The key chart
The key message
The gradual steepening of EA yield curves has led to renewed questions about the relative importance of the shape of the yield curve vis-à-vis the level of ST rates for the region’s banks (and their share price performance).
Banks’ NIMs have a positive relationship with both factors but, generally, the former is more important in countries and sectors exposed to higher fixed-rate lending and vice versa. Despite a shift away from floating-rate lending since 2009, just under 60% of all new loans to HHs and NFCs in the EA carry a floating rate. In other words, sensitivity to the level of ST rates remains high. As always, however, significant variations exist at the country, sector (and individual bank) levels. In France and the Netherlands, for example, only 36% of new loans carry a floating rate and only 15% of new mortgage loans for the entire EA carry a floating rate.
A scenario of steeper yield curves combined with delayed ST rate rises is broadly positive for the sector, and would favour fixed-rate countries (France, Netherlands, Belgium) and fixed-rate mortgage lending markets (France, Belgium, Germany, Netherlands, Italy, Ireland, Spain, Austria). This is very different from the (short-lived) period in early 2018 when expectations focused on higher ST rates combined with flatter yield curves. This favoured floating-rate economies (Finland, Portugal, Italy, Austria and Spain), NFC-lending sectors and floating-rate mortgage markets (Finland, Portugal) and led to brief outperformance from Italian, Spanish banks (and Erste Bank).
Investors’ expectations were dashed ultimately in 2018 and the case for a sustained steepening in EA yield cases remains unproven today (especially given M Lagarde’s comments on 22 February that the ECB was “closely monitoring” the market for government bonds).
On Thursday this week (25 February), the ECB will release its first review of monetary developments in the EA for 2021. As noted in my previous post, the key signals to look for then and in subsequent 2021 releases are: a moderation in monthly deposit flows; a resynching of money and credit cycles; and a recovery in consumer credit.
“What if?” – The charts that matter
Yield curves in the euro area’s (EA) two largest economies have steepened YTD (see chart above) albeit to a lesser extent than in the US (see key chart). This leads to the obvious question about the relative importance of the shape of the yield curve vis-à-vis the level of ST rates for the region’s banks (and their share price performance).
Yield curves versus ST rates – the background
Banks’ net interest margins (NIMs) have a positive relationship with both the shape of the yield curve and the level of ST rates. In short, this reflects two core functions of services that banks provide – a maturity transformation service (yield curve) and a deposit transaction service (ST rates). The relative importance of each factor depends largely on whether lending is predominantly fixed or floating-rate lending.
The slope of the yield curve is more relevant in countries or sectors with relatively high exposure to fixed-rate lending. In contrast, changes in ST rates have a greater impact on net interest margins in countries or sectors that are characterised by floating-rate lending. Furthermore, banks prefer a fixed rate when they expect reference rates to decline in the future and prefer a variable rate when they expect reference rates to increase. Borrowers have opposite preferences. In this regard, differences between loan characteristics provide an indication about the expectations of banks and borrowers with respect to the evolution of rates and their respective bargaining power. This in turn depends on factors such as banks’ funding conditions, competitive dynamics and borrowers’ levels of solvency.
(The impact of bank size is acknowledged here but is beyond the scope of this summary. However, it is worth noting that bank size may also have an impact on the sensitivity to both factors. This reflects the fact that larger banks are typically able to hedge their interest rate risk exposures better than smaller banks.)
Yield curves versus ST rates – the EA context
Despite a shift away from floating-rate lending since 2009, 59% of all new loans to HHs and NFCs in the EA carry a floating rate (or an initial fixation period of up to one year). The peak level of floating rate lending in the past 15 years occurred after the GFC in January 2009 (84%). The lowest level occurred very recently in November 2020 (55%). As explained below, this trend affects both country and sector effects.
The key point here is that, while the sensitivity to the shape of the yield curve has increased, EA banks remain highly sensitive to the level of ST rates (at the aggregate level).
As always, however, significant variations exist at the country, sector (and individual bank) levels. The highest shares of floating-rate lending in new loans are currently found in Finland (93%), Portugal (78%), Italy (73%), Austria (68%), Spain (68%) and Ireland (66%). In contrast floating-rate lending in the Netherlands and France accounts for only 37% and 36% of total new loans respectively (see chart above).
While NFC lending remains largely floating-rate, only 15% of new mortages carry a floating rate (see chart above). Again significant differences exist here at the country level. The share of floating rate mortgages in total new mortgages ranges from highs of 98% and 67% in Finland and Portugal respectively to lows of 10%, 4% and 2% in Germany, Belgium and France respectively (see chart below).
Yield curves versus ST rates – different scenarios
A scenario of steeper yield curves combined with delayed ST rate rises is broadly positive for the sector, and would favour fixed-rate countries (France, Netherlands, Belgium) and fixed-rate mortgage lending markets (France, Belgium, Germany, Netherlands, Italy, Ireland, Spain, Austria).
This is very different from the (short-lived) period in early 2018 when expectations focused on a scenario of higher ST rates combined with flatter yield curves. This favoured floating-rate economies (Finland, Portugal, Italy, Austria and Spain), NFC-lending sectors and floating-rate mortgage markets (Finland, Portugal) and led to ST outperformance from Italian, Spanish banks (and Erste Bank).
Conclusion
Investors’ expectations were dashed ultimately in 2018 and the case for a sustained steepening in EA yield cases remains unproven today, especially given M Lagarde’s comments on 22 February that the ECB was “closely monitoring” the market for government bonds. This was interpreted as a sign that the ECB might act to prevent rising yields undermining any economic recovery.
On Thursday this week (25 February), the ECB will release its first review of monetary developments in the EA for 2021. As noted in my previous post, the key signals to look for then and in subsequent releases are: a moderation in monthly deposit flows; a resynching of money and credit cycles; and a recovery in consumer credit (see, “Three key charts for 2021”)
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.