Monthly flow into O/N deposits is 3.2x the 2019 average monthly flow (3m MVA, EURO mn) Source: ECM; CMMP analysis
Summary
The latest message from the euro area (EA) money sector is clear – unprecedented levels of uncertainty continue to challenge the “v-shaped recovery” narrative.
The fastest YoY growth in M3 since July 2008 (8.9%) largely reflects increased holdings of overnight deposits, which contributed 7.6ppt to the headline growth alone. May’s monthly flow of overnight deposits of €167bn (3m MVA) was 3.2 times the average monthly flow in 2019. Households (HHs) and corporates (NFCs) continue to demonstrate strong liquidity preferences – €9.6trillion is currently sitting in (cash) and overnight deposits despite negative real rates of return.
From a counterparts’ perspective, credit to private sector contributed 5.3ppt to broad money growth with increasing demand from NFCs and resilient HH demand for mortgages offsetting on-going weakness in HH demand for credit for consumption. No major change in the message here.
Looking forward, there is some support for the argument that we may have passed the low point in the “sharpest and deepest recession in non-wartime history”, but little to suggest that the recovery will be anything other than “sequential (geographically), constrained and uneven” (M. Lagarde, 26 June 2020). The answer lies largely in the extent to which the increase in savings highlighted here is “forced” or “precautionary”. Forced savings can be released relatively quickly to support economic activity. In contrast, precautionary savings are unlikely to move straight into investment and consumption.
Previous CMMP analysis indicates persistent private sector net financial surpluses since the GFC and suggests a bias towards more precautionary savings. These are unlikely to more rapidly into either investment or consumption and pose an on-going challenge to the “v-shaped recovery” narrative.
Please note that the summary comments above and graphs below are extracts from more detailed analysis that is available separately.
The six charts that matter
O/N deposits are the main contributor to accelerating M3 growth (contribution in ppt, % YoY) Source: ECB; CMMP analysisHHs and NFCs continue to demonstrate strong liquidity preferences (EUR bn, 3m MVA) Source: ECB; CMMP analysisNo changes in the message from a counterparts’ perspective – increasing NFC and resilient mortgage demand offset weakness in consumer credit (% YoY) Source: ECB; CMMP analysisLooking for positives – O/N deposit monthly flows may have peaked in March? Source: ECB; CMMP analysisLooking for positives – mortgage credit demand is resilient and the contraction in consumer credit has slowed Source: ECB; CMMP analysisBut don’t forget, the private sector has been running persistent net financial surpluses since the GFC, despite negative/very low policy rates – a very strong indication that the economy is still suffering from a debt overhang Source: ECB, CMMP analysis
Messages from the money sector V – SMEs in the euro area
The key chart
Concerns over the availabilty of credit for SMEs in the EA are rising sharply (net percentage terms) Source: ECB/EC (22nd SAFE survey); CMMP analysis
Summary
The latest ECB/European Commission SAFE survey indicates that SMEs in the euro area (EA) are facing similar challenges to their UK-based peers.
SME turnover and profits were declining across the EA before the Covid-19 pandemic hit, despite accommodative financing conditions
Weaker turnover and lower profits have become obstacles to obtaining external finance for the first time since 3Q14 especially, but not exclusively, in southern Europe
The weakening economic outlook is compounding these trends with significant deteriorations noted in Germany, Italy and Finland
The survey indicates that SMEs see the availability of internal funds declining substantially and by more than during the 2012 sovereign debt crisis
External financing needs are rising, unsurprisingly, but SMEs indicate that they expect the availability of these funds (loans, credit lines and overdrafts) to deteriorate sharply, but to a lesser extent than the availability of internal funds.
Unorthodox monetary policy has been successful in reducing financing costs for SMEs in the EA and in the UK, but the challenge of accessing funding in sufficient volumes and in the face of declining operating performance remains.
SMEs in the EA are signalling rising operational, economic and financing risks and a widening financing gap vis-a-vis large corporates, raising concerns for investors in the sector and banks with relatively high SME exposure.
Introduction
I highlighted the widening financing gap between large UK corporates and SMEs in “Mind the financing gap” earlier this month. In this post, I summarise the results of the ECB/EC’s Survey on the Access to Finance for Enterprises (SAFE). This was conducted between March and April this year and the results were summarised in the ECB’s latest Economic Bulletin.
The key message from the euro area (EA) is similar to the UK version – while SMEs are benefitting from lower funding concerns, they are reporting a deterioration in activity and rising concerns about the future availability of external financing. Policy measures need to reflect and adjust to these concerns.
The charts that matter
What are the trends in SME turnover and profits? Source: ECB/EC (22nd SAFE survey); CMMP analysis
SME turnover and profits were declining across the EA before the Covid-19 pandemic hit and despite accommodative financing conditions. Turnover declined across the region for the first time since early 2014. Italian SMEs were hit particularly hard (19% fall), followed by SMEs in Slovakia, Greece and Spain.
SMEs also reported a sharp deterioration in profits, from -1% in the previous survey to -15%. Italian SMEs stood out again, with profit declines of 36%, followed by Greek, Slovakian and Spanish SMEs. This occurred despite accommodative financing conditions, with high labour costs highlighted as a key contributing factor, and the “industry” sector hit relatively badly by declining profits.
How do turnover trends vary across the EA? Source: ECB/EC (22nd SAFE survey); CMMP analysisHow do profit trends vary across the EA? Source: ECB/EC (22nd SAFE survey); CMMP analysis
Weaker turnover and lower profits have become obstacles to obtaining external finance for the first time since 3Q14. This applies across the EU (with the exception of Greece) but is particularly severe in Spain, Italy and Portugal.
Why does this matter? Source: ECB/EC (22nd SAFE survey); CMMP analysisWhere does this matter? Source: ECB/EC (22nd SAFE survey); CMMP analysis
The weakening economic outlook is compounding these challenges with significant deteriorations noted across the EA and particularly in Germany, Italy and France. The net percentage of firms signalling that the weakening in economic outlook was affecting access to finance rose to -30%, a level not seen since 1Q13.
And the economy? Source: ECB/EC (22nd SAFE survey); CMMP analysisHow widespread is the economic impact? Source: ECB/EC (22nd SAFE survey); CMMP analysis
The survey indicates that SMEs see the availability of internal funds declining substantially and by more than during the 2012 sovereign debt crisis. External financing needs are rising, unsurprisingly, but SMEs indicate that they expect the availability of these funds (loans, credit lines and overdrafts) to deteriorate sharply, but to a lesser extent than the availability of internal funds.
How urgent are SME external financing needs? Source: ECB/EC (22nd SAFE survey); CMMP analysisHow do actual and expected availability of external finance compare? Source: ECB/EC (22nd SAFE survey); CMMP analysis
Conclusion
Unorthodox policy has been successful in reducing financing costs for SMEs in the EA and in the UK, but the challenge of accessing funding in sufficient volumes and in the face of declining operating performance remains severe. The risks to SMEs are rising as are the risks for those banks with relatively high SME exposure.
Please note that the summary comments above are extracts from more detailed analysis that is available separately.
Or more a vote of confidence in Ursula von der Leyen?
The key chart
Banks play catch up since 18 May 2020, but what kind of rally is this and can it be sustained? Source: FT, CMMP analysis
Summary
The SX7E index of leading European banks bounced 38% between 18 May and 5 June 2020, outperforming the broader SXXE index by 15%.
Among the index “heavyweights” (by market cap), the biggest share price gains corresponded with the largest previous YTD share price falls – BNP Paribas, ING, Unicredit and Soc Gen. Trading volumes also rose from recent lows but remained below those seen during March’s sell-off.
The rally took place (1) two months after the broader market, (2) despite a worsening operating environment, and (3) in the absence of the macro building blocks required for a sustained recovery in sector profitability.
It coincided with the announcement of the EC’s proposed €750bn “Next Generation EU” fund and can, therefore, be seen best as a vote of investor confidence in the policy response rather than a fundamental shift in banking sector dynamics (note parallels with the performance of the oil and gas sector).
Looking forward, the limited progress in dealing with the region’s private sector debt overhang still clouds the LT investment perspective. High debt levels explain, in turn, why money, credit and business cycles in the EA were already significantly weaker than in past cycles, why inflation remains well below target, and why rates were expected to stay lower for longer even before the Covid-19 pandemic hit.
Last week’s ECB forecasts indicate that the growth recoveries expected in 2021 and 2022 will not make up for the 8.5% real GDP contraction this year. Weak pre-provision profitability levels represent the key challenge facing EA banks in terms of addressing the associated challenges and suggest that the MT investment perspective also remains negative.
A positive investment case rests, therefore, largely on valuation (ST investment perspective). Banks established new support levels in terms of absolute price at distressed valuation levels (0.2-0.4 PBV). Despite rallying off these levels, share prices of large EA banks typically remain 20-30% lower than at the start of the year and valuations low in a historic context.
Bank valuations remain low/distressed in absolute terms and versus historic trends. Conviction in the current rally and sector outperformance is challenged, however, by the lack of alignment between the three investment perspectives that form the basis of the CMMP analysis investment framework.
In my view, the true value in analysing developments in the financial sector remains less in considering investments in developed market banks and more in understanding the implications of the relationship between the banking sector and the wider economy for corporate strategy, investment decisions and asset allocation.
As before, the key message from the money sector here, is the importance of the EC’s proposal for the “Next Generations EU” fund. Investment returns, including the impact of country and sector effects, will be driven to a large extent by how this debate concludes, as will the future of the entire European project.
Please note that the summary comments above and the graphs below are extracts from more detailed analysis that is available separately.
The charts that matter
A classic bounce – the big fallers up until 17 May, were the biggest gainers in the subsequent rally Source: FT, CMMP analysisPrice/volume trends for Santander reflect wider sector trends – trading volumes recovered but remained below those seen in March’s sell-off Source: FT; CMMP analysisAfter bottoming in April, the SX7E index trended sideways until the announcement of the “Next Generation EU” fund Source: FT, CMMP analysisHow low can you go? The current investment case rests largely on low price and valuation levels Source: CMMP analysisPerformance, valuation (and the inversion of yield curves, not shown here) point to 2020 being worse that 2016 Source: CMMP analysisYTD valuation lows for index heavyweights (ex KBC) set at very distressed levels Source: YCharts.com, CMMP analysisDespite the recent rally, YTD performance remains poor (with the exception of Deutsche Bank) Source: FT, CMMP analysisCurrent valuations remain low, but are banks merely a value trap? Progress regarding the “Next Generation EU” fund may provide the answer… Source: YCharts.com; CMMP analysis
The recovery in NFC credit demand is a positive sign but masks the widening volume gap between large corporate and SME funding (% YoY, £25m annual turnover threshold) Source: Bank of England; CMMP analysis
Summary
UK corporate lending grew 11% in April 2020; the fastest rate of growth since July 2008 and in direct contrast to slowing trends in the household sector. April’s monthly change was lower than March’s “dash for cash” but was still double the monthly amounts borrowed over the previous six months. The cost of borrowing also fell to the lowest level since December 2010. NFCs are also increasing financing from bonds, commercial paper and, to a lesser extent, equities.
Behind these positive trends, the gap between large NFCs and SMEs is widening in volume terms. SMEs are benefitting from lower borrowing costs but volumes remain low and growth subdued. Furthermore, only 24p in every £ lent in the UK is directed to the NFC sector. More concerning, 77p in every pound is directed at less-productive FIRE-based lending (FIs and real estate).
The fact that NFCs are accessing finance in larger volumes and at lower costs is welcome, but the widening gap between large NFCs and SMEs and the on-going concentration of lending in less-productive sectors means that headline numbers are not as positive as they appear at first.
Mind the financing gap
In April, NFC lending grew at the fastest rate (11% YoY) since July 2008, in contrast to slowing growth (3% YoY) in the HH sector Source: Bank of England; Haver; CMMP analysis
UK corporate (NFC) lending grew 10.7% YoY in April 2020, the fastest rate of growth since July 2008. This was in contrast to trends in the household (HH) sector, where credit growth slowed to only 2.5%, the slowest rate of growth since June 2015.
M4L in the NFC sector rose £8.4bn in April versus £4.3bn average over the previous six months Source: Bank of England; CMMP analysis
Outstanding NFC loans grew by £8.4bn in April. This was lower than the £30.2bn raised in March but was still approximately double the average amounts borrowed over the previous six months (£4.3bn). The cost of (new) borrowing for NFCs fell to 2.26%, the lowest rate since December 2010 and 30bp lower than in February.
NFCs raised £32bn and £16bn from banks and financial markets in March and April 2020 respectively, versus an average of £3bn over the past three years Source: Bank of England; CMMP analysis
Looking at wider financing trends, NFCs raised a total of £16.3bn from financial markets in April, down from the £31.6bn raised in March but still above the average monthly financing of £3.2bn seen over the past three years. After March’s “dash for cash” from banks, NFC repaid £1.0bn of bank loans in April but raised £7.7bn in bonds and £7.0bn in commercial paper (including finance raised through the Covid Corporate Financing Facility) and £1.4bn in equity.
After March’s “dash for cash” from banks, NFCs turned to the bond and commercial paper markets in April (£bn) Source: Bank of England; CMMP analysis
These positive trends mask that (1) the gap between large corporates and SMEs is widening sharply in volume terms and, that (2) NFC lending remains a relatively small part of UK bank lending. SMEs are benefitting from lower borrowing costs: the effective rate on new loans to SMEs fell by 52bp to 2.49% in April the lowest level since 2016 (when the BoE series began) and almost 100bp below the 3.44% cost of borrowing in February. SMEs borrowed £0.3bn in April and March but this is only 1.2% higher than a year earlier.
SME credit growth is above recent average but remains subdued in absolute terms (% YoY) Source: Bank of England, CMMP analysis
Despite the rise in NFC lending described above, only 24p in every £ of UK lending is lent to the NFC sector. Alternatively, using my preferred distinction between more productive “COCO-based” and less-productive “FIRE-based” lending, 77p in every pound lent in the UK is directed at financial institutions and real estate with obvious negative implications for leverage, growth, stability and income inequality.
Conclusion
The fact that UK corporates are accessing finance in larger volumes and at lower costs is welcome. Nonetheless, the widening gap between large corporate and SME financing is of concern as is the fact that UK lending remains concentrated in less-productive FIRE-based lending. This week’s Bank of England data contained good news for sure, but not to the extent that headline numbers might suggest.
Please note that summary comments above are extracts from more detailed analysis that is available separately.
Messages from the money sector III – UK Households
The key chart
Risks to UK growth and bank lending from the HH sector rose sharply at the start of 2Q20 (% YoY) Source: Bank of England; CMMP analysis
Summary
Risks to the UK growth outlook and bank lending from weakness in the household (HH) sector were evident before the Covid-19 pandemic hit. The “message from the money sector” (and from this week’s Bank of England monetary data) is that these risks rose at unprecedented rates at the start of 2Q20.
HHs increased deposit holdings in April 2020 by four-times the average monthly amount seen over the past two decades, despite negative real deposit rates. At the same time, they repaid debt in record amounts, notably consumer debt. Mortgage approvals also collapsed and mortgage lending grew at the lowest monthly rate since December 2011.
While it is dangerous to over-interpret one month’s data, the early message is clear: with UK HHs displaying “extreme caution not consumption” and repaying debts despite low costs of borrowing, the on-going risks to a v-shaped recovery and to the UK banking sector profitability have risen sharply.
Caution not consumption
In “Poised to disappoint”, I highlighted the dominant role that HHs play in UK economic activity (FCE/GDP) and bank lending (the desire to buy properties). The HH sector had been funding recent consumption by dramatically reducing its savings rate and accumulation of net financial assets. With real growth in disposable income slowing and the savings rate close to historic lows, I concluded that the risks to UK growth lay to the downside even before Covid-19 hit.
Extreme caution – HH deposits rise at 4x the average monthly rate seen over the past twenty years (£mn) Source: Bank of England; Haver; CMMP analysis
The current “message from the money sector” is that these risks have risen sharply and at an unprecedented rate. April’s monetary aggregates (released on 2 June 2020) showed that HHs increased their holdings of deposits by £16bn in April 2020, a rate that is 4x the size of the average monthly increase of the past twenty years and despite negative real rates of return.
Trends in UK HH deposit rates in nominal and real terms – rates remain negative in real terms but less so than in the recent past Source: Bank of England; Haver; CMMP analysis
Interest rates on new time deposits fell 15bp to 0.98% while rates on sight deposits fell slightly to 0.41%. Deposit rates remain negative in real terms but less so than in the recent past due to the decline in inflation below 1.0%. The key message here is the HH sector’s rising preference for liquidity indicates very high levels of caution and a low appetite for risk.
HHs repaid twice as much consumer credit in April than in March (£bn LHS, % growth YoY RHS) Source: Bank of England; CMMP analysis
At the same time, HHs are repaying debt in record amounts most notably consumer debt. They repaid £7.4bn of consumer debt in April 2020, twice the amount repaid in March. These repayments were the largest net repayments since the series began and unprecedented in scale (see graph below).
Current repayment levels are the largest since the series began and unprecendented in scale (£bn) Source: Bank of England; Haver; CMMP analysisConsumer credit now growing at the slowest rate since August 2012 (% YoY) Source: Bank of England; Haver; CMMP analysis
The largest repayments (£5.0bn) were on credit cards, but HH also repaid £2.4bn of “other loans” (eg, car finance). In March and April, credit cards fell -0.3% and -7.8% YoY compared with 3.5% growth in February. Growth in other loans fell from 6.8% in February to 5.6% in March and 3.1% in April. While the slowdown in consumption is not surprising, its scale and pace send important signals regarding the hit to future consumption.
Within consumer credit, credit cards were hit hardest (% YoY) Source: Bank of England; CMMP analysis
The money sector is also sending important messages about weakness in the housing market. Approvals for house purchase and remortgage have fallen 78% and 34% since February. Lending has also fallen rapidly. New mortgage borrowing fell 38% from £23.1bn in February to £14.1bn in April. At the same time, repayments also fell 26% from £18.8bn to £13.bn, reflecting (in part) the effect of payment holidays.
Trends in approvals (January – April 2020) show volumes collapsing in two months Source: Bank of England; CMMP analysis
With gross lending falling faster than repayments, net mortgage borrowing rose by only £0.3bn in April compared with an average rise of £4.5bn over the previous six months. This net increase was the lowest since December 2011.
April’s net increase in mortgages (£0.3bn) was the slowest since December 2011 Source: Bank of England; CMMP analysis
Conclusion
It is dangerous to over-interpret one month’s data. Nevertheless, the early 2Q20 message from the money sector is clear: with HHs displaying “extreme caution not consumption” and repaying debts despite low costs of borrowing, the on-going risks to a v-shaped recovery and to the UK banking sector profitability have risen sharply.
Please note that the summary comments above are extracts from more detailed analysis that is available separately.
