-
11, an increase of over 50%. But as bank share prices showed, sovereign risk fears can outweigh increased capital levels.
Economic Outlook Worse
–
Global economic prospects continue to worsen sharply and we expect shrinkage for many peripheral Euro countries in 2012. Consensus earnings downgrades will continue, in our view.
3 Year LTRO Averted Near
-
Term Disaster, but Time For a Funding Re
-
Think?
–
Central bank action means we are not worried about short term liquidity. But longer term funding for Euro banks is more worrying. Euro banks have changed a bit, but likely not enough. Significant balance sheet restructuring is necessary.
Global Credit Crunch? –
Western European banks account for c50% of global bank assets, but just c25% of equity. Euro ex
-
UK banks are deleveraging and withdrawing from EM banking. In Asia the rise of the rest should offset this, but CEE could be vulnerable.
21
Funding Change: Deposits to Assets, LDR’s
European banks have not addressed the funding challenge; US banks have; UK banks are doing so
22
European Banks: Challenging Times, pre 3yr LTRO
Equity Valuations Dropped, US and Europe Converged
–
European and US bank multiples both dropped below 1x tangible book in Aug
-
2011 for the first time since 1Q09.
US, UK and Eurozone Bank Valuations Converged
–
Anomalously, US banks, typically valued at a premium, traded in line with European banks. For most investors, US banks appear more attractive given (1) fewer funding & sovereign concerns, (2) better economic growth, and (3) greater divergence from its long term valuation trend.
Record Valuation Dispersion
–
the ratio between the highest and lowest rated quintiles of European banks (by P/TBV) spiked well above previous peaks; for some time contradicting the historic ‘Buy Value’ signal.
Credit Spreads Blew Out
–
Recent trends in credit markets have been worse than in equity markets. CDS spreads were worse for European banks than in 2008
-
09 crisis. Cash markets have largely been frozen.
Capital Raised But Enough?
–
European banks added around €
300bn of core Tier 1 capital 2008
-
11, an increase of over 50%. But as bank share prices showed, sovereign risk fears can outweigh increased capital levels.
Economic Outlook Worse
–
Global economic prospects continue to worsen sharply and we expect shrinkage for many peripheral Euro countries in 2012. Consensus earnings downgrades will continue, in our view.
3 Year LTRO Averted Near
-
Term Disaster, but Time For a Funding Re
-
Think?
–
Central bank action means we are not worried about short term liquidity. But longer term funding for Euro banks is more worrying. Euro banks have changed a bit, but likely not enough. Significant balance sheet restructuring is necessary.
Global Credit Crunch? –
Western European banks account for c50% of global bank assets, but just c25% of equity. Euro ex
-
UK banks are deleveraging and withdrawing from EM banking. In Asia the rise of the rest should offset this, but CEE could be vulnerable.
31
Pan Euro Banks –
Half the World
32
Credit Crunch Abroad?
33
European Banks: Sovereign Risk crisis at the heart of recent concerns
Capital Raised, but how much is enough given exposure to own sovereign?
–
European bank share prices show that sovereign risk fears can outweigh increased capital levels. As well as the risk of sovereign debt haircuts (PSI contagion’?) and potential eurozone breakdown, banks in weaker peripheral economies face restricted access to equity capital markets, funding difficulties/costs, and the effects of economic austerity on growth and credit quality. A DM not EM Sovereign Risk Crisis –
Unusually, in historic terms, this is a crisis of developed economies. This gives it a very different political dynamic to previous sovereign crises. ‘Won’t Pay’ not ‘Can’t Pay’ phenomenon
–
This isn’t about nations facing mass poverty; it’s about politics, denial, blame and over
-
consumption in the past. Economic History offers little reason for optimism
–
Historically, when major nations such as the US and UK have recovered from peaks in fiscal debt/GDP (usually post
-
war) fiscal tightening has NOT contributed positively to the reduction in the debt burden (the opposite, in fact). Nominal GDP growth (real + inflation) has been the driver. What are the chances of this is Europe?
New fiscal austerity agreements and bail
-
out, but will they work or help the banks?
–
Will economic and fiscal reforms really be implemented –
the new Greek deal doesn’t resolve the implementation failures in the past? –
Will politics/’debt fatigue’ undo them before they have time to take effect? –
Will they really reduce fiscal deficits and longer
-
term debt burdens in practice, even if implemented? –
Won’t 120% debt/GDP still be too high? –
Could it be a case of ‘the operation was a success, but the patient died’?
–
Could banks simply be nationalised to ensure they lend or for political reasons?
34
Macro –
EM Opportunities, DM Headwinds
Source: IMF & CIRA
35
European Banks: Sovereign Risk crisis at the heart of recent concerns
Capital Raised, but how much is enough given exposure to own sovereign?
–
European bank share prices show that sovereign risk fears can outweigh increased capital levels. As well as the risk of sovereign debt haircuts (PSI contagion’?) and potential eurozone breakdown, banks in weaker peripheral economies face restricted access to equity capital markets, funding difficulties/costs, and the effects of economic austerity on growth and credit quality. A DM not EM Sovereign Risk Crisis –
Unusually, in historic terms, this is a crisis of developed economies. This gives it a very different political dynamic to previous sovereign crises. ‘Won’t Pay’ not ‘Can’t Pay’ phenomenon
–
This isn’t about nations facing mass poverty; it’s about politics, denial, blame and over
-
consumption in the past. Economic History offers little reason for optimism
–
Historically, when major nations such as the US and UK have recovered from peaks in fiscal debt/GDP (usually post
-
war) fiscal tightening has NOT contributed positively to the reduction in the debt burden (the opposite, in fact). Nominal GDP growth (real + inflation) has been the driver. What are the chances of this is Europe?
New fiscal austerity agreements and bail
-
out, but will they work or help the banks?
–
Will economic and fiscal reforms really be implemented –
the new Greek deal doesn’t resolve the implementation failures in the past? –
Will politics/’debt fatigue’ undo them before they have time to take effect? –
Will they really reduce fiscal deficits and longer
-
term debt burdens in practice, even if implemented? –
Won’t 120% debt/GDP still be too high? –
Could it be a case of ‘the operation was a success, but the patient died’?
–
Could banks simply be nationalised to ensure they lend or for political reasons?
36
Banks face Fundamental Challenges on Top of Sovereign Risk Politics –
Banks are universally unpopular. They are ‘blamed’ for the economic crisis, ‘fail’ to lend, and are seen as paying egregious bonuses to staff. Regulation
–
A degree of ‘regulatory forbearance’ has been evident in Europe (less so the UK) due to concerns about bank lending; but the regulatory agenda remains negative for bank profitability.
–
Basel capital and liquidity requirements
–
Resolution/bail
-
in regimes
–
Consumer ‘protection’ End of the 30 year ‘Bull Market’
–
we’re at the conclusion of a 30 year process of credit expansion, falling inflation and interest rates, and globalisation. This impacts revenue growth prospects
–
The scope for asset and deposit accretion is limited; deleveraging by households has a long way to run in many economies, re
-
risking by investors limits activity and volumes.
–
Interest rates remain low, compressing margins
–
When rates rise, credit quality is likely to suffer –
corporate default rates in Europe are already rising
–
Lack of job creation given pressure on retail, financial and public sectors, combined with more evident growth in inequalities in income and wealth, have led to a ‘crisis of capitalism’ and social unrest.
Returns on Equity are Structurally Lower
–
Lower leverage, higher minimum capital requirements
–
Regulatory changes has increased risk
-
weightings on may assets and activities
–
Liquidity less certain, more expensive; deposit margins compressed by competition and low rates
–
New consumerist regulation limits new revenue opportunities, eg PPI in the UK. 37
Banking Activity Penetration (Loans/GDP)
Source: IMF, EuroStat and CIRA
World Economies –
Loans to GDP, 2010A
–
EM remains ‘underbanked’ relative to developed Europe –
China and South Africa have the highest loan to GDP ratios among EM countries –
Chinese bank lending statistics are distorted by the role of the State
–
Peru, Mexico and Nigeria have the lowest loan to GDP ratios, about half the level of major EM markets and about a fifth of China’s
European Economies –
Loans to GDP, 2010A
38
Banks face Fundamental Challenges on Top of Sovereign Risk Politics –
Banks are universally unpopular. They are ‘blamed’ for the economic crisis, ‘fail’ to lend, and are seen as paying egregious bonuses to staff. Regulation
–
A degree of ‘regulatory forbearance’ has been evident in Europe (less so the UK) due to concerns about bank lending; but the regulatory agenda remains negative for bank profitability.
–
Basel capital and liquidity requirements
–
Resolution/bail
-
in regimes
–
Consumer ‘protection’ End of the 30 year ‘Bull Market’
–
we’re at the conclusion of a 30 year process of credit expansion, falling inflation and interest rates, and globalisation. This impacts revenue growth prospects
–
The scope for asset and deposit accretion is limited; deleveraging by households has a long way to run in many economies, re
-
risking by investors limits activity and volumes.
–
Interest rates remain low, compressing margins
–
When rates rise, credit quality is likely to suffer –
corporate default rates in Europe are already rising
–
Lack of job creation given pressure on retail, financial and public sectors, combined with more evident growth in inequalities in income and wealth, have led to a ‘crisis of capitalism’ and social unrest.
Returns on Equity are Structurally Lower
–
Lower leverage, higher minimum capital requirements
–
Regulatory changes has increased risk
-
weightings on may assets and activities
–
Liquidity less certain, more expensive; deposit margins compressed by competition and low rates
–
New consumerist regulation limits new revenue opportunities, eg PPI in the UK. 39
European Banks –
Winners and Losers The ‘Repricing Challenge’ –
which banks (and national industries) have the competitive advantage and pricing power to be able to reprice bank products and services to compensate for the regulatory and economic challenges to revenues? Exposure to higher growth EMs
–
Asian and LatAm economies offer revenue growth opportunities in retail and wholesale banking. CEE could be challenges by European bank devereraging. Sovereign matters
–
we prefer banks domiciled in strong sovereign, mostly Nordics and Northern Europe. Funding costs and access to capital markets are likely to be better for these banks.
Self
-
sufficient Funding
–
the LTRO programme buys time for many weaker banks, but it cannot go on indefinitely. What happens when these loans need to be refinanced? We don’t expect major bank failures, but we do expect some enforced restructuring of balance sheets and shareholders may not be so protected as in 2009. We prefer banks with strong deposit or secured funding franchises. Unencumbered Assets
–
pre
-
LTRO, over 20% of European bank assets were already encumbered; post
-
LTRO this is likely to be considerably higher. Unsecured funding markets are likely to remain effectively closed for many banks. This will add to the ‘nationalisation’ of the funding structures of many weaker banks. Cost control
–
in an era of delveraging and challenged revenues, the ability and willingness of management to cut costs is essential for value
-
creation. Trends in 2H11 were not very encouraging, but management guidance is more optimistic. The jury is out.
41
Market Value and Lending Penetration Source: Company reports, IMF and CIRA. Note: Size of bubbles represents banks sector market cap
Market Cap
-
to
-
GDP, Loans
-
to
-
GDP (2010A) and Bank Sector Market Cap
China’s high bank lending ratio is a reflection of its low direct State borrowing and the use of State
-
owned banks intermediating credit to State
-
owned firms
Most EM countries have low loan
-
to
-
GDP ratios and relatively high market cap
-
to
-
GDP ratios
Nigeria, Mexico, Peru and Indonesia have the lowest loans
-
to
-
GDP ratios
42
Market Value and Margins
Source: Company reports, IMF and CIRA
Note: Size of bubbles represents banks sector market cap
Market Cap
-
to
-
GDP, NIM on Average Total Assets (2010A)
and Bank Sector Market Cap
High
-
margin countries have high market cap
-
to
-
GDP –
but several medium margin countries with high leverage also have high market cap
-
to
-
GDP
Countries with low absolute and risk
-
adjusted margins typically have low market cap
-
GDP and are usually mature economies
Market Cap
-
to
-
GDP, (NIM –
Bad Loan Expense) on Average Total Assets (2010A) and Bank Sector Market Cap
43
APPENDIX –
supporting material
44
Sovereign Financing Needs
45
EBA Identified Capital Shortfalls (2)
46
Bank Deleveraging and Expense Cutting Plans
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