ECB 1Q16 Lending Survey: Concerns Over Banks' Profitability Have Increased Even Further

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Summary

The ECB published its 1Q16 Bank Lending Survey.

The credit conditions eased; however, the key takeaways were negative.

Overall, the data from the ECB 1Q16 lending survey looks weak - the concerns over banks’ profitability have increased even further.

The ECB has recently published the 1Q16 Bank Lending Survey, which is a reliable leading indicator for the key trends in the European Banking Sector (NASDAQ:EUFN)

The credit conditions have eased; however, this was driven by pressure from competition.

This is now the eighth consecutive quarter that we see an easing of credit conditions in Europe - from a historical perspective, lending conditions remain very loose both in terms of actual changes and in terms of expectations.

Actual change in credit standards lending to Business, House Purchase and Consumer Credit

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Source: Bloomberg, Renaissance Research

Expected change in credit standards lending to Business, House Purchase and Consumer Credit

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Source: Bloomberg, Renaissance Research

At the country level, credit standards to enterprises eased in Italy and Germany - a small positive for UniCredit (OTC:UNCFY), Intesa (OTCPK:ISNPY), Commerzbank (OTCPK:CRZBY) and Deutsche Bank (NYSE:DB):

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Source: ECB

A tightening in credit standards for housing loans is not a concern as it was due to implementation of the EU mortgage credit directive, which requires in-depth credit assessments of borrowers.

That said, I find the data rather weak due to the following reasons:

First, the easing of standards was driven by pressure from competition. I think this is a concern, as competitive pressures will likely have a negative impact on banks' margins, which have already been worsened by negative interest rates environment:

During the first quarter, competition remained the main factor behind the net easing of credit standards. In addition, both risk perceptions and banks' cost of funds and balance sheet constraints continued to contribute marginally to the net easing, while banks' risk tolerance had a marginal tightening impact.

Source: ECB

Second, the contribution from fixed investments fell significantly q/q, staying positive only in Italy - a positive for UniCredit and Intesa though. Could it be a sign of decelerating Eurozone GDP growth?

Third, interest rates remain one of the main factors contributing for loan demand. Hence, this suggests to me that loan demand is driven by corporates renegotiating existing loans to lower rates thanks to cheap TLTRO/TLTRO2 money.

Source: ECB

The impact of the negative DFR: 85% of banks expect NII to decrease further

For the first time, the ECB asked banks to consider both the direct and indirect effects of the negative DFR (deposit facility rate):

With respect to the impact of the ECB's negative deposit facility rate on banks' net interest income 9, a net percentage of 81% of euro area BLS banks reported a decline in their net interest income over the past six months. This impact is expected to increase to a net percentage of 85% over the coming six months.

Source: ECB

If the economic situation deteriorates, the ECB will likely add stimulus measures. Should that happen, the pressure on margins would intensify.

It's also worth mentioning, that the impact of the DFR on lending volumes is surprisingly meager - see below

Source: ECB

Bottom line: Overall, the data from the ECB 1Q16 lending survey looks weak. The concerns over banks' profitability have increased even further. Although it was widely expected that negative policy rates would have a negative impact on the banks' margins, the pressure on the sector's NIM have been further intensified by increased competition - European banks are using cheap TLTRO/TLTRO2 money to gain market share, while loan demand is driven by corporates renegotiating existing loans to lower rates.

Disclosure: I am/we are long CRZBY.

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