The looming European credit crunch may not be the first thing on European leaders’ minds this weekend, but it’s coming, at least according to Citigroup.
Three of the bank’s European economists, Jürgen Michels, Guillaume Menuet and Michael Saunders, have looked at the recent ECB lending surveys, and in a note published Friday, they argue that a credit contraction is coming — with a eurozone recession not far behind.
The ECB, of course, announced on 6 October that it was reintroducing longer-term refinancing operations (LTROs), but that won’t be enough to stop a downward spiral of asset shedding, capital raising, loan contraction and reduced growth, suggests Citi.
From the note, emphasis ours:
Banks to shrink their balance sheets to replenish their capital buffers
The European Banking Authority is updating its calculations of potential bank capital shortfalls from a further deterioration in the price of some sovereign debt holdings. Few details are known beyond the probable targeted level of 9% Tier One Capital and an estimated capital gap of €90-100bn 2 . Nevertheless, Sunday’s Euro Summit will likely announce a coordinated plan to recapitalize the banking system, probably giving financial institutions between six to nine months to boost their capital buffers.
We believe that many banks will prefer to sell some of their non-core businesses and retain earnings instead of diluting their shareholders further. Another avenue likely to be pursued at the same time would be to reduce the balance sheet. As a result, we argue that the European banking system will not be able to maintain the same level of lending. We suspect that the flow of loans to the private sector (see Figure 5) will be reduced to a trickle, as it was in the six quarters ending in Q1 2010.
It is not surprising that senior loan officers tightened lending standards significantly in the October survey.
Our aggregated measure of lending standards shows that a net 16% of banks 3 (+0.2 standard deviations) applied more restrictive criteria in Q3 up from 5% in Q2. This was the highest percentage since the 21% recorded in Q3 2009. More worrying perhaps is the net 17% (+0.37 std) of senior loan officers expecting a further tightening in lending standards in Q1 2012 While these levels remain modest compared to those witnessed in 2008-09, the direction is clear. We believe that unless investors’ perception of risk related to bank debt diminishes significantly over the next few months, a larger net proportion of banks will tighten lending standards and the supply of loans will decline. The magnitude of the resulting credit squeeze will be determined by the extent to which this phenomenon is concomitant to a contraction in demand.
Households are set to be the first to suffer, adds Citi:
The rapid deceleration in the rate of mortgage loan growth from an annualized rate of 4% in the first half of 2011 to less than 1% in July and August does not bode well for non-financial corporate credit dynamics. The six-month lag observed between the rebound in both series at the start of 2009 could easily be shorter on the way down, given the uncertain macro backdrop.
All of which means, despite Germany’s continuing strength, Citi reiterates its consensus-busting forecast of a 2012 eurozone recession:
Compared to the consensus, we are pessimistic about the ability of the euro area to grow in 2012, not only because we do not expect a solution to be found at the Euro summit that will solve the crisis, but also because we fear that the deterioration in macro leading indicators has further to run. We expect a mild recession in 2012, with negative quarterly GDP growth from Q4 2011 to Q3 2012. While most core countries might avoid a technical recession, we believe that the size of the fiscal tightening effort in financially-supported countries will lead to a sizeable fall in economic activity in those countries, hence dragging down the Euro zone aggregate.
In bocca al lupo, Mario.
Related links:
The looming crunch de crédit – FT Alphaville
Citi: Euro area recession likely to begin in Q4 – FT Alphaville