Still Struggling In A Tough Operating Environment


BMI View: We maintain our downbeat outlook towards the France banking sector, which in many ways mirrors much of the weaknesses of the wider economy. While loan growth rates are comparable to the eurozone's stronger economies, asset quality deterioration remains a major risk, particularly in light of relatively weak capital buffers. Over 2013, banks will continue to focus on cost cutting and rebuilding capital buffers , although we do not expect to see an improvement in profitability until 2014 at the earliest.

In line with our expectations, loan growth remains relatively weak, with loans to households growing by 2.7% y-o-y in May and loans to non-financial corporates growing by 1.0% in the same period. We expect aggregate loans to grow by 1.5% in 2013 and 3.5% in 2014. The operating environment for banks will remain tough this year, as we expect French household consumption will c ontract in real terms as concerns over the economy feed through into spending patterns , and a robust recovery in household credit growth remains unlikely. Non-financial corporate lending will remain similarly subdued, with the weak growth outlook likely to curtail investment borrowing over the coming quarters. Domestic retail banking operations account for around 20-30% of the major French banks with the remaining revenues arriving from a roughly equal split of commercial banking/retail operations abroad - many of which are being divested to help build capital - and capital markets-based revenues , which we expect to come under pressure due to regulatory restraints.

Weak Economy Suppressing Loan Growth
France - Household and Non-Financial Corporate Loans, % chg y-o-y

Poor profitability will see French banks continue to cut costs in order to restore profitability, as Société Générale 's net profit declined by about half to EUR364mn in the first three months of 2013 compared to the same period last year . The bank said that it would add an additional EUR900mn in cost savings by 2015 to previous co st cuts of EUR550mn (US$707mn), which will also entail a trimming of personnel co sts, with job losses likely to exceed 1,000 . This should help to stabilise profitability over coming quarters , although we see numerous headwinds that will prevent a strong recovery in earnings next year.

Demand For Investment Loans Remains Low
France - Non-financial Corporate Loan Growth, % chg y-o-y

In particular, rising regulatory interference will continue to dog the sector. In July, the French senate passed a law forcing banks to mov e purely speculative trading into separately funded entities. High frequency trading has also been banned, as well as commodity derivatives trading. While the reforms represent a substantially watered down version of Hollande's campaign promises, capital market operations are unlikely to return to pre-2008 levels for the foreseeable future, leaving the big banks increasingly reliant on slowing domestic retail operations for revenue growth .

SME Access To Financing Is Still Good
France - SME Financing Grants (fully or over 75%), % total

Nonetheless, we emphasize that there are some positive trends in the sector. Access to finance for SME's appears to be substantially healthier than neighbouring economies such as Italy and Spain . In Q213, the amount of cash credit granted (fully or over 75%) rose to 72%, from 63% in Q412, while 88% of investment loans requested were granted, up from 87% in Q412. Furthermore, financing costs have remained low, with only 2% of SMEs in Q213 declaring that the cost of financing rose, versus 22% that declared a drop in the total cost.

French Banks Among The Weakest
Core 1 Ratio Tier 1 Capital Ratio NPL Ratio
Notes: Average and median are taken from Bloomberg bank peer group. Source: BMI, Bloomberg
BNP PARIBAS 11.8 13.6 6.5
CREDIT AGRICOLE SA 9.2 11.7 5.3
SOCIETE GENERALE 10.7 12.5 6.5
Median 11.6 13.4 5.1
Average 12.6 14.4 5.4

While SME financing appears relatively stable, the French government has launched a new initiative designed to allow insurer's to lend to SMEs. The finance ministry has announced it intends to loosen laws restricting insurance company's ability to lend, allowing them up loan up to 5% of their balance sheet to corporates . The move could in theory release around EUR90bn, although over the short term the actual amount loaned out is likely to be far smaller. That said, big French banks could still stand to benefit, as BNP Paribas and Credit Agricole have both invested in the new fund.

Nonetheless , the move highlights the broader problems facing the sector as a whole, which is struggling to maintain profitability and lending growth against a backdrop of rising capital requirements. Furthermore, we still believe the sector is extremely exposed in the event of any major eurozone shock, given that capital ratios relative to peripheral sovereign debt exposure are extremely poor. While eurozone risks have been contained to some extent by the ECB's implicit backstop, severe risks remain in Spain, Italy and Greece which could still see a sovereign bond blowout occur . Combined with our negative outlook towards the wider French economy, we retain our downbeat assessment of the sector over the next 12 to 18 months.

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Geography: France