This year the Eurozone will experience annual GDP growth for the first time since 2011, but at just 0.9% the growth will not be strong enough to support a level of uplift in financial services that will drive further economic recovery according to The EY Eurozone Financial Services Forecast (EEFSF). The growth in business lending has been revised significantly down, with €211b less to be lent in 2014 than previously forecast in October. Consumer credit is also flagging – it shrank by €29b in 2013, as households felt pressure to reduce their debt in the face of high unemployment. The forecast for consumer lending in 2014 has dropped by €26b and consumer credit will not recover to 2012 levels until 2016.
The outlook is more balanced for financial services sectors outside of banking. AUM will continue to rise, hitting €5t for the first time this year. However, low economic growth, low inflation and historically low interest rates will limit the scope for further gains. And while the outlook for insurers is improved, with profits estimated to have increased by 20% in 2013, continued high levels of unemployment will curtail the pace of insurers' recovery.
Predictions for lending have fallen significantly – timing of AQR 'less than ideal'
The low economic growth predicted for 2014 has negatively affected the forecast for bank lending. A downgrade this quarter to the forecast for business investment combined with a more cautious attitude from banks towards lending, means that business lending is now expected to grow by just 1.6% in 2014, instead of 3.8% as previously forecast. That equates to €211b less lending to businesses. Consumer credit forecasts have also fallen significantly.
Robert Cubbage, Banking and Capital Markets leader for EY in Europe, Middle East, India and Africa (EMEIA), comments: "While projections for overall lending over the next few years remain positive in most markets, they have fallen significantly since the last forecast. The Eurozone's slow recovery from recession is one driver of weak lending growth, but the growing realization of the asset quality review's (AQR) likely effects is also a major factor. Applying common EU standards will inevitably create shocks, and it is no secret that a number of Eurozone banks are already increasing their provisioning. Balancing the demands of the AQR with the need to deliver growth and support business lending is definitely going to be a challenge for the banks this year."
Andy Baldwin, Global head of financial services at EY, adds: "With the benefit of hindsight, the timing of the AQR program, coming alongside such a sluggish recovery, is less than ideal. Economic recovery depends on a banking system that is not only well capitalized but also able to extend credit where it is needed. Right now Europe's SMEs need it more than most but banks will struggle to provide it this year."
Bad loans, lending and insurance premiums all point to a lasting two-speed Eurozone
The forecast for 2014 shows that the prolonged macro-economic differences between countries in the Eurozone is having a noticeable effect on the ability of financial services industries in those countries to support economic recovery.
The forecast for Germany predicts an increase of 3-4% in lending to business, consumers and on mortgages. In France, an increase of 2% is forecast across all three categories. In the Netherlands, business lending rose 2.9% last year despite a contracting economy and it is forecast to fall 2% this year, but consumer credit and mortgage lending are both expected to increase by 4% and 1.5% respectively. However in Italy lending will remain broadly flat. And, in Spain business lending is forecast to fall another 3.2% in 2014, bringing the total fall since 2008 to 35%. Mortgage lending will fall 3% and consumer credit will fall by 2.4%.
The lending forecasts in the Eurozone reflect the impact of non-performing loans (NPLs). The ECB's AQR appears to have triggered an early recognition of NPLs in Italy; bad loans were higher than expected in the first three quarters of 2013 and are estimated to have peaked at 11.8% of all loans at the end of the year. In Spain, there has already been a significant review of balance sheets and so no significant negative surprise is expected from the AQR, however very high unemployment (26.6% at the end of 2013) means that NPLs will continue to rise during 2014, when they are expected to peak at 13.6%. In contrast, record low unemployment, robust growth and sound corporate balance sheets in Germany, means that NPLs should fall steadily from 3.2% in 2013 to 2.8% in 2017.
Non-life premium growth also strongly reflects national economic outlooks. In Germany, non-life premium growth will be strong, averaging 3.2% over the next four years, in comparison to 2.4% Eurozone average. This is underpinned by a stronger domestic economy, faster house price inflation and a stronger corporate sector. By comparison, premium growth in Spain and Italy is expected to average 1.1% and 1.7% respectively over the same period.
Marie Diron, Senior Economic Adviser to the EEFSF, comments: "There is now a very real prospect of the two-speed Eurozone becoming a long-term issue. The divergences we see in lending and insurance premiums are linked to macro-economic factors –namely unemployment and non-performing loans. And the gap continues to widen. While GDP growth rates are forecast to start to converge in 2015 or 2016, the cumulative effect of the widening gap between the Eurozone economies will be felt for much longer."
Insurers' profit grew 20% in 2013 but growth to slow in the face of high unemployment
The profits of European insurers in 2013 are estimated to have increased by more than 20%, but this was from a very low base and profits still remain 50% below the 2007 industry peak. Unemployment will average 19.3m across the Eurozone in 2014, a level which could make policyholders very price sensitive and limit the prospects of insurers, especially in Italy, The Netherlands and Spain. As a result, while profits are forecast to grow again this year, growth is predicted at a more moderate rate of 5%.
Higher household income should support life premiums however, which are forecast to reach $625b in 2014 - the first time they have been above $620b since 2008.
Andreas Freiling, EMEIA Insurance Leader at EY. Comments: "The outlook for insurance remains comparatively stable – markets are calm and the economy is slowly gaining momentum but there is still no sign of relief from low interest rates, and high levels of unemployment in some markets are challenging. Against what is a fairly static economic picture, the conclusion of Omnibus II negotiations has pushed Solvency II back to the top of the agenda for 2014."
AUM to hit €5t for the first time as funds switch away from emerging markets
Eurozone AUMs started to grow again in Q3 2013 as investors became less concerned that the US Federal reserve tapering would disrupt developed markets and as investors switched away from liquidity sensitive emerging market assets.
AUMs are estimated to have increased by 6.9% in 2013 to €4,853b and in 2014 AUMs are forecast to rise above €5t for the first time. However, low economic growth, low inflation and historically low interest rates limit the scope for further growth, which is forecast to average 4.5% per year between 2014 and 2017 – well below the historic average of 6.7%.
Roy Stockell, EMEIA & Asia-Pac Asset Management Leader says that sentiment remains fragile however. "It is far from clear that European equities can deliver sustained long-term capital growth. As equity indices move back toward their 2008 levels, there are signs of underlying nervousness in the market. One indicator of fragile sentiment is the level of cash being held by European investors."
Capital continues to flow into recovering residential and commercial real estate, infrastructure funds and European hedge funds. However, funds of hedge funds continue to see their AUMs fall. The EEFSF estimates that they ended 2013 with around a quarter of the assets they had at the end of 2007.
Banks and asset managers need to guard against 'real' risk of deflation
Banks and asset managers do need to start to guard against the risk of deflation. As Marie explains: "Although it remains an outside risk, we think the threat of deflation is real. Our forecast for Eurozone inflation this year is just 1.1% despite some assumed weakening of the euro exchange rate. There is little room for error. Deflation would have significant consequences on the financial services sector – on banks and asset managers in particular - which needs to start taking the threat of deflation more seriously."
