Deutsche Bank Research analysts Jan Schildbach and Claudius Wenzel analyze the factors leading to a sharp divide between the performance and outlook of the European banks vis-à-vis their U.S. counterparts.
“On the one hand, US banks are back at pre-crisis record profitability levels – indeed, in Q2 this year they reported their highest quarterly net income ever (USD 42 bn). On the other, European institutions are struggling to find new ground in a profoundly changed, politically and economically more challenging operating environment…”
The yawning gap
The stock market, that ruthless arbiter, has shown clearly that investors favor U.S. banks – the Dow Jones U.S. Banks Index (INDEXDJX:DJUSBK) is up nearly 80% in the last two years, double that of European banks.
European banks market capitalization
Another measure, market capitalization, presents an even starker contrast. European banks held about half the aggregate market cap of the 25 biggest financial institutions, pre-crisis. The analysts estimate that this share has dwindled to just 17.5% currently. U.S. banks, however, managed to increase their slice of the pie from 22% in 2009 to 31% today.
Even earnings have diverged significantly, as clear from the chart below. The analysts point out that U.S. banks reported net income in 2012 (USD 141 bn) that was up by 20% year-over-year in America, but down another 43% in Europe (to EUR 16 bn), from an already disastrous previous year performance.
Why are the two largest and most advanced banking systems in the world diverging so widely?
GDP growth in the U.S. has been positive over the past 2.5 years, whereas the European economy is showing signs of emerging from recession only now, and economists fear that growth could be low for some time more.
The analysts cite the aggressive Fed, the reserve currency status of the dollar, global confidence in the solvency of the U.S., a flexible labor market and a relatively distributed intensity (not closely interlinked as in Europe) of its trade as the reasons for the superior economic performance of the U.S.
Revenues down in Europe but stable in the U.S.
Whereas U.S. banks have recorded revenues that have been higher than before the crisis, European bank revenues have been sliding and are lower than pre-crisis levels. The main reason is improved corporate lending due to the better economic climate in the U.S.
Real estate excesses not yet corrected
The analysts point out that the housing market in the U.S. has already corrected by over 20% from pre-bubble levels in 2007, and the path to a sustained recovery looks much more promising. The rising issuance levels of mortgage-related securities are a pointer to this. In contrast, housing prices in European countries such as France, Sweden or the UK are still out of sync with fundamentals and remain at high levels. This has depressed retail lending in Europe as banks adopt a cautious stand.
Loan loss provisioning
Due to aggressive loan loss provisioning (“front-loaded”) in 2009 and later, U.S. banks were able to bounce back into profitability much more strongly when the economy improved, reporting lower NPL ratios. The analysts point out that loan loss provisions at U.S. banks are now down by nearly 20% from crisis highs.
In comparison, European banks were slower to provision and therefore, legacy charges may continue to be an overhang on their profits.
More pains from deleveraging
With new capital requirements on the anvil, deleveraging was unavoidable for both U.S. and European banks. Yet the latter faced more pain because U.S. banks were traditionally already compliant with higher levels of capital ratios, plus their stronger earnings provided “organic capital generation.” Besides, because of their stressed economies, European banks found it much more difficult to tap capital.
As a result, European banks had to resort to shedding risk-weighted assets to shore up capital ratios – and this affected their income streams.
“In particular, de-risking and shedding assets have come at a real price for the (European) banks: they have exited higher-yielding business segments (e.g. proprietary trading, securitizations), cut back exposures to certain clients and overall have become much more restrained in making new, capital-intensive commitments. This also meant banks were less focused than before on investing in new business and on generating revenues.”
As a result European banks have become more introverted, and are concentrating on familiar markets where they have market share. But this means they are losing out on the high growth markets such as the emerging countries, and even the U.S. itself.
The analysts do sound a note of caution, though, and remind that the U.S. stands at the threshold of a lengthy tightening (tapering) process, and still has to push through crucial housing reforms.
Nevertheless, the bottom line is that the gulf between U.S. and European banks is probably here to stay.