The ten big banks are likely to make 213 billion euros in net interest income this year, according to Visible Alpha, which is 36% more than in 2021.
Banks such as HSBC and Intesa Sanpaolo have achieved good results thanks to a tighter monetary policy which has boosted returns. The ten largest stocks in the STOXX Europe 600 Banks index will generate an average return of 13% on tangible capital this year. This outcome was unthinkable for much of the past decade when low or negative interest rates kept yields well below the 10% typically required by bank investors.
Despite the current good performance, bank share prices do not reflect the possibility that this good performance will last long. The ten banks on average trade slightly below expected tangible book value, suggesting that long-term returns will fall below the cost of capital. In simple terms, the profits party that has buoyed bank bosses such as Lloyds Banking Group’s Charlie Nunn and UniCredit’s Andrea Orcel will be short-lived.
It’s easy to be skeptical about European banks: money came too easily last year. European banks were able to invest cost-free deposits by a notable margin. Even two-year German debt, considered ultra-safe, has returned almost 3% since the start of 2023, while money deposited at the European Central Bank and the Bank of England has paid around 4% and 5% respectively, compared to nothing in 2021. The result was a huge amount of interest income that boosted revenues. The ten big banks are likely to make 213 billion euros in net interest income this year, according to Visible Alpha, which is 36% more than in 2021.
When interest rates begin to fall, it may appear that profits will decline as well. Not according to bank bosses, who are still targeting consistent double-digit returns for this year and next. Banco Santander, for example, expects a return of 16% this year and 15-17% in 2025. This implies a large gap between market expectations and those of the bank, which is valued below tangible book value – implying that its long-term returns could be in the single digits. Analysts are generally optimistic, forecasting flat average returns of around 13% for the ten banks over the next few years, despite looser monetary policy.
There are ways in which banks could actually benefit from both situations. For one thing, rates may not fall as much as they have risen. Central banks are cutting rates, but they are not bringing them back to zero – or below zero, as has been the ECB’s policy for many years. Investors expect the Eurozone’s key lending rate to remain comfortably above 2% by the end of next year, while the Bank of England’s equivalent is expected to be just below 4%. This level will reduce the margin that Santander and other banks can earn on idle liquidity. But the spread will still be positive, and certainly larger than in the dark days of negative Eurozone rates.
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Decreasing rates will also bring some direct benefits. Households and customers may be more willing to borrow, for example. This would allow Crédit Agricole and its peers to profit more from the difference between existing and new loans, which UBS analysts estimate to be 1.8 percentage points in France for mortgages and 2, 2 percentage points for consumer credit. It makes sense that for customers, falling prices create greater demand. ING, for example, recently said that its net interest income will increasingly depend on lending volumes rather than interest rate margins.
Demand for another banking product – merger advice and issuing stocks and bonds – is also expected to rise. This is particularly relevant for banks with large investment banking divisions such as Barclays and BNP Paribas. Merger deals and debt and equity issuance generated about $23 billion in revenue last year in Europe, according to data from LSEG, which was the lowest result since 2016. This is expected to increase as rates fall, allowing companies to borrow more for mergers and acquisitions and giving startups confidence to go public. In the US, JPMorgan, Bank of America, and their peers reported a huge increase in transaction fees in the second quarter. Citigroup saw a 63% increase, year over year. Morgan Stanley boss Ted Pick thinks easing inflation and lower rates have created "the early stages of a multi-year cycle driven by investment banking."
Finally, lower rates should reduce one of the biggest risks for investors in European banks: debtors unable to pay. Annual provisions for bad debt for the ten largest European banks have remained around 30 billion euros in recent years. This is close to the pre-pandemic norm, despite one of the fastest interest rate increases in history. The rate cuts could save families and businesses that would otherwise fall into arrears, meaning lower loan loss burdens for banks.
Each bank has its own unique exposure to rates, both rising and falling. BNP’s net interest income, for example, represents about two-fifths of overall revenue, while for BBVA it is about three-quarters. Southern European lenders historically have higher loan losses than Dutch lenders. But prevailing valuations suggest that investors are still too pessimistic about the sector, despite a nearly 20% rally this year. Perhaps it’s because they’ve been burned by years of poor performance, or are expecting a hit from the region’s rising political and populist volatility. There are many challenges for European banks, but a drop in interest rates is one they should be more than capable of dealing with.
Original article published on Money.it Italy 2024-08-02 07:25:00. Original title: Le banche europee e il dilemma dei tassi di interesse
