Many of the largest banks in the Eurozone exceeded second-quarter earnings forecasts, despite worries about a more challenging outlook. Although their shares were limited, Reuters claims they profited from high interest rates and substantial investment banking activity.
According to Chris Burt, Director of the Risk Coalition Research Company, “where the market suspects the organisation is taking more risk than might be appropriate,” shares may be lower than expected due to financial results and company performance.
“Imagine the Titanic moving at full speed across the Atlantic, making fantastic progress,” he continues.
While European banking shares increased by 20% between January and July 2024, hitting nearly nine-year highs, “the STOXX Europe 600 Banks index was down 0.5% after a raft of bank earnings fed into analyst and investor concerns about the sustainability of the sector’s profit growth. Eurozone banks see investment banking boost but outlook stalls shares,” according to Mathieu Rosemain, Tom Sims, and Valentina Za’s article.
A legal provision related to Deutsche Bank’s failing Postbank unit contributed to the company’s quarterly loss and 7% stock decline. The company also scrapped plans for a repurchase and increased bad loan loss charges. Although BNP Paribas anticipates exceeding its €11.2 billion net profit goal, an 11% decline in net interest income (NII) has raised worries in its retail division.
Additionally, Moody’s Ratings thinks that UniCredit and Santander’s NII have essentially peaked. As a result, risk charges will go up, even though growing profits have improved investor mood. Despite this, lenders have traded below their tangible book value, which raises questions about whether their profitability can last.
Despite this, the investment banking businesses of BNPP and Deutsche helped to diversify revenue streams in recent quarters by offsetting any shortfalls.
“At BNPP, revenue from equities trading and prime brokerage services jumped 58%,” added Rosemain, Sims, and Za.
Ambivalent attitude
According to Olivier Panis, Associate Managing Director of Financial Institutions Group at Moody’s Ratings, the outlook for Eurozone bank earnings remained rather stable. In 2023, the banks in the zone increased their net interest margins (NIMs).
“We expected profitability to stabilise in countries where variable-rate lending predominates,” he said.
In the first half of 2024, HSBC and other Italian and Nordic banks did better than their counterparts. In 2025, Moody’s Ratings predicts that bank profitability in the Eurozone will “remain strong” notwithstanding a drop.
As per Panis, Moody’s Ratings believes most profit margins have peaked as policy rates began to decline this year. However, the move from current accounts to more costly term accounts will slow down.
After two years of low lending activity, Panis continues, “Stable economic growth and inflation near central bank targets will offer the opportunity for stronger lending volumes while also supporting asset quality and risk charges.”
However, he believes that operating costs will continue to rise. Higher compensation costs and technology are to blame for this. As a result of higher interest rates in nations like Spain, Portugal, and Italy, Moody’s Ratings believes that there may be some divergent profitability trends among banking systems with a larger percentage of assets at variable rates.
According to Fitch Ratings, the biggest banks in Europe are expected to be profitable in 2024, matching the high levels of 2023. Fitch’s September 2024 “Large European Banks Quarterly Credit Tracker” indicates that most of the 20 major banks experienced strong results in the first half of the year.
Due to their “better than expected earnings,” it raised its full-year projections for a few banks. For instance, according to a press release, HSBC and other Italian and Nordic banks did better than their counterparts in the first half of 2024.
They were expected to continue performing at a high level from July to December. French banks, on the other hand, are falling behind their counterparts and are only predicted to see modest increases in profitability.
According to Z/Yen Senior Research Partner Hugh Morris, the outlook is generally favourable. He claimed that the Eurozone’s growth rate is likely between 3-4%, which should boost bank profits throughout the banking industry because mortgages account for half of bank lending in the Eurozone, and demand for them has been generally weak over the past few years.
He clarifies that the European Central Bank (ECB) “believes the banks will be able to improve with a forecast of global GDP growth of 3.4% for the next two years.”
ECB believes that the Eurozone is expected to closely align with this forecast. One of the driving factors behind this is the anticipated long-term increase in mortgages, in contrast to their previous period of stagnant growth in the region.
Income from net interest
Morris finds the banks’ net interest incomes (NIIs) among the most intriguing aspects. They are crucial to the medium-term financial gains of banks. He claims that cost management has been a major driver of BNP Paribas and that it is one of the factors that drive short-term development.
He underscores that while other criteria may fluctuate, NII remains the benchmark. For instance, cost control helped BNP achieve record profits, Morris continues. During a 40–50-year cycle, banks manage costs when they have to and don’t when they don’t.
The market examines NII because it has doubts about BNP’s ability to maintain rigorous cost control. That is the crux of the problem. For what reason does the market have doubts about BNP? A significant portion of the solution is NII.
“A full-scale conflict in the Middle East is another possibility. The entire world will get sick if someone sneezes in that region. More than Ukraine is to blame for the rise in the price of Brent crude oil. These kinds of price shocks will impact bank lending and investment decisions. Although no one can predict what will occur, these are the main contributing elements. Morris also believes that the Eurozone is growing slowly and that banks’ expansion would be constrained by the West’s latent productivity,” Morris added.
The banks resist
It is possible that certain banks were undervalued and are not receiving the full reflection of profitability, which is why they have been held back. Morris thinks that worries about NII and the long-term viability of headline profits may be to blame.
He said, “A lot depends on how each bank is made up, and there is cyclical falling in love and out of love with investment banking as a way to kick start growth.”
Deutsche Bank incurred significant losses as a result of this mistake. Twenty years ago, Deutsche Bank aimed to establish itself as a global investment bank to rival the American market, but within five to ten years, everything crumbled. Despite having fewer assets than Santander, it is the 22nd largest bank globally. In terms of assets, it is only somewhat larger than the Toronto Dominion Bank.
The NII is a significant measure of medium-term performance, and stock markets are attempting to price in the value of future performance. If they observe that the NII’s performance deviates from short-term gains, they will pay closer attention to that.
Interest rate issues have hindered certain banks, according to Panis. The sustainability of banks’ profit growth may be affected, he believes, as the advantages of higher rates to their net interest margins have begun to wane.
Despite rate reduction by central banks, he predicts that borrowing costs will continue to be higher than they were before 2022. This will have an impact on borrowers’ capacity to refinance and repay debts.
The increased cost of living and the fact that asset values in Europe have not changed significantly since 2022 only make the situation worse.
“As a result of the monetary tightening, the cost of funding has materially increased, with the end of targeted longer-term refinance operations (TLTROs) and a material shift in the deposit mix toward more expensive term deposits,” he continues, adding that he believes this could affect asset quality and moderate lending volumes.
Even while this change may have stabilised, the deposit mix hasn’t changed since 2022, and central banks have started lowering interest rates once more.
The revenue and expenses from the stock market compound these difficulties.
According to him, capital markets income helps sustain revenue, but inflation in salaries and one-time expenses are driving up costs, which may hurt the long-term viability of profit growth.
He agrees with Morris that “geoeconomic fragmentation, which could increase volatility, impact banks’ operating environments, their asset risk, and profitability,” has several sources of uncertainty. The turmoil in the Middle East and the war in Ukraine are two prime examples of this.
The effect of NII
However, Morris believes that NII is primarily responsible for the worries regarding the durability of profit increases.
Before adding that the market has witnessed the emphasis on cost management and the interest in erratic industries, like investment banking, come and go, he states, “It is the bread-and-butter business, and it is not looking so rosy.”
The biggest banks in Europe are probably going to be profitable in 2024, matching the high 2023 levels.
Despite the market’s attempt to incorporate its likely performance into the current stock price, NII remains a persistent presence. Since the share price ought to reflect the present value of anticipated medium-term profit streams, Morris views it as Economics 101.
He believes that this indicates that “the markets’ perception of forward value will outweigh one set of half-year results.”
He doesn’t know Unicredit well, but he thinks it’s an unusual strategy that the CEO, Andrea Orcel, decided to give back almost all of the company’s profits to shareholders in the form of dividends and buybacks.
Morris further says it is unclear whether the choice to purchase a digital bank in Belgium resulted in a decline in quarterly revenues, especially with regard to the latter, and whether it caused a 3% decline in shares.
Even if purchasing a digital bank costs money up front, Unicredit may benefit in the long run. At the same time, it will not become distinctly apparent for a considerable amount of time.
“This uncertainty would cause its shares to decline, and although the markets appreciate innovation, they are leery of money pits and white elephants,” Morris noted.
According to Panis, increased market volatility is driving activity for investment banking, and client transactions are increasing capital markets revenue. He claims that this will help revenue growth in 2024. This is especially true for banks that “may suffer from low lending activity in commercial banking, as is the case for French banks, for example.”
Nevertheless, he notes that the growth of the capital markets division “drove a 6% rise in adjusted revenue to $65 billion for European global investment banks in Q2 2024, with a significant boost from equity and investment banking income.”
Then there are the fees associated with underwriting and advising on debt issuances, equity, and M&A transactions. According to him, each of them adds to the total earnings.
“When a deal is there to be done, the fees and margins are probably better than they have been,” Morris adds, even though there are fewer opportunities available.
Leverage against the cost base is necessary, and he discovers that if three individuals are needed to complete a $50 million deal, it might take all of them to complete a $500 million contract. He asserts that while this approach is advantageous for finding deals, it may leave you with an uncovered cost base when market conditions change. This indicates that the cost base stays essentially fixed. Growing economies of scale tend to make profitability highly volume-dependent.
Capital market diversification
However, diversification of capital markets activities in Europe has benefited investment banking, in part because of the COVID-19 pandemic, which caused several banks to suffer considerable losses. Panis pointed out that certain banks also decided to lower their risk appetite restrictions for specific equity derivatives with exotic structures.
Banks have also developed more balanced worldwide market divisions with a more diverse product mix as a result of geopolitical crises, such as the Russia-Ukraine war, which generated price instability.
“This diversification is rather credit-positive when implemented successfully because it exposes less of the overall business model of those banks to market turbulence and makes capital market revenues relatively less volatile,” he says, adding that not all European banks have equal access to the depth of the US capital market.
Nonetheless, Morris holds the belief that certain banks are concealing issues and should return to their fundamental role as a value store. He believes that banking should be a boring, medium-margin industry.
However, he believes that balance sheets are very challenging to correctly understand since “human ingenuity has added multiple layers of risk and complexity to that, to the point that banks’ report and account. This leads to a wobble and a misconception of share value.”
According to author and banking futurist Brett King, a conceptual shift is necessary to align investments with broader social initiatives and evolving value creation. This requires a re-evaluation of how performance is assessed.
He argues that, despite the profitability of investment banking, it is not appropriate for the modern world. He believes that investment banks, along with banks in general, must adopt a fundamentally new way of thinking to continue thriving. To achieve this, they need to develop more diverse revenue sources that align with contemporary value systems.
High interest rates and strong investment banking revenues have driven banks’ profitability, but market scepticism persists, reflected in restrained stock performances. Analysts attribute this hesitation to factors such as declining net interest income (NII), rising operational costs, and geopolitical uncertainties.
Geopolitical tensions, inflation, and fluctuating deposit mixes further complicate the outlook. While stable economic growth and improved lending volumes offer hope, rising operating costs and risk charges may offset these gains. The banking sector’s ability to navigate these challenges will depend on strategic cost management and adaptability to evolving financial conditions.
Ultimately, while Eurozone banks have demonstrated resilience, doubts over their long-term profitability persist. The market remains cautious, weighing short-term earnings against the broader economic landscape. As interest rates shift and global uncertainties loom, the banking sector must strike a balance between growth and risk management to sustain investor confidence and maintain profitability in an increasingly complex financial environment.