Banking on a recovery
The recent Asset Quality Review and Stress tests carried out by the ECB certainly garnered a lot of newspaper headlines and media comment, if not that much broad reaction in the share prices of major European banks. The sector index for Eurozone banks only moved marginally in the days after the announcement of the results.
While the stress tests may have been making the headlines, at Appian we were actually paying more attention to a less high profile report from the ECB just two days after the comprehensive assessment – the quarterly survey of bank lending standards (BLS). The Bank surveys 137 banks across the Eurozone to assess whether they are loosening or tightening their credit standards for lending to companies and households. Ultimately the key factor for the overall Eurozone economy will be whether credit is getting into the real economy to spur growth. According to the survey, credit standards for all loan categories became more relaxed in net terms in the third quarter of 2014, following on from a similar easing in Q2. This was mainly driven by an improvement in banks’ liquidity positions and access to market funding.
There was some evidence of banks being a bit more cautious based on the general economic outlook and factoring that into their lending decisions. This will be an important feature to watch as policy confusion between the different stakeholders, namely the Central bank and some individual governments, is currently acting as a drag on economic momentum.
The good news in the survey was that the percentage of banks reporting an increase in loan demand is on the up across both companies and consumers. Importantly the banks expect a continued increase in loan demand across all categories in this final quarter of the year.
It’s clearly still fragile. Bank balance sheets may be healing but are far from robust health and this means that banks are still being very cautious in their lending policies. Banks still have high leverage ratios which means small amount of equity relative to their actual assets. These high leverage ratios impair the ability of banks to finance growth. This can lead banks to seek to make heavily collateralised loans, against property for example or to hold highly rated assets. What we need is bank lending for productive and sustainable growth. Today credit supply in Eurozone is still very constrained. By contrast in the US, bank lending growth has just reached a six-year high.
We currently hold no Eurozone banks in our portfolio, but we do keep a close eye on trends in lending and capital as it is a critical part of the economic recovery story. We hold large well capitalised banks such as Wells Fargo and HSBC, with dominant franchises, solid business models and trading at attractive valuations. Elsewhere we own stocks such as UBS where we believe there is long term potential in areas such as wealth management.
We remain very selective in our holdings in this sector but vigilant on its overall prospects as we believe banking will play a pivotal role in the Eurozone economic recovery.