Bullish for banks

ECB highlight deposit rate could rise earlier than prime rate

Investors debate tapering – raising the deposit rate would be more bullish for banks. We discussed that a higher deposit rate would be more positive for banks than tapering, as 1) the former would be a strong signal that the ECB is taking action, which eases pressure on bank profitability, and 2) a higher deposit rate has an immediate and direct effect on bank P&Ls. So far, lifting the deposit rate has not been widely discussed in the market. European banks’ excess liquidity is at an all-time high of c.EUR1.3tn and the direct earnings impact from a 40bp higher deposit rate would be equal to an earnings uplift of c.3% for Eurozone listed banks, CSe. Tapering could have unwanted side effects in the form of wider sovereign spreads in peripheral European countries, negative knock-on effects on economic growth and risks of asset quality deterioration.

We note that late last week an ECB governor, for the first time, highlighted that the deposit rate could rise before the prime rate. Ewald Nowotny, at the ECB, stated that the American model was to finish bond purchases first, but the ECB might not follow that model exactly and that “All interest rates also wouldn’t have to be increased simultaneously nor to the same extent” and that “The ECB could also raise the deposit rate earlier than the prime rate”, Handelsblatt, 16 March, 2017. We note that ECB members have previously highlighted the unwanted consequences of ultra-low rates is an undue pressure on bank profitability. Markets are pricing in a 32% chance of a 20bp deposit rate hike by December, 2018.

The Reflation Trade: the start of a long-term theme for banks. Bond yields explain c.80% of banks’ performance and gearing to rising rates is historically high: 1) capital is 1.7x and short-rate sensitive assets are 2.5x pre-crisis levels; and 2) the sector is priced for only c.35bp higher short-rates, hence still valued for negative rates. Our rates model shows 100bp higher rates would raise sector EPS c.9%. We highlight reflation stories with a combination of 1) high gearing to rates, 2) better than peers’ asset quality (lower risk of LLPs) and 3) rate sensitivity driven by excess liquidity, rather than floating loans (to avoid repricing risk) : ISP (OP), EPS impact c.20% for 100bp; BKIR (N), c.21%; CABK (N), c.14%; NDA (OP), c.14%; and BKIA (OP), c.19% impact.

Equity Research – Credit Suisse