Bank earnings: Deutsche spots a €6 billion disintermediation opportunity
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Bank earnings: Deutsche spots a €6 billion disintermediation opportunity

€3bln for DCM, €3bln for FICC; UniCredit, Commerzbank and Crédit Agricole to benefit as funding shifts to bonds

Deutsche Bank says there could be as much as a €6 billion investment banking revenue opportunity in the long run as a result of the accelerating shift of corporate funding from the banking sector to the capital markets.

The bank claims that this opportunity is based on its estimates that as much as $3 trillion of bank lending might be disintermediatedon the capital markets, amounting to about half of all European corporate bank lending.

Banks’ debt capital markets and secondary trading businesses stand to benefit most from the shift, potentially creating a €3 billion revenue prospect for DCM businesses and €3 billion opportunity for secondary FICC sales and trading.

"Relative to an overall investment banking revenue pool of $290 billion to $330 billion forecast for 2014 (bear case and base case), this may not seem that large," Matt Spick and Nick Burns, bank strategists at Deutsche Bank in London, write in a February report. "But credit trading is becoming a more concentrated market. We would expect the largest banks to take 10% to 15% each of this potential revenue pool, or $1 billion each per annum. This would be a helpful positive for any FICC franchise."

Spick and Burns suggest the revenue uplift will happen over the long run and that the DCM divisions of UniCredit, Commerzbank and Crédit Agricole might benefit most.

For Deutsche, the banks with the "greatest sensitivity" to the DCM opportunity are those that, first, have a good market share of corporate lending and so are present in the euro-area DCM business already; second, are concentrated on euro-area business and do not have large diversified portfolios; and last, but not least, are relatively unprofitable.

On this last point, Spick and Burns say "this is a purely mechanical point, and may not play out in practice", but that "an unprofitable bank gets more potential percentage upgrade from any given opportunity".

The research report was specifically focused on the profitability of corporate lending, a business in which the value to a bank has long been questionable.

Spick and Burns warn, for instance, that bank lending to large European companies is not only "structurally unprofitable" but that the level of ancillary revenues from other cross-sold banking businesses needed to justify a marginal loan is implausibly high, although this is the basis on which many banks have traditionally run their lending business.

However, they say that for lending to medium and smaller corporates, "we find profitability for banks much improved, but this is primarily due to banks re-pricing and widening the gap between SME deposit rates and SME loan rates."

Low-growth cyclical utilities

"We find return on equity above the cost of capital for lending to SMEson a through-cycle basis, implying that as we see better GDP trends/lower default expectations, SME lending will recover." That sounds encouraging, but this is a relatively small business. The analysts say: "We also find that low-single-digit growth in SME lending is immaterial to most bank earnings, and does not change our core view of European banks as low-growth cyclical utilities."

The stark assessment demonstrates how the poor economics of bank lending to large companies is as critical a factor in the contraction in corporate credit as the lack of loan demand from cautious companies or lack of capacity within the banking sector.

"It doesn’t matter if banks have enough capital," say Spick and Burns. "If marginal loans are loss-making, then banks will be disincentivized to make them."

They argue that the large corporate segments of banks’ loan books are structurally unprofitable as a direct and "unavoidable consequence" of the rise in funding costs for European banks, a rise that they believe will be sustained over the long term.

"Thanks in part to bail-in regulatory requirements," they say, "these will force more losses on bank bond holders, increasing funding costs for banks."

That large European companies such as Airbus are setting up their own in-house bank to lend to customers and suppliers is almost certainly because of this. Airbus announced in February that it is buying Salzburg München Bank from Raiffeisenverband Salzburg.

"In the coming years the whole group can benefit through increased financing flexibility," says Harald Wilhelm, Airbus CFO. "Salzburg München Bank provides us with a good platform to launch our company bank project."

New financial regulation is the primary force behind the strategic shift banks have been undertaking, with higher capital requirements under Basle III in particular forcing banks to make "hard decisions on what clients to prioritize," says Lars Cordi, vice-president and treasurer of brewer Carlsberg.

That can be a ruthless decision-making process that can often result in a long-term lending relationships being cut or at the very least downsized.

However, banks need to be careful when re-evaluating how much credit they provide to their large corporate clients and, in turn, if they have the capabilities in DCM, for example, to pitch for that business, should lending be pared back.

Kathy Cassidy, senior vice-president and treasurer of industrial group GE and GE Capital, told Euromoney earlier this year: "For every bank, we know what their strengths are and what their weaknesses are too. We also know how much credit they supply to us, which is still a very important factor."

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