Analyst Stuart Graham at Merrill Lynch has a very thorough note out today on the macro outlook for Europe’s banks.
Buried some way down in the voluminous report is this little table:
It’s a neat little summary of the report’s key finding: that the deleveraging of Europe’s banks will be a €5.5 trillion affair.
The call is based, ultimately, on one key metric: the ratio of banks’ assets to GDP - currently, Europewide, at 247 per cent.
The 20-year adjusted average for that ratio is 187 per cent. A mean reversion, as you can see from the table above, would hoick the €5.5 trillion deleveraging to €8.4 trillion.
Merrill though, is anticipating a normalisation at 210 per cent:
..the sector’s adjusted asset/GDP ratio averaged 223% in the tough years of 2001-03. Given the scale of the MTM hits the banks have taken in 2007 and 2008, combined with the likely tougher regulatory environment in the coming years (discussed below), we think this ratio could bottom at a lower level this time around. The pain to the banks has been much more pronounced than in 2002. We think 210% could be a possible bottom (a 23% reduction in leverage from the peak), with 230% representing a more normalised future operating environment. Both numbers allow for an extra 10% assets/GDP because of the greater depth in the repo market than in the past.
What exactly, does a €5.5 trillion deleveraging involve? How do banks shed those assets? With difficulty.
In spreadsheet-land it is relatively easy to model a decline in leverage to our assumed level of 210% of GDP. But in real life that means European banks would need to shed €5.5 trillion of assets - much of which should come from the wholesale banks. At current rates of progress that could take seven years to achieve.
Banks will either have to sell off assets faster and more painfully, or else face a very long and winding road to recovery.
