Deposits are growing and lending set to recover but AQR looms large for Eurozone

 

EY LLC, Kyiv, Ukraine, 
Wednesday, October 23, 2013

·         Bank deposits to increase3.2% this year, the highest rate of growth since 2010

·         Eurozone banks will lend€4.6t to business in 2014 – 3.8% more than in 2012

·         AUM growth to average 3.9%between 2014 and 2017, well below historic average

LONDON, 23 OCTOBER 2013. Thereturn to growth in the Eurozone economy is fuelling a recovery in key driversof profitability for financial services, with companies looking to borrow againand cash flow for households and businesses has improving. But the road aheadis not without obstacles according to The EYEurozone Financial Services Forecast (EEFSF).The upcoming Asset Quality Review (AQR) and the insurance industry’svulnerability to changes in interest rates present challenges.

Marie Diron, SeniorEconomic Adviser to the EEFSF, says: “The Eurozone has emerged from its longestrecession in at least three decades and, although GDP is expected to fall by0.5% this year, activity will gradually pick up. As a result the growth insupply and demand for financial services is starting to return.”

Andy Baldwin, Global Headof Financial Services at EY, adds: “Over the summer we saw signs that asustainable economic recovery in the Eurozone may finally be underway. But anumber of challenges remain before we will see a return to profitability and,more importantly, stability in financial services. Not least the unintendedconsequences and legacy of well-intentioned regulation.”

AQR process coincides with renewed demand for capital from the realeconomy

After contracting for sevenconsecutive quarters, business investment is expected to pick up again thisyear. Improving GDP growth and credit conditions are gradually feeding anincreased willingness to borrow. After a contraction of 2% in 2013, Eurozonebanks are forecast to lend €4.6t to business in 2014 – 3.8% more than in 2012.Growth in business lending is forecast across all the major Eurozone economiesin 2014. In Italy it is forecast to grow 3.8%, in Spain it will grow 3.2% andin France and the Netherlands it is predicted to grow 2.7%. Signs that exportsare at last beginning to revive will drive particularly strong growth in lendingin Germany - 5% in 2014.

Consumer credit conditionseased in Q2 2013 for the first time since 2007. Consumer lending is predictedto grow by 1.7% overall in 2013, but this growth will be centered in Germanyand France, where lending will increase by 3% and 2.6% respectively. In Italy,Spain and the Netherlands lending to consumers will not start to grow until2015.

Residential mortgage lendingis already expanding again this year in Germany, France and the Netherlands butnot until 2014 in Italy and 2015 in Spain.

Andy says: “The forecastsshow that cash flow is improving and companies are ready to borrow. But,somewhat ironically, just as credit demand starts to recover, the banks arepreparing for the AQR and the further balance sheet pressures this may cause.Whether the AQR will allow banks to begin the transition to growth agenda orwill trigger a further round of restructuring and capital raising is hard tosay, but it has the potential to push recovery out to beyond 2014 andpotentially even further in some markets.”

Bank deposits are growing rapidly in all core markets

Bank deposits are growingrapidly at a forecast rate of 3.2% in 2013 and 3.6% in 2014, considerablyhigher than the 0.9% growth seen in 2012.

Deposits are growing acrossall the major markets. In France they will grow 3.8%, up from 3% in 2012; inGermany they will grow 3%, up from 1.7% in 2012; in The Netherlands they willgrow 6.5%, up from 4.2% in 2012; and in Spain they will grow 2.1% this year,after shrinking 3.9% in 2012. In Italy however, while growth is still strong at5% it is below last year’s rate of growth which was 7.9%.

Bank operating income to increase by 7% in 2014, the fastest rate since2009

Non-performing loans willpeak at 7.8% of total loans in 2013, falling to 4.6% in 2017. And, while totalbank operating income (profit realized after taking out operating expenses) willimprove by just 1% this year, it is set to rise by 7.1% in 2014, as banks putthe worst of the provisioning behind them.

Robert Cubbage, Banking andCapital Markets Leader for Europe, the Middle East, India and Africa (EMEIA) atEY comments: “Operating income growth has been anemic or negative for the last fouryears but a number of factors should contribute to increasing profitability inmost markets next year. As economic recovery and a steeper yield curve boostlending and net interest margins, banks’ operating income is forecast to increaseconsiderably in 2014.  If the forecastshold good, banks’ operating income should sustain growth of around 7% for thenext three years.”

Continued low interest rates pose an existential threat to some insurers

Interest rates are forecastto remain low until H2 2017, when the ECB is expected to start raising the rateslowly from the current 50bp to 100bp by the end of 2017.

Andreas Freiling, EMEIAInsurance Leader, says: “European insurers remain very vulnerable to interestrate changes. While rapid interest rate rises could hit profits, growinglongevity risks mean that low interest rates are putting balance sheets underever-greater pressure. If the ECB keeps rates at their current levels until2017, this will create a serious challenge to the life industry. Another twoyears of very low rates will pose an existential threat to some Europeaninsurers.”

AUM growth to average 3.9% from 2014 to 2017, well below 6.7% historicaverage

Although Assets Under Management (AUM) grewjust 2% in H1 2013, assets in pan-Eurozone funds are still forecast to grow by6.1% this year to €4,817b. However, this is just half the 12% rate of netexpansion in 2012, and average AUM growth is expected to reduce further to 3.9%between 2014 and 2017, well below the historic average of 6.7%.

The forecast for AUM growthacross the Eurozone varies considerably, reflecting investors’ exit from safehaven bonds in France and Germany as they search for value in peripheralEuropean markets. Driven by investment in bonds, total AUM growth remainsstrong in Italy (8% yoy) and Spain, (15.8% in 2013 and 9.6% in 2014).Incontrast, after growth of 6.3% in 2012, assets in The Netherlands are expectedto stagnate this year, as the country is seen as a low-yielding core market incomparison to the periphery.

While total AUM growth inGermany this year is strong ( 6.7%), it tails off from 2014. However, afterseveral tough years for German property funds, AUM is forecast to increase 2%this year and build steadily to reach 4.4% annual growth by 2017.

In France total AUM willfall 4.4% this year and another 1.6% in 2014, settling at an anemic 1-1.8%growth for the following three years. This reflects investors exiting Frenchbonds but also outflows from money market funds, which make up half the Frenchmarket.

Roy Stockell, EMEIA andAsia-Pac Leader for Asset Management at EY, says: “While the movement in AUMs primarilyreflects movement in and out of bonds, neither bonds nor equities will offermanagers an easy route to growth. Instead, managers will continue to broadentheir horizons and many are keen to explore setting up funds as lendingplatforms, for infrastructure and potentially SMEs, which promise much betterreturns than low-yielding bonds.”

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