European banks earnings season - the groundhog day

We are coming towards the end of the reporting cycle for European banks for the first half of 2024. Unlike other quarterly reports, mid-year results are particularly useful in our view. They confirm the trends that we have already seen in the first half of the year, and thus validate or indeed put into question, the outlook that the management teams laid out for the full fiscal year. With only five months left of the year, the results offer a credible outlook for trading conditions in the remaining months. This reporting season offers an insightful perspective on the whole year, while the final releases are, in most cases, only available in February onwards. With that in mind, it is reassuring that we have seen more of the same, with banks frequently reiterating strong full-year outlooks or indeed increasing their prior guidance.

Firstly, to put the results into some context, EURO STOXX Banks Index (SX7E) constituents have seen return on equity of 11.1% for FY23. The latest figure of the index stands at 11.8%, and is expected to land at 11.5% for FY24. For the following year the expectation is for a moderate reduction to 10.5% – this figure reflects the expected rate cuts that would feed into consensus estimates. Alongside this latest release, some banks had revised their targets higher, while many others have trended above their stated goals – even if they did not upgrade those this past quarter.

Secondly, the strong results we have seen and the revised expectations for the full year have been frequently underpinned by a message of better-than-expected asset quality and therefore lower provisions. Somewhat counterintuitively, for the time being higher rates are not feeding into increased cost of risk and some banks have even made downward revisions of their expectations for full year loan loss provisions. We would point out that unemployment is often cited as the leading indicator of asset quality deterioration and obviously this statistic has received enormous spotlight in the US just last week. However, it is worth stating  that the expected reduction in interest rates is likely to increase affordability metrics and provide a tailwind against any potential further deterioration in the labour market.

Thirdly, funding profiles remain resilient. This element of bank performance is particularly important now, as the sector’s interest earnings shifted from lending margins (in a low-rate environment a few years ago) to deposit margins (in the higher rate environment now). During the latest results, we have observed some further migration out of sight deposits and into term accounts - the trend has been substantially slower than in 2023, however. With regards to term accounts, we have also seen more favourable pricing in some jurisdictions – most notably in the UK, but also in Germany – which provided a welcomed tailwind to net interest margins versus management expectations, and versus trends we have observed in the last quarter of 2023. As we look ahead, we are mindful of banks having to still repay central bank borrowings (TLTRO - Targeted longer-term refinancing operations, TFSME - Term Funding Scheme with additional incentives for SMEs), and will certainly monitor depositor behaviour as the rate cutting cycle gets underway. We take comfort, however, in very strong liquidity profiles across the sector, which give flexibility around the reduction in deposits and a buffer against the need to compete for funding.

Finally, capital levels remain comfortably ahead of regulatory metrics. Banks have largely confirmed the expected headwinds from the final Basel rules – a topic we have covered before – and there is little in the way of additional headwinds that have come to the forefront this reporting quarter.

We take comfort in yet another solid set of results from the sector. We are particularly reassured by the low level of provisions and revised expectations for lower cost of risk for the reminder of the year. We remain mindful of the dynamics on the funding side, given the importance of deposit margins to the overall profitability, but at the same time acknowledge that the latest releases do not raise a cause for concern. Indeed, our expectation is for a gradual reduction in rates, and we see the sector gradually adapting to that environment. We expect all of these dynamics will continue to support the sentiment around the European banks and in this context, are not surprised that the AT1 market outperformed other pockets of credit in the latest sign of market weakness.