22 February 2012 at 9:32 GMT
Quelle horreur! Nobody was toasting with fine Bordeaux after the Q4 results for Societe General (GLE) were released last week. SocGen missed analysts’ estimates after reported slumping earnings (Euro 100m in Q4).
Another large French bank, BNP Paribas (BNP), managed to beat expectations as earnings dropped less than expected, to Euro 765m in the quarter. And Credit Agricole (ACA), reporting this Thursday 23 February, is expected to have lost approximately Euro 750m in 2011.
The picture is mixed and uncertainty high, and we have been among the skeptics about French banks in past themes. However, if you have the right kind of risk tolerance, French banks may actually be more resilient that some might think.
Here are my arguments: first of all, core earnings are picking up. Secondly, concerns about the quality of the loan book may be misplaced. Returns are low, but risk level may decline, making those low returns relatively more attractive.
Core earnings are building momentum
First, let's look at core earnings, or net interest income. They are heading in the right direction, according to consensus, as is net income. This is on the back of increasing margins on deposits and loans, which don’t necessarily take into account a rapid credit expansion, chart 1 and Chart 2.
What investors are concerned about is the quality of the loan book, which according to analyst estimates will have reached its peak in 2011, chart 3, and the diminishing return on equity (ROE) which they say will contract considerably in the years to come.
This lower ROE makes investment in banking shares relatively less attractive in relation to other assets.
However, if the risk level also goes down, that could change things. New capital regulations coming in to force are aiming to limit risk, and we think French banks will be an attractive investment going forward.
Trading income fading away – back to basics
The French banks were particulary dependent on trading income, and this has hurt them over the past couple of years. Virtually all banks globally grew fat on trading income: during the good years could count for 30-50% of their overall result. Now banks all over Europe and the US are currently experiencing a painful “detoxification” to lower risks.
Trading income has fallen dramatically in the last years and are expected to stay that way for the next three years, chart 4. Being able to offset the lower trading income will be the key for the French banks to come back from the prior year’s slump. While the future is never certain, we think they will!
