French retail banking: not as bad as you might think
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French retail banking: not as bad as you might think

Manageable private-sector leverage and the unlikely prospect of a deposit war should help insulate French retail banks from the austerity storm, says Citi.

Who would be an equity investor in French banks these days? Apart from a developed world balance-sheet recession, the euro crisis, asset-class correlations, still-strong banking competition –in fixed income, commodities and currencies in particular– and stubbornly high costs, French banks face a stark regulatory future.

French socialist president François Hollande has said a banking-reform law will be introduced by year-end that would see an enforced separation of retail and investment-banking activities, a blow for BNP Paribas, Société Générale and Crédit Agricole.

The fact that France is not seeking to coordinate structural banking reforms on an EU-wide basis, as per the Liikanen report,  probably reflects the macho mode of gung-ho policymakers. No matter. The European bank-holding company structure is on its way, complicating French banks’ efforts to attract capital amid question marks about the future of their corporate and investment banking books.

French banks’ retail banking prospects are also challenged amid eurozone austerity. Nevertheless, strategists at Citi on Wednesday struck a relatively bullish tone over the outlook for French retail banks, a rare silver lining in today's banking environment:

“- Private leverage remains manageable – French household leverage is one of the lowest of advanced economies (67% of GDP vs c90% for sample). Corporate leverage (136% of GDP) is more comparable to the average (140%) and could be partly driven by a high number of large French multinationals. 

- LDR [loan-to-deposit] deleveraging helped by deposit growth – We believe that markets with high levels of off-balance sheet savings pools benefit from ‘natural’ deleveraging. Like the US, we believe that France has been a beneficiary of a significant shift from US MMFs to deposits (Figure 12), allowing its loan-to-deposit ratio to
decline from c140% to a more manageable c120% today. This ratio should further decline as deposit growth (up 9% yoy in July) continues to outpace loan growth (c2%, respectively) - see our accompanying ‘French Big Picture’ report.

- Still a Cash Cow – Although under pressure from the weak economy (subpar revenue growth, provisioning cycle), the French retail banking model remains intact, in our view, with RoE remaining above 15-20%.

Not so fast. Here are the risks:

Sluggish revenue growth: We forecast -0.5 to -1% revenue decline in 2013E – subpar to historical trends compared to nominal GDP growth..

Volume slowdown to continue but remains positive and with further LDR improvement.

Net interest margins should see modest pressure. Negative pressure comes from declining reinvestment yields, further deterioration in the deposit mix and deposits not re-pricing as rapidly as loans. This should be partly offset by ongoing replacement of (pricier) wholesale funding with deposits through asset re-pricing. See our detailed analysis on margin trends.

- Provisioning cycle to be tame – The key driver for NPLs, and therefore provisions, remains GDP growth. Based on historical trends, we therefore expect provisions at 40-50bp vs c40 bps in 2012E.

Nevertheless, a deposit war is unlikely, Citi reckons:

Better prepared for funding tail risks
– Deposit war remains key risk, but unlikely, given (i) robust deposit growth, (ii) considerably lower pressure on wholesale funding (vs late 2011), (iii) central bank warnings, (iv) the oligopolistic banking structure.

– Resurging €-zone stress: A reversal in the improvement of bank wholesale funding costs is possible, but as demonstrated over 1H12 this is surmountable with (a) high levels of pre-funding, (b) higher reliance on covered bonds and private placements, (c) lower funding requirements driven by deleveraging, (d) optionality of access to central bank funding.



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