[Mb-civic] Buttonwood Making hay

Wed Feb 9 10:40:08 PST 2005

Buttonwood

Making hay

Feb 8th 2005
>From The Economist Global Agenda

Most of Europe¹s banks have been trading on lower multiples than their
American rivals. Is it time to re-rate them?

BUTTONWOOD had a small sorrow recently. It involved a lock of hair. Before
heading out to the long grass some years ago, she left various treasures at
her bank for safekeeping. A decade later, these proved hard to recoup. After
many months, the bank found one large manila envelope in a warehouse in the
English Midlands‹but not, alas, the one containing an apricot-coloured curl
from first daughter¹s first haircut. A spate of similar tales from friends
prompts the suspicion that British banks, at least, are getting a bit
stretched where customer service is concerned.

Not that you would know it from their 2004 results, which are beginning to
come out now. Northern Rock, a building society-turned-bank, announced
record profits late last month. That prepared the way for what promises to
be a profits bonanza all round. On February 28th HSBC, Britain¹s biggest
bank though with thoroughly global operations, looks set to reveal profits
as much as £2 billion ($3.7 billion) higher than the £9.8 billion figure
from Shell a week ago that was hailed as the largest profit ever made by a
British company. Altogether, Britain¹s nine listed banks are expected to
show after-tax profits £35 billion-40 billion higher than the year before.

They are not alone. Bank profits in continental Europe have also been
buoyant. Deutsche Bank kicked off with a big increase in net profits for
2004. In the past week France¹s BNP Paribas, Dutch ABN-Amro and
Switzerland¹s UBS have all reported sharply higher profits. In America,
where most banks reported earlier, profits for money-centre banks,
especially, were sharply higher than a year earlier. In both Europe and
America, bank shares have outperformed their broader market indices (see
chart).

In Britain, where the class struggle is not dead, just resting, this spate
of profits has provoked complaints that banks are gouging their customers.
It is true that some markets are more competitive than others. But banks are
companies, and company profits around the globe have been booming. Like
them, banks in most places have benefited from the strongest world economic
growth in decades, low inflation and interest rates, and improving credit
quality. Many have also cut costs and restructured, so volume increases in
business have been moving through to the bottom line more quickly.

The tide is on the turn now, and banks everywhere will have to row harder to
make for shore. ³Banks rely on two basic sources of profit‹maturity
transformation (borrowing short and lending long) and credit risk (lending
to borrowers who may pay you back),² as Andrew Smithers, an economic
consultant, puts it. ³Neither of them looks particularly bright this year,
though a third source‹commissions on market transactions‹may hold up better
in the short term.²

In America the yield curve has been flattening for some time, putting the
squeeze on banks¹ interest income. All the indications are that the Federal
Reserve will continue to tighten short-term rates a little at a time. As
economic growth eases, credit quality is still solid, but Standard & Poor¹s,
a rating agency, has warned that corporate credit could deteriorate this
year. America¹s heavily indebted consumers, too, could be vulnerable to any
downturn in house prices. Merger and acquisition activity, however, is
booming and will generate billions of dollars in commission income for banks
and investment banks.

As for Europe, it is tricky to generalise, given the diversity within the
region. Switzerland¹s big wholesale banks are very different from Italy¹s
retail-oriented banks; and Germany¹s universal banks have to contend with a
distinctly earthbound domestic economy while France¹s are beginning to
cross-sell like mad to increasingly interested retail customers. As so often
in matters European, Britain hovers offshore in a market that looks more
American in its sophistication and indebtedness, but where most banks aspire
to wield a universal clout like the continentals.

With this caveat, in Europe the picture is a rather different from that in
America. Growth in the euro area is expected to be only 1.6% this year,
compared with America¹s 3.5%. (In Britain it is a brisker 2.4%.) Inflation
has ticked up a trifle, but short-term interest rates are not expected to
rise, so banks may find it easier to retain their net interest margins. And
there is still scope for restructuring to push up profits: Deutsche Bank and
ABN-Amro are among those that have announced plans. Except for Santander¹s
purchase of Abbey National last November, banks seem to be eschewing the
megamergers that American banks have chosen, preferring to reshuffle their
portfolios and add weight through modest deals. Concern over a sagging
housing sector and increasing competition for corporate borrowers is
beginning to rear its head‹in Britain, especially‹but all in all, Europe¹s
banks are in reasonable shape.

Ian Scott, the global head of equity strategy at Lehman Brothers, an
American investment bank, is one who believes that Europe¹s banks deserve a
higher valuation than their American rivals this year. Most European bank
stocks trade at a slightly lower multiple of estimated forward earnings than
American banks do, once immigrant HSBC is taken out of the sector. They have
also been less profitable than their American counterparts in recent years,
with an average 14.5% return on equity in 2003 compared with the Americans¹
18.1%, according to Lehman Brothers. The gap narrowed substantially last
year, however.

One of the main reasons why Europe¹s banks look brighter these days is that
retail customers are asking for more financial services from their banks,
particularly in Spain and France. Why is this, if Citigroup¹s spin-off of
its insurance business is telling us that financial supermarkets don¹t work?
This is mainly a matter of history: in countries which separated different
financial businesses by law or custom (America and, to a lesser extent,
Britain), banks have found it hard to play as big a role in channelling
savings as they do in other countries (Germany, France).

Mostly history, perhaps, but not entirely. Booz Allen Hamilton, a consulting
firm, recently surveyed banks and their customers in six European countries
and found that while on average 40% of Europeans would expect their bank to
provide a wide range of financial products, only 20% did so in Britain.
Branch staff were not very knowledgeable and the queues were too long. Room
for improvement? Now, about that lock of hairŠ

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