European banks – things may not be what they seem

Spectators at recent ECB press conferences may well have come away thinking that there is little, if any, evidence of a credit crunch in Europe. According to the ECB, ‘the growth of bank loans to non-financial corporations has remained very robust despite the rises in short-term rates’ and ‘the availability of bank credit has, as yet, not been significantly affected by the tensions.’

We suspect that the reported numbers significantly overstate banks’ willingness and ability to lend. To understand why, it’s worth having a look at a comment that Richard wrote in February about how Porsche outmanoeuvred the banks. In short, earlier this year, Porsche took advantage of a credit facility with a bank, where the facility had been set up before the credit crunch hit. The bank was forced to lend billions to Porsche at unprofitable rates for the bank.

Credit facility drawdowns are becoming more and more widespread. A report released this week by JP Morgan estimates that over the first five months of 2008, circa 46% or $165bn, of credit growth in the Euro area could be attributed to the drawing down on such credit lines. Despite the best efforts of banks to incentivise companies not to use these facilities, irrevocable credit facilities (often made at the height of the credit bubble) remain some of the most attractive funding available for companies. The report estimates that if the entirety of the $4.6 trillion of credit lines outstanding at the end of 2007 were drawn during the next 12 months, capital in the region of $184 billion would have to be posted by the banks.

Clearly the potential for further drawdowns is another in a long line of headaches for the banking sector. All is not well, despite noises to the contrary from the ECB. Banks have raised $320 billion of capital since Q3 2007. As this chart shows, banks still need to raise another $80bn to cover losses and write-downs that have occurred to date (and they’ll need to raise even more to cover bank losses and write-downs that occur in future) . Add in the credit facility problem, and it seems that banks will continue to hoard capital and see their profit margins challenged.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Stefan Isaacs

Job Title: Deputy CIO Public Fixed Income

Specialist Subjects: Bonds

Likes: Football, travel and the prospect of retirement

Heroes: Sir David Attenborough, Bill Shankly and Theodor Herzl

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