ECONOMY

Retail banking has limits

Three out of the five major Greek banks managed to beat market expectations in the first quarter, delivering a strong set of results. This led to a new round of upward earnings revisions and higher price targets for their shares by well-known foreign investment houses. Although most pundits expect this favorable trend to continue in the next few quarters, setting Greek banks aside from their European counterparts, everyone should understand that the end of the glory days of retail banking, which has been the prime driver of revenue and earnings growth, is no more than two-and-a-half years away. This means that banks should lay the groundwork for new and untapped sources of revenue. Asset management is one of them and should be high on the agenda. National Bank, the country’s largest commercial bank, announced an increase of 30.2 percent in first-quarter pretax earnings after minorities to 145.7 million euros, beating consensus forecasts of 140.7 million. A higher-than-expected increase in all revenue streams, including net interest income, dividends, fee income and trading income, underlined the result with trading income being the top performer, as it came out at 40.8 million euros versus an expected 15 million. The bank’s investment case was further enhanced by the good impression that its new chairman, Takis Arapoglou, made upon the Greek and foreign analysts attending the teleconference following the release of the first-quarter financial outcome. These combined to prop up the bank’s share to the top 10 gainers of the pan-European stock index FTSE/Eurotop 300 in the last week of April. Alpha Bank, the country’s second-largest commercial bank in terms of assets, also surprised pleasantly with net earnings growth of 65 percent in the first quarter to 99.6 million euros on the back of a strong rise of 21.3 percent in operating income, underlined by a 17.3 percent increase in net interest income and a jump in trading income. Cost containment also worked, as operating expenses rose a mere 1.8 percent year-on-year. Piraeus Bank, the country’s fifth-largest bank, also reported a better-than-expected 36.7 percent rise in net profit to 35 million euro in the first three months of the year. EFG Eurobank Ergasias, the country’s third-largest bank in terms of assets, is also expected to report a double-digit increase in net earnings this week. Beating market expectations consistently in the four quarters of 2003 has earned them significant earnings revisions, helping their stocks outperform the European bank share indices and the local major stock indices. According to analysts who have been following them for quite some time, Greek banks offer a unique story in the European banking sector: Strong in most cases, with double-digit revenue growth for this year and a high single-digit growth rate next, coupled with a greater awareness of the need for cost control which should lead to satisfactory earnings growth in 2004 and 2005. This bright picture is being reinforced by the country’s strong GDP growth rates, estimated at more than 3.0 percent this year and next, by the lack of loan quality issues so far, lower than the EU15 average loan-to-GDP levels, and by more limited competition compared to other countries. As a well-known bank analyst working at a European bank puts it: «You cannot find such large asset spreads in other European banking sectors. Greek banks gain both from the asset side (loans) and the liability side (deposits). This shows that competition in the Greek banking sector is inadequate.» According to the same analysts, no other sector in «old» Europe offers such a potential. Other southern European countries Greece could compare with do not seem to offer a satisfactory alternative at this point. Italy, for example, is plagued by relatively low GDP growth rates, many of its key industries are vulnerable to the advance of the euro vis-a-vis the dollar and other major currencies, and there are also concerns of asset quality, especially if interest rates start rising. On the other hand, Spain’s economy appears to be in much better shape, but loan volume growth is not as strong as in Greece and competition among banks is much fiercer, as evidenced by much lower asset spreads, making efficiency the name of the game. What appears to be their strong point currently, namely healthy loan volume growth coupled with large spreads, may turn out to be their liability in a couple of years if they become dependent on it to sustain satisfactory earnings growth rates. This is because volume growth is bound to slow down considerably, opening the road for a war on market shares which is bound to normalize asset spreads. Having the luxury of this two-year grace period, local banks should start working for the day after. That was exactly what National Bank’s Arapoglou had in mind last week when he said that the need for M&A activity in the Greek banking sector will become more urgent after two years or so, when revenues from retail banking slow down considerably. M&A activity may be an answer at the time, but it will seek to address more the cost side and no one can be sure that labor market laws will be more flexible at the time to allow for efficiency gains. Faced with this reality, Greek banks may have a way out in asset management. Although Greek retail investors have yet to recoup from the steep losses suffered during the stock market bubble in 1999 and are therefore hesitating to invest in equities, sticking instead to low-yielding money market instruments, one should not rule out greater participation down the road as memories fade and confidence recovers. Given that equity funds and bond funds enjoy wider spreads and higher fees than money market funds, banks should benefit from this trend and should do their best to reinforce it. In addition, asset management will be the prime beneficiary of a likely amnesty given to residents keeping money offshore. Although there is no accurate estimate, it is likely that offshore funds account for anything from 50 billion to 200 billion euros. Assuming a good portion of this money flows into Greece, it will most likely give a boost to bank asset management revenues. A positive, possibly large contribution should be expected from inflows related to pension funds. Faced with a crisis in the pay-as-you-go public pension system and an aging population, the new government has no option but to reform the system in the most politically painless way. Providing tax incentives for employees to save for retirement and facilitating the management of pension funds by institutional investors is such a way. Local banks’ quest for future sources of revenue to supplement retail banking two years down the road should start now. Asset management is such an alternative revenue source and its potential should not be underestimated. After all, banks do not have many alternative sources for growth before they start cutting to the bone to deliver the kind of earnings growth demanded by the markets.