Eurozone EY Eurozone Summer edition 2013 Outlook for financial services
Welcome Introduction Andy Baldwin A few weeks ago, President Hollande of France assured a Japanese audience that the Eurozone crisis is over. But while economic recovery remains visible, reaching it does not seem to be getting any easier. Our forecast still anticipates that the Eurozone will return to growth in 2014, but we expect recovery to be slower than before. Head of Financial Services Europe, Middle East, India and Africa Contact details Tel: +44 (0) 20 7951 1315 Email: abaldwin@uk.ey.com Keep in touch Follow us on Twitter @EY_Eurozone Find us at ey.com/eurozone Contact us at fsoutlook@uk.ey.com 02 03 04 06 08 10 14 Contents Macroeconomic overview Executive summary Banking forecast Banking remains depressed Viewpoint: Robert Cubbage EMEIA Banking & Capital Markets Leader Insurance forecast Life insurers see slow start for premium growth in 2013 Viewpoint: Andreas Freiling EMEIA Insurance Leader Asset management forecast Eurozone asset valuations have largely recovered Viewpoint: Roy Stockell Partner, EMEIA & ASIA PAC Leader for Asset Management Country forecasts Highlights Key issues Appendix Similarly, unemployment is now expected to peak at a higher level than anticipated in our last forecast. Recession, unemployment and lower real incomes represent a major challenge to financial services companies that look for growth. Even so, there are signs of optimism within the industry, including among Eurozone banks which will play an integral role in economic recovery. Eurozone banking union is critical to preventing the international markets losing some of this new-found optimism. However, the proposed union will need to make concrete progress toward a resolution scheme and deposit guarantees if it is to be credible. A key step in the formation of the banking union will be the forthcoming asset quality review (AQR) on banks that will now be supervised by the European Central Bank (ECB). The AQR process will need to be both transparent and rigorous if it is to address the concerns being raised about non-performing loan (NPL) levels in some countries. Time will tell whether the AQR process can become the key milestone we all hope for on the road to recovery of the Eurozone banking sector. For now, it is encouraging to see that banks in core Eurozone markets are beginning to show greater willingness to advance credit to SMEs albeit at the expense of other lending. The current economic situation represents a serious challenge to insurers revenues and profitability. The mismatch between current asset yields and historic liabilities is a particular threat in some markets. The Eurozone s life industry is also facing a fast-evolving distribution environment. The Retail Distribution Review (RDR) is heralding a new regime in the UK, along with the possibility of similar changes in the Netherlands. Local regulatory initiatives and some further EU-wide legislation are encouraging many firms to shake up their distribution strategies. Despite the challenges that the financial services industry faces, there are still opportunities for companies that are able to seize them. Wealth management continues to be a growing area of focus among banks, insurers and asset managers. In the high net worth market, private banks and private client teams are also helping customers to diversify into alternative asset classes. However, Mifid II will require the traditional private banks to revamp their client proposition to recognise the need for greater transparency around product provider-related fees, and the return of offshore-held funds to meet the needs of greater tax transparency. We also think that opportunities will increase in the mass affluent arena. In particular, the growing longevity of European populations and the increasing share of wealth owned by the post war baby boomers in some countries offer insurers and asset managers a chance to develop their services in the postretirement de-cumulation market. Whether or not financial firms are able to capitalize on current opportunities will depend in part on the course of European regulation. While remaining true to the primary directive of stability and security, policy-makers also need to be alive to the law of unintended consequences. They risk unwittingly hindering recovery of the financial sector though well-intended legislation. The growing chorus of concerns being expressed on the potential impact of the financial transactions tax (FTT) and some of the latest proposed amendments give encouragement that a balance is being sought. Policymakers need to weigh a desire for the financial sector to shoulder more cost for necessary economic reform against a recognition that the FS industry in Europe must remain a vibrant, open and competitive single market. We hope that you find our forecast and industry viewpoints informative and interesting. Published in collaboration with 2 Ernst & Young Eurozone : Outlook for financial services Summer edition 2013 EY Eurozone : Outlook for financial services Summer edition 2013 1
Macroeconomic overview The Eurozone has now spent more than a quarter of its short history in recession. Fortunately, an end is now in sight. Growth should start to pick up later this year, but even so we expect the economy to contract by 0.6%. From next year, the Eurozone should slowly recover, with GDP growing almost 1% in 2014, then around 1.5% a year until 2017. Assets 2008 Assets are set to fall back to 2008 levels this year, but 2013 is expected to mark the bottom of the cycle. Executive summary Banking sector highlights Banking service demand still weak, profit margins continue to be squeezed and balance sheet consolidation continues through 2013. Assets set to fall back to 2008 levels this year, but 2013 should mark the bottom of the cycle. NPLs expected to reach 7.5% of total loans in 2013, a higher peak than previously thought. Total loans forecast to grow by 17% between 2013-2017. Two contrasting sets of forces are at work behind this forecast On the upside, the focus of fiscal policy is at last shifting from short-term austerity to longer-term credibility. There is increasing acceptance among policy-makers that the pace of austerity should be slowed. Some countries have been given more time to reduce their budget deficits to 3% of GDP. We estimate that halving planned austerity measures would raise Eurozone GDP by 1% by the end of next year, with Greece and benefiting most. On the downside, the outlook for emerging markets is cooling as the world adjusts to slower growth in China. This will limit the scope for Eurozone economies to expand through exports. Recent developments in global exchange rates will also make it harder for Eurozone companies to compete, as many emerging market currencies have been slipping against the euro. A sharp fall in the yen is hampering export prospects by intensifying competition from Japan. For these reasons, we now expect a slower bounce-back than previously envisaged. Slow recovery increases unemployment A consequence of the delayed recovery has been high and still rising rates of unemployment. We now forecast unemployment to peak at 12.7% early next year, rather than 12.2%. This means we are expecting an additional one million unemployed workers. As a result, private consumption will contract again this year, bringing further challenges for businesses. It also delays the reduction of private sector debt, which needs to fall before the economy can sustain robust growth. With so many people out of work, rising rates of youth and long-term unemployment bring particular concerns. Almost half of those unemployed have been without a job for more than a year. These workers become deskilled and detached from the labor market, hindering the Eurozone s medium term growth prospects. There is also a risk of social unrest, as governments will face stiff protests against fiscal consolidation and other reforms that would cost jobs in the short term. and lowers interest rates A quarter-point cut in the European Central Bank (ECB) refinancing rate in May reflected these poorer growth prospects. But cutting interest rates when they are already so low will do little to stimulate the economy. Neither will it address the wide disparity in corporate borrowing rates across the Eurozone, which is so damaging for peripheral economies. The ECB has side-stepped this issue so far, but it has instead begun to encourage much-needed structural reforms. With the shift in focus toward longer term fiscal credibility, there is now more scope to improve competitiveness. Some of the countries hardest hit have already been forced to reform labor market regulation and social welfare systems. There are signs that the Eurozone will emerge stronger from the crisis. Household wealth 23 % By 2017, gross household wealth is expected to rise by 23%, bringing new business opportunities. AUM growth 12 % 8 % AUM growth is expected to slow from 12% in 2012 to 8% this year, falling to an average of 4% between 2014 and 2017. ECB s AQR could force faster restructuring: banks may need to shrink balance sheets by a further 1.5t. Insurance sector highlights Life premium growth expected to rise by only 1.3% in 2013, but should pick up pace to 2.6% between 2014 and 2017. Low interest rates have raised the cost of providing term products, making it hard for life insurers to balance investment risks and returns, and reducing profits. Car sales and house prices set to pick up and corporate profits are forecast to rise from 2014, pushing non-life premiums to an average 2.6% between 2014 and 2017. Profits for Eurozone insurers increased by 11% in 2012, helped by costcutting measures. By 2017, gross household wealth expected to rise by 23%, bringing new business opportunities. Asset management sector highlights: AUM growth expected to slow from 12% in 2012 to 8% this year, before averaging 4% between 2014 and 2017. As confidence returns, investors are expected to move out of German and French bond markets in search of higher yields with increased focus on the US and emerging markets. Current low household income (especially in the periphery) is expected to encourage some investors to cash in positions. Low volatility of bond yields in the periphery expected to increase their attractiveness. The strong hedge fund performance in 2012 continues, earning 5.7% so far this year. 2 EY Eurozone : Outlook for financial services Summer edition 2013 Return to Contents EY Eurozone : Outlook for financial services Summer edition 2013 3
Banking remains depressed Banking forecast Banking remains depressed The protracted recession is delaying the revival in demand for banking services. We now expect total banking assets in the Eurozone to fall back to 2008 levels this year. Business loans will reach a six-year low of 4.5t and personal loans will shrink to 595b, their lowest levels for seven years. There was a particularly marked reduction in demand for personal and housing loans in the first quarter of this year, as Eurozone unemployment continued to rise. Consumers were therefore more reluctant to spend. In response, although banks intend to continue tightening credit conditions for household loans, they will ease the pace according to the most recent ECB bank lending survey. In the meantime profit margins will continue to be squeezed. With no immediate prospect of an economic revival, banks will have to rely on restructuring their balance sheet to cut costs and boost profits. This may include selling non-core businesses or squeezing lending even more. Some pan-european banks have recently announced staff cuts in the face of stagnant revenues. but 2013 will mark the bottom of the cycle Recent ECB comments indicate a determination to keep interest rates low for as long as necessary to kick-start growth, and we expect Eurozone GDP to begin to pick up later this year. Risk aversion should decline as the Eurozone economy starts to grow again, enabling banks to ease their credit supply constraints. Lending will rise, albeit slowly at first. We forecast a 3% loan book expansion in 2014. But faster growth in subsequent years should secure a 17% increase in total loans between now and 2017, to reach 13.9t. Intentions to lend to small and mediumsized enterprises (SMEs) have started to pick up in recent months. SMEs are considered more risky than large corporates, but this move may be a response to political pressures rather than a willingness to take on more risk. We do not expect to see a dramatic improvement in confidence or risk appetites until economic activity shows clear signs of revival. Nevertheless, these small improvements in sentiment suggest that progress is under way. NPLs will rise further We expect NPLs to reach a peak of 7.5% of total loans in 2013, before starting to fall back next year. This is higher than we had previously thought likely, and reflects the slower recovery and increased unemployment rate. Banks may therefore need to increase bad and doubtful loan provisions again. The better news is that, as the economy recovers and unemployment starts to ease from next year, loan book quality should also begin to improve. By 2017, NPLs should fall back to 4.3% of total loans. Even so, this is still high by pre-crisis standards. In peripheral countries like and, NPLs will not peak until 2015, and will remain far higher than the Eurozone average. Wide disparity in conditions between core and periphery Financing conditions differ widely between core and peripheral Eurozone countries. There was a clear break in 2011, when interest rates charged to businesses in peripheral countries started to diverge from rates in the core countries. Since then, lending growth, deposit flows, NPL ratios and interest rates have all been more favorable in the core than the periphery. Our simulations show that 0.7% would be added to Eurozone GDP by 2017 if half of the credit tightening introduced since 2008 could be reversed within two years assuming this would not increase banking risks. Unemployment would also fall by almost 500,000. Unfortunately, at its June press conference, the ECB downplayed any plans to foster lending to SMEs. Fragmentation looks set to hold back Eurozone banking for years to come. The AQR could force faster restructuring A major source of uncertainty for the banking sector is the forthcoming AQR by the European Central Bank (ECB) in its new capacity as pan-european supervisor. Eurozone banks have been slower to restructure than their US counterparts. US commercial bank assets shrank by 10% in 2009 and 2010 as they repaired their balance sheets, but so far Eurozone assets have fallen only 5% from peak levels. This suggests that there is more pain to come, although it is not yet possible to estimate the size of the clean-up required. Drawing from US experience, balance sheets may need to contract by as much as a further 1.5t. In that case, loan books would continue to shrink in 2014, probably to around 11.5t, compared to 12.3t in our baseline forecast. This would reduce them to 2007 levels. The ECB is due to begin its AQR at the start of next year. The new supervisory regime could force through restructuring more quickly than banks had planned for, requiring further recapitalization. Uncertainties also arise from lack of clarity about how any restructuring would be achieved before a framework for a common resolution mechanism has been agreed. Recent events make it clear that there is no one favored way of dealing with bad assets, as the experiences of Cyprus and testify. But tougher EU rules will require all investors, except insured depositors, to share restructuring losses. There are some signs of an improvement in risk appetite, especially in core countries. This could be a welcome prelude to stronger SME lending. Viewpoint Robert Cubbage EMEIA Banking & Capital Markets Leader Contact details Tel: +44 (0) 20 7980 0558 Email: rcubbage@uk.ey.com Europe s banking industry is at a delicate stage in its recovery. Some banks are increasingly confident, but others remain under pressure. The latest forecasts provide ammunition for both optimists and pessimists. On one hand, the Eurozone recession continues to depress lending. On the other, credit will begin to expand again as the economy recovers. There are some signs of an improvement in risk appetite, especially in core countries. This could be a welcome prelude to stronger SME lending, although construction and real estate firms are unlikely to benefit. Leverage requirements also mean that any increase will need to be offset elsewhere. Despite political pressure, under-capitalized banks will struggle to expand their lending. Many Eurozone banks have made significant cost reductions, and most are maintaining their focus on efficiency. Those under the strongest pressure to improve their profitability are prioritizing short-term cost cutting and balance sheet repair. In contrast, Banking highlights NPLs 7.5 % NPLs are expected to reach 7.5% of total loans in 2013, a higher peak than previously thought. Total loans 17 % Total loans are forecast to grow by 17% between 2013 and 2017. more confident banks are taking a strategic approach to efficiency by including costrelated goals in every decision they take. NPLs continue to rise, as banks balance sheets catch up with economic reality. The comparatively slow pace of asset disposals is also a contributory factor. An optimist could interpret the anticipated decline in core Eurozone NPLs from 2014 as encouraging. Then again, a pessimist might expect the ECB s AQR to reverse this improvement. The ECB is keen to understand its contingent risks, and is emphasizing the AQR s rigorousness. There is no doubt that some banks in the core as well as the periphery will need to make further impairments. How significant will the required restructuring be? Some banks will be able to address any capital shortfalls without external help. But state-led reconstruction is a possibility in some markets, especially where under-capitalization is compounded by over-supply. ECB s AQR 1.5 t The ECB s AQR could force faster restructuring and banks may need to shrink balance sheets by as much as a further 1.5t. 4 EY Eurozone : Outlook for financial services Summer edition 2013 Return to Contents EY Eurozone : Outlook for financial services Summer edition 2013 5
Life insurers see slow start for premium growth in 2013 Insurance forecast Life insurers see slow start for premium growth in 2013 The life insurance market continues to struggle with intense competition and the low interest rate environment. Premiums fell 7% last year, and we expect them to rise just 1.3% in 2013. Competition from banks for single premium savings products has been a major factor in the decline. Some customers will return to products offered by insurance firms but, given the lack of price and product competitiveness, Eurozone insurers may never fully recover this lost business. Furthermore, the operating environment continues to be extremely tough. Persistently low interest rates have resulted in unattractive investment returns, especially for bond-heavy portfolios. This has raised the cost of providing term products, making it hard to balance investment risks and returns, and reducing profits. Firms in search of higher yields may invest in more risky assets or transfer more investment risks to customers. As old business rolls off insurers books, it may be replaced with newer, less profitable products. We expect the profit squeeze to continue. Bond yields have started to rise in recent weeks and we expect them to rise further. For example, since early May, 10-year German bund yields have risen from 0.8% to 1.2% and we expect them to have risen by a further percentage point by the end of 2015. An even faster and unexpected reversal of low interest rates would increase unrealized losses in portfolios. Although there is only a small risk of this happening no more than 10% insurers should nevertheless consider planning for this possibility. Our alternative, faster growth scenario envisages 10-year bund yields rising to 3.3% by the end of 2015, compared with a baseline forecast of 2.2%. but improvements expected by 2014 Assuming this does not happen, premium growth will be held back this year by high unemployment and fairly stagnant consumer incomes. However, once the Eurozone economy emerges from recession, demand should begin to rise again, enabling premiums to grow on average 2.6% a year between 2014 and 2017. This is a slow pace of expansion by historic standards. Economy holds back non-life business Non-life premiums are forecast to increase by 1.3% this year, similar to the rise in 2012. Growth will be driven by moderate price rises rather than new sales, as the economy continues to contract. But from next year, business conditions should improve as growth re-emerges. This will enable car sales and house prices to pick up a little and corporate profits to rise further. In aggregate, car sales should increase by 5.3% between 2014 and 2017, with house prices rising 8.1% and profits picking up by almost 15%. Consequently, we expect premium growth to average 2.6% between 2014 and 2017. As the economy improves, more substantial price hikes could be prevented by the increased use of price comparison sites. Surveys from Mintel show that customers in the UK have adopted this technology in vast numbers. Well over half of British motor and home insurance customers use a price comparison website to research the market. By the end of last year, 37% of all motor insurance policies were taken out or renewed through one of these websites, possibly prompted by substantial price rises in 2010 and 2011. For now, this trend has been limited mostly to the UK. However, if the use of price comparison sites rises in the Eurozone, it would increase price visibility and enable customers to shop around, squeezing insurers profit margins. Cost-cutting helps Eurozone insurers return to profitability A focus on streamlining systems and processes to cut costs helped to secure an 11% increase in profits last year, despite the tough operating environment. Firms will continue to reduce operating expenses for the next few years, and we expect some to consider mergers or acquisitions to improve profitability, given the limited potential available from organic growth. They should have more time to focus on building their businesses now that the implementation of the Solvency II directive has been delayed from January 2014 to possibility as late as January 2016. However, even by 2017, profits will still be 25% lower than the peak reached in 2007. Ageing, wealthier population brings business opportunities With limited opportunities for growth in current business areas, an ageing and increasingly wealthy population may bring new prospects. By 2017, we expect gross household wealth to have risen by 23%, and 20% of the population will be over 65 years old. Recent experience in Japan, where the insurance industry had been struggling with a low interest rate environment for many years, suggests that, as the population ages, the demand for savings products, health insurance and critical illness products rises. Wealthier households may also increase their demand for travel insurance and cover for household contents. Insurers that are able to harness these opportunities or develop innovative new products are likely to grow more rapidly than is currently assumed in our forecast. So far, little progress has been made, which means there are still opportunities for the taking. Creative thinking could be the key to unlocking some potential opportunities. In the short- to medium-term, this includes changes to investment strategies. Viewpoint Andreas Freiling EMEIA Insurance Leader Contact details Tel: +49 6196 996 27267 Email: andreas.freiling@de.ey.com The outlook for Europe s insurance industry remains inextricably linked to the Eurozone s economic woes. Recession, growing unemployment and a continuing squeeze on disposable incomes mean that forecasts for premium growth remain weak across life and non-life businesses. The limited scope for organic expansion is encouraging insurers to grow their businesses in other ways. Insurers are investing to expand their domestic distribution, whether by buying networks of sales agents or developing their online capabilities. Firms in core countries and with capital to spare are also acquiring businesses in the Eurozone periphery or in developing markets nearby, such as Poland and Turkey. Low growth may be a strategic challenge, but it is low interest rates that are causing Eurozone insurers the greatest pain. Safe haven bond yields can only increase from current levels, but benchmark rates will Insurance highlights Life premiums remain low over the next few years. Weak investment returns are a threat to all insurers, especially life companies unable to reconcile historic investment guarantees with current asset yields. This is particularly acute in Germany, where the proportion of insurance sold with guarantees is higher than in many other European markets. Faced with this environment, it is no wonder that many insurers are feeling pessimistic. Even so, creative thinking could be the key to unlocking some potential opportunities. In the short- to medium-term, this includes changes to investment strategies. Some insurers are not only increasing their exposure to corporate bonds and equities but also subject to regulatory limitations to property, infrastructure and other non-financial assets. Looking further ahead, life insurers that can intelligently address the changing needs of an ageing population while limiting their own exposure to longevity risks could enjoy significant long-term success. Insurers profits 1.3 % 11 % Life premium growth is expected to rise by only 1.3% in 2013, but should pick up pace to 2.6% between 2014 and 2017. Non-life premiums 2.6 % Car sales and house prices are set to pick up and corporate profits are forecast to rise from 2014, pushing non-life premiums to an average 2.6% between 2014 and 2017. Profits for Eurozone insurers increased by 11% in 2012, helped by cost-cutting measures. 6 EY Eurozone : Outlook for financial services Summer edition 2013 Return to Contents EY Eurozone : Outlook for financial services Summer edition 2013 7
Asset management forecast Eurozone asset valuations have largely recovered Valuations have risen since the depths of the financial crisis in 2008-09, but equity and bond markets are still quite volatile. Equity markets tend to rise in anticipation of a pickup in growth, but these rises are also a reflection of quantitative easing (by the US and Japan particularly) pushing investors away from cash and into higher-yielding asset classes to help stimulate growth. As a result, the AUM of global funds which focus mainly on Eurozone assets have risen 43% since their low point in the first quarter of 2009. Indeed, by the end of Q1 2013, AUMs were just 1% below their pre-crisis high of 4.8t. Equity price-earnings ratios have now returned to levels last reached at least two years ago in many Eurozone markets, and yield spreads between bonds in the core and peripheral countries have narrowed. This limits the scope for further price rises. As most of the upside has now been realized, we expect the value of AUMs in the Eurozone to grow more slowly this year, by 8% compared with 12% in 2012, winding down to around 4% a year until 2017. This is well below the historic average of 6.7%, and is likely to encourage investors to look elsewhere for better returns. As recovery continues, we expect safe havens to become less attractive As the Eurozone economy gradually moves from recession to anemic growth and risk appetites return to more normal levels, safe haven bond yields are likely to rise, making them less attractive investments. We believe that holders of money market funds will no longer be prepared to accept negative real returns as a trade-off for security. We therefore expect bond AUM growth to slow from 31% in 2012 to virtually zero by 2014, and money market AUMs to contract by 3% in 2013. However, periodic spikes in volatility will continue, caused by concerns about potential threats to the recovery, such as a premature tightening of monetary policy. As confidence in the Eurozone increases, we therefore expect investors to move out of German and French bond markets in search of higher returns. Some of the sales will probably be cashed in, however, and used to support private consumption at a time of declining household incomes, especially in peripheral economies. Real incomes are now 14% lower than their pre-crisis peak in, and almost 10% lower in. in favor of higher yielding assets There is little evidence yet of a fundamental shift in risk appetites. Indeed, we have recently experienced another bout of risk-on investor behavior. However, when it happens the beneficiaries will be higher yielding assets like corporate bonds, equities and multi-asset funds. As the Eurozone economy returns to growth later this year, bond yields in the periphery will become less volatile. They will still be higher than yields in the core, and will therefore remain relatively attractive. So we expect bond, multi-asset and equity investments in countries like and to increase over time. A big risk for Eurozone-focused fund managers, however, is that investors will be drawn to faster-growing regions such as the US and emerging markets. Although Eurozone-based equity funds with a high international exposure that can generate good returns will remain competitive, as will multi-asset funds with investments outside the Eurozone. Therefore, we expect equity-based and multi-asset funds to continue their expansion, and to grow faster than bond- and money-market offerings. Less traditional investment opportunities will also be developed in the search for higher yields. Fund management groups are investing staff and resources to develop leveraged loans, infrastructure and property products, which had previously been the preserve of banking operations. Increasingly, these areas look set to be managed by fund management groups as banks focus on retrenchment and restructuring in the aftermath of the financial crisis. Multi-asset funds will benefit from outsourcing In addition to increasing regulation, pension fund sponsors and trustees are realizing that additional time and expertise is required to access today s more sophisticated investment approaches. We expect these two factors to drive more pension funds to outsource most or all aspects of their investment management, including asset allocation decisions. This will affect smaller pension funds in particular, given their disproportionate cost burden. Small, specialist boutiques managing multiasset funds are likely to pick up some of this additional business, as long as they have a good performance track record. But many institutional investors will want recognized brand names, creating opportunities for the fiduciary investment business of the large investment consultants. We expect AUMs in multi-asset funds to grow by 9% in 2013, with a similar rate of expansion forecast over the next few years. Strong hedge fund performance should attract investments Eurozone-focused hedge funds returned 11% last year and have earned a further 5.7% so far in 2013. Despite such strong performance, AUMs in hedge funds shrank in 2012 and were flat in the first quarter of 2013. On the face of it, this is puzzling. But some of the withdrawals may reflect profittaking. Investors may also be searching for higher risk and returns outside the Eurozone. The current risk environment appears to be following a risk-on, risk-off model, which may continue for some time. But as the Eurozone returns to growth, Eurozone asset valuations have largely recovered risk normalization will mean higher riskadjusted returns should stimulate interest in hedge funds. The sector is still a very small part of the Eurozone asset management market, so an improving environment will provide plenty of growth opportunities. Therefore, we expect the recent downward trend to be reversed, with AUMs in hedge funds increasing from 2014 onwards. As the Eurozone gradually returns to a more normal risk environment, markets will be hit by fewer systemic shocks such as bank failures. From 2014 onwards, we expect to see lower market volatility than in 2011 and 2012. This should enable funds to hold positions for longer without being forced to sell by their risk models. As part of the process of risk normalization, correlations across asset class, markets, sectors and stocks are likely to fall. This will increase the opportunities to make investment decisions based on fundamentals and create a more fertile environment for long and short funds. Viewpoint Roy Stockell Partner, EMEIA & ASIA PAC Leader for Asset Management Contact details Tel: +44 (0) 20 795 10332 Email: rstockell@uk.ey.com Asset managers that have benefited from the recovery in European equities have good reason to be thankful to the ECB, not to mention the US Federal Reserve and, more recently, the Bank of Japan. Sadly, the Eurozone s weak economic outlook is now expected to depress growth in assets under management over the next few years. In response, asset managers will redouble their focus on the growth potential of developing markets. Large firms will harness their capital, distribution reach and research capabilities to increase their exposure to Asia-Pacific and Latin America. Niche players with specialized asset or market knowledge will also use their expertise to attract above-average inflows. In the Eurozone, the economic environment continues to reshape asset allocation. Insurers and other institutional investors are hoping to achieve the near-impossible: to increase portfolio yields without taking on excessive risk. Equities will continue to enjoy particularly strong net inflows. Investors will increase their exposure to infrastructure assets, and there is growing appetite for structured corporate loans an asset class Asset management highlights Investments Investors are expected to move out of German and French bond markets in search of higher yields. There will be an increasing focus on the US and emerging markets. Bond yields The attractiveness of bond yields in the periphery is expected to increase due to reduced volatility. that requires distinct risk management skills. Private equity will also attract more institutional inflows. Regulation remains at the top of the industry s agenda. Reluctantly, asset managers are realizing that current compliance levels are unlikely to recede anytime soon. The ongoing saga of the FTT which now looks likely to be adopted in a piecemeal fashion illustrates the atmosphere of regulatory uncertainty. Firms need to embed the ability to assess and respond to regulatory change into their ongoing processes. Looking further ahead, Europe s ageing population represents a strategic opportunity for asset managers with the right capabilities (see graphic: demographics and/or household wealth). The industry is under-represented in postretirement financial decumulation, but some firms are developing layered products that meet a range of needs such as travel, medical bills and the costs of long-term care. Co-operation with life insurers may represent the best chance of success. Hedge funds 5.7 % Strong hedge fund performance in 2012 set to continue, earning 5.7% so far this year. 8 EY Eurozone : Outlook for financial services Summer edition 2013 Return to Contents EY Eurozone : Outlook for financial services Summer edition 2013 9
Country forecasts Highlights Country forecasts Highlights France Netherlands Banks continue to deleverage and NPLs peak at 4% of total loans Gentle revival for insurers Money market funds decline in popularity, as bond AUMs grow by almost 20% Germany Economy forecast to shrink in 2013, holding back banking sector Premiums fell last year, creating second toughest insurance market in the Eurozone Equity and bond markets expected to underperform the Eurozone average Netherlands Germany Banking sector remains strong Recent floods take toll on insurers, but industry overall supported by growing economy Renewed focus on equities over safe haven assets Recession continues through 2013, and NPLs reach 12% of total loans Mixed outlook for insurance industry France NPLs expected to reach 11% of total loans following AQR Fund management industry set to pick up for the first time since 2000 Insurance industry underperforms compared with Eurozone average AUMs boosted by economic reforms 10 EY Eurozone : Outlook for financial services Summer edition 2013 Return to Contents EY Eurozone : Outlook for financial services Summer edition 2013 11
Country forecasts Key issues Country forecasts Key issues AQR set to increase NPLs The Italian banking sector will continue deleveraging for at least the next five years in response to regulatory pressures and weak GDP growth. The ECB s forthcoming AQR is likely to force through restructuring more quickly than we had previously forecast. As a result, we now think that NPLs will reach 11% both this year and next, which is well above the Eurozone 2013 average of 7.5%. Insurance industry underperforms compared with Eurozone average We estimate that both life and non-life premiums fell in 2012 as the economy contracted by 2.4%. This would be the second consecutive fall for life premiums. Because we do not expect the economy to start growing again until early 2014, the Italian insurance industry will underperform the Eurozone average, with premium growth of less than 1% in 2013. Economic reforms boost funds under management Reforms introduced by the previous technocratic government led by Mario Monti helped Italianfocused funds to grow 6% last year. Buoyed by the ECB s commitment to support peripheral bond markets, bond AUMs were up 20% more than reversing their 2011 decline. AUMs in money market funds fell by 26% as investors switched from safe havens. These economic reforms are unlikely to be reversed by the new government, so the Italian bond market should remain attractive to investors this year. It offers an additional 3.2 percentage points of yield over German bunds. Unlike last year, equity AUMs should also rise in 2013, as investor confidence improves gradually. Overall, we expect AUMs to increase more than 5% in 2013. Bonds 3.2 Italian bonds to remain attractive in 2013, offering an additional 3.2 percentage points of yield over German bunds. France French banks continue deleveraging Lending this year will be constrained by the weak French economy. Business loans are expected to inch up, but personal and mortgage lending will shrink as household consumption falls and unemployment rises. NPLs will peak at 4% of total loans in 2013, lower than the Eurozone average. On a more positive note, total operating income is expected to rise in 2013 to 635b from 622b in 2012, as non-interest income rises. And bank lending is also forecast to pick up again from next year. Deposits will increase faster than loans over the next five years as deleveraging continues. A gentle revival for insurance Competing bank savings products took market share from life insurers last year, but single premium business should revive now that many savers hold the maximum allowed in equivalent banking products. We expect premiums to rise by 0.9% in 2013 and 3.8% in 2014. Non-life business has fared better. Premiums increased last year, taking them 13% above the low-point reached in 2010. The pace of growth is likely to slow as the French economy continues to stagnate. Therefore, we forecast average premium growth of just 1.8% over the next two years. Popularity of money market funds will start to decline French-focused fund AUMs rose 5.6% in 2012. More than half of this growth was in money market funds, which account for just over half of the French fund management industry. However, the fastest growing asset class was bonds, which expanded by almost 20%. This growth can be attributed to the desire for safe havens over the past few years. But, as the risk environment gradually normalizes over the next few years and investors begin to look outside Europe for returns, we expect investments to shift from money market and bond funds to equities. The net effect should be a near 6% increase in total assets under management this year. Income France Netherlands Dutch banks face tougher operating conditions in 2013 The Dutch economy is forecast to shrink almost 1% this year, which will hold back the banking sector. We expect lending to remain much the same as last year, although corporate loans should grow a little. The quality of the loan book is good by Eurozone standards. NPLs will fall to 2.9% in 2013, down from 3.2% last year. This is lower than the Eurozone average, which is forecast to be 7.5% this year. Deposits are expected to increase over 6% in 2013, helping to support operating income. Recession hits non-life insurance business Insurance premiums are estimated to have fallen by over 3% last year in the Netherlands, making it the second-toughest non-life market in the Eurozone after. The environment will remain difficult as the economy is expected to continue contracting in 2013. Employment is forecast to fall a further 1.3%, with house prices set to drop by almost 6%. Consequently, we expect non-life premiums to fall 2.7% this year before starting to pick up again in 2014. In contrast, life premiums in the Netherlands fell far less last year than the Eurozone average. We expect this relative strength to continue over the next two years, with premiums growing roughly 4.7% a year. Slow AUM growth as equity and bond markets underperform AUMs in the Netherlands grew over 6% last year. Increases in equity and bond products more than offset a 32% decline in money managed by Netherlands-focused hedge funds, as investor risk profiles altered. This year, we expect the Netherlands equity and bond markets to underperform the Eurozone as a whole. Therefore, AUM growth is likely to slow to 5%. Life premiums 635 b 4.8 % Banks total operating income expected to rise to 635b in 2013 from 622b last year. Netherlands Non-life premiums expected to fall by 2.7%, while life premiums set to grow by 4.8%. Germany German banking sector strongest in Eurozone Prospects for German banking and lending quality are better than elsewhere in the Eurozone, and NPLs are expected to peak at just 3.2% this year. Nevertheless, the outlook has been affected by our recent GDP downgrades, even though the domestic economy is relatively resilient. Although we were expecting very little loan growth three months ago, even this forecast has now been cut to well under 1% this year. Growing economy will support insurance industry We expect non-life premiums to grow more than 3% a year for the next five years, exceeding the Eurozone average of a little over 2%. Premiums will benefit from a stronger domestic economy, which will mean faster house price inflation in Germany than the Eurozone average and stronger profits growth. However, recent floods in Germany will have an impact on 2013 profits. The German association of insurance companies estimates that the cost to insurers will be higher than for the century flood in 2002.. Life premiums will recover this year, growing by 0.7%. This is lower than the Eurozone average of 1.3%, but their decline last year was also less marked. From 2015, we expect life premium growth to exceed the Eurozone average as the German economy rebounds more strongly. Renewed focus on equities to lift funds under management Last year s 6% increase in German-focused AUMs was only half the pace of growth seen in the wider Eurozone. This underperformance reflects the comparatively weak growth of bond and equity funds. We expect an improvement in 2013, to over 8%, as yield-hungry investors focus more on equities and less on safe-haven bunds. NPLs Germany German NPLs set to peak at only 3.2% this year compared with EZ average of 7.5%. Spanish recession continues and banks face a difficult 2013 The Spanish economy is expected to remain in recession for the rest of 2013. Business and residential mortgage loans will be most affected, contributing to an 8% decline in total lending. But the shrinkage also reflects the removal of more bad loans into SAREB, the bad bank established by the Spanish government. Increased pressure from the Bank of to make further write-downs on restructured loans will result in rising levels of bad loans. We now expect NPLs to reach 12% of the total loan book next year, far higher than the Eurozone average of 7.5%. There is also a risk that the forthcoming AQR may require additional provisions. Mixed outlook for the insurance industry suffered the largest Eurozone decline in non-life premiums in 2012. The estimated fall is almost 5%, well below the Eurozone average of 1.2% growth. This weakness is likely to continue for the next two years, as tough business conditions persist. House prices are forecast to fall another 4%, even though they are already 28% lower than their peak in Q1 2008. Meanwhile, car registrations are expected to be flat for the next two years. Spanish life businesses faced the toughest market conditions outside France last year. Premiums were down an estimated 8.2%, as employment fell 4.5% and nominal household income shrank 2.7%. The environment should start to improve, though, as we expect household incomes to start growing again in 2013. This should result in premium growth of around 2.5% in each of the next two years. Fund management industry set to pick up for the first time since 2000 had the weakest European fund management industry last year. AUMs declined 4.9%, mainly because bond funds fell almost 10%. Multi-asset funds also shrank by over 6%. Spanish AUMs should increase this year for the first time since 2000. We expect growth of 2% in 2013 and 6% in 2014. This will be driven by a gradual improvement in the economy, which will make equity funds more attractive. In addition, a substantial yield spread over German bunds will reduce the outflow of Spanish government bonds. Lending 3.2 % 8 % Total lending expected to decline by 8% in 2013, with business and mortgage loans most affected. 12 EY Eurozone : Outlook for financial services Summer edition 2013 Return to Contents EY Eurozone : Outlook for financial services Summer edition 2013 13
Appendix Appendix Banking Introduction Table 2 for the Eurozone economy Macro variables Table 1 for the Eurozone economy (annual percentage changes unless specified) GDP -0.5-0.6 0.9 1.4 1.5 1.6 Consumer prices 2.5 1.6 1.5 1.4 1.4 1.4 Unemployment rate (level) 11.4 12.4 12.7 12.4 12.0 11.6 Government budget (% of GDP) -3.7-2.8-2.4-1.9-1.5-1.2 Government debt (% of GDP) 91.4 94.7 96.9 98.2 98.5 98.3 ECB main refinancing rate (%) 0.9 0.6 0.5 0.5 0.5 0.7 Exchange rate ($ per ) 1.28 1.29 1.21 1.17 1.17 1.17 Nominal GDP growth (%) 0.8 0.7 2.3 2.9 3.0 3.1 Real GDP growth (%) -0.5-0.6 0.9 1.4 1.5 1.6 Nominal consumption growth (%) 0.8 0.6 2.0 2.5 2.7 3.0 Nominal personal disposible income growth (%) 0.2 0.6 2.0 2.4 2.5 2.8 Nominal private investment growth (%) -2.7-1.4 3.3 4.3 4.3 4.1 Financial variables 3-month Euribor rate (%) 0.6 0.2 0.3 0.3 0.3 0.6 10-year government bond yield (%, Eurozone average) 4.0 2.9 3.0 3.3 3.7 4.0 Banking Chart 1 Total loans (excl. MFIs) of Eurozone banks b 16,000 Other Loans Residential mortgage loans 14,000 Consumer credit Business/corporate loans loans 12,000 10,000 8,000 6,000 4,000 Chart 3 Eurozone non-performing bank loans % total loans 14 Germany France Eurozone Netherlands 12 10 8 6 4 Table 3 Eurozone: banking Total assets ( b) 32,698 31,842 32,430 33,334 34,317 35,433 Total loans ( b) 12,197 11,897 12,280 12,807 13,340 13,868 Business/corporate loans ( b) 4,543 4,500 4,693 4,937 5,182 5,427 Consumer credit ( b) 604 595 605 621 640 659 Residential mortgage loans ( b) 3,831 3,785 3,849 3,948 4,054 4,171 NPLs as % of total gross loans 6.7 7.5 6.5 5.7 4.9 4.3 Deposits (% year) 0.9 2.3 4.2 4.5 4.5 4.5 Loans/deposits (%) 110 104 103 103 103 102 Total operating income ( b) 622 635 683 745 806 857 Source: ECB, Oxford Economics 2,000 2 0 2005 2007 2009 2011 2013 2015 2017 0 Chart 2 Total operating income of Eurozone banks b 250 France Germany Netherlands 200 150 100 50 0 2008 2010 2012 2014 2016 14 EY Eurozone : Outlook for financial services Summer edition 2013 Return to Contents EY Eurozone : Outlook for financial services Summer edition 2013 15
Appendix Insurance Appendix Insurance Insurance Chart 4 Eurozone interest rates % 6.0 5.0 10 year 4.0 3.0 2.0 3 month 1.0 0.0 2000 2004 2008 2012 2016 Chart 5 Eurozone insurance industry profits b 80 60 40 20 0-20 -40 Chart 6 Eurozone gross household wealth b 22000 20000 18000 16000 14000 12000 10000 2000 2004 2008 2012 2016 Table 4 for the Eurozone economy Macro variables Nominal GDP growth (%) 0.8 0.7 2.3 2.9 3.0 3.1 Real GDP growth (%) -0.5-0.6 0.9 1.4 1.5 1.6 CPI (% yoy) 2.5 1.6 1.5 1.4 1.4 1.4 Labor market Total employment (thousands) 146,176 144,362 144,093 144,425 144,853 145,335 Employment in manufacturing (thousands) 21,589 21,109 20,867 20,770 20,711 20,648 Employment in non-manufacturing (thousands) 124,587 123,253 123,227 123,655 124,142 124,686 Unemployment (thousands) 18,061 19,985 20,413 19,943 19,288 18,618 Demographics Population (thousands) 333,116 333,539 333,979 334,205 334,315 334,432 Population of working age (thousands) 219,061 218,371 217,846 217,164 216,398 215,638 Population aged 65+ (thousands) 62,969 64,061 65,075 66,135 67,221 68,307 Consumers Nominal personal disposable income (% yoy) 0.2 0.6 2.0 2.4 2.5 2.8 Gross household financial wealth ( b) 16,324 17,000 17,746 18,518 19,284 20,019 Total household borrowings ( b) 6,780 6,799 6,881 7,036 7,242 7,484 Motoring Car registrations (thousands)* 7,030 6,546 6,579 6,672 6,786 6,893 Housing market House prices (% yoy) -2.1-1.3 1.0 2.0 2.4 2.6 Corporate sector Company profits ( b) 2,128 2,130 2,186 2,263 2,350 2,442 Financial variables 3-month Euribor rate (%) 0.6 0.2 0.3 0.3 0.3 0.6 10-year government bond yields (%) 4.0 2.9 3.0 3.3 3.7 4.0 Equity market (% yoy) 13.8 3.1 9.4 8.2 7.7 6.0 *Car registrations and company profits refer to the sum of Germany, France, and -60 2000 2002 2004 2006 2008 2010 2012 2014 2016 Table 5 Eurozone: insurance sector Life gross premium ($b) 588 596 613 628 643 661 % year -7.3 1.3 2.9 2.4 2.4 2.7 Life gross claims payments ($b) 249 284 292 299 306 314 Life claims ratio (%) 42 48 48 48 48 48 Non-life gross premium ($b) 414 419 430 440 452 464 % year 1.2 1.3 2.5 2.4 2.7 2.8 Non-life gross claims payments ($b) 193 201 210 220 230 240 Non-life claims ratio (%) 47 48 49 50 51 52 Profits ( b) 28.4 37.7 41.3 44.9 48.3 51.6 16 EY Eurozone : Outlook for financial services Summer edition 2013 Return to Contents EY Eurozone : Outlook for financial services Summer edition 2013 17