2022, the year that changed banking in Europe | Popgen Tech

For European banks, home is no longer such a bad place to be.

Lenders such as Spain’s BBVA, which sought to escape Europe’s negative interest rates by expanding in emerging markets, are again looking at domestic deals. France’s BNP Paribas SA plans to reinvest the proceeds from the sale of a US unit in Europe as it builds out its franchise and expands its equity business.

Fixed income dealers such as Deutsche Bank AG have regained market share as their lending businesses gain momentum. Even American powerhouses like JPMorgan Chase & Co. and Citigroup Inc. rediscover the continent and expand their private and corporate banks to take on the Europeans on their home turf.

After a decade of struggling to keep up with Wall Street, European banks are enjoying a rare period of outperformance, supported by four major interest rate hikes in the space of just half a year. By cutting costs and raising fees in lean times, they will benefit as rising lending income allows them to boost shareholder payouts, invest in trading units and absorb losses on loans during a recession that has probably already begun.

“There’s a real tailwind from interest rates at this point, which is great for the banks,” Deutsche Bank CFO James von Moltke told a conference call last month. “The negative rate environment has really leached a lot of profitability — and with that profitability, the ability to invest in the future — out of the banking system.”

Lending income at the region’s top banks is on track to hit the highest in more than a decade this year and hit a record in 2023, analysts polled by Bloomberg predict. It is a sharp reversal from eight years of negative interest rates that eroded income from the bread-and-butter business of lending and turned banking on its head.

“We are constructive on the outlook for European banks in 2023 despite the economy heading into recession,” analysts including Chris Hallam at Goldman Sachs Group Inc. wrote in a recent note. “It may seem counter-intuitive; however, in several ways the fundamental dynamics for the sector stand in stark contrast to those of past recessions.”

While the rising tide lifts almost all boats, Credit Suisse Group AG stands out as the region’s biggest loser after a series of self-inflicted losses and scandals. A handful of other firms, including Societe Generale SA, have been hit by the fallout from sanctions against Russia, which have seen them take a financial hit to their businesses there.

Lenders with large corporate and retail units such as Banco de Sabadell SA and Commerzbank AG, in contrast, saw big increases in their share price. Commerzbank recently raised its revenue outlook for 2024 by about $1 billion due to rising interest rates in Europe. Banco Bilbao Vizcaya Argentaria SA is considering domestic deals again, two years after abandoning an attempt to buy Spanish rival Sabadell.

“We will do some domestic consolidation if we can,” Chief Executive Officer Onur Genc said in September. “For example, we tried to do this with Sabadell in Spain, because we think that local scale is critical.”

With the European Central Bank signaling that it will continue to raise interest rates, lenders can charge more for loans while still paying next to nothing on deposits. Banks in the US, where the Federal Reserve has raised the cost of borrowing faster, face downside risk to net interest income next year as depositors demand higher interest on the balances in their accounts, according to analysts at Citigroup.

That departure gave European lenders a rare advantage, with their shares beating an index of their US peers for the first time since 2009, the end of the financial crisis.

The performance also reflects expectations that European banks will be able to pay out more money through buybacks next year. JPMorgan Chase & Co. analysts led by Kian Abouhossein expect European lenders to spend a combined $30.6 billion to buy back shares next year, a 30% increase from two years earlier. By contrast, buybacks by US firms are expected to remain well below what they were in 2021.

Regulators and governments could throw another wrench into those plans. Senior European officials told Bloomberg they expect only the best-capitalized firms to be able to make big buybacks if the economy suffers next year from higher interest rates and the energy crisis. In Spain and Poland, governments have proposed measures that squeeze some of the extra profit lenders make and use it to ease the burden on low-income earners from high inflation.

And even though European bank stocks have outperformed this year, they are still down and trading at a discount to their US peers. The continent’s nine largest listed banks combined are worth less than JPMorgan alone, underscoring how much the balance of power has shifted to Wall Street since the financial crisis.

For now, however, the rapid reversal in the ECB’s monetary policy is not only raising the income that banks in Europe earn on loans; it also added to the market volatility that has fueled trading results at the big investment banks for the past three years.

Deutsche Bank, long a symbol of the decline of banking in Europe, managed to regain market share in fixed-income trading, the biggest contributor to revenues. The German lender, which spun off its trading unit in 2019, is gradually getting back into businesses it abandoned over the past decade. He is considering trading residential mortgage-backed securities again, after adding high-yield credit default swaps and dipping his toes into trading in base metals.

In equities, where companies including Credit Suisse have been forced to cut, BNP Paribas picked up the pieces. The French firm, which emerged over the past decade as one of Europe’s strongest lenders, wants to build a franchise that can rival the biggest American firms. Domestic rival SocGen, meanwhile, is strengthening its equity unit with a joint venture with AllianceBernstein.

“The European banks are starting to get their act together,” said José Linares, head of corporate and investment banking at Banco Santander SA, who has risen through the ranks of merger advisers.

One notable exception remains Credit Suisse, which is selling much of its securitized products business and spinning off much of its investment bank after a series of missteps and losses. The firm just completed a $4.3 billion capital raise to fund thousands of job cuts and a pivot into wealth management.

Other banks are sitting on excess capital that they can now use for deals, as rising profitability and gradual steps towards the creation of a single European banking market make takeovers more attractive. International regulators removed one obstacle to consolidation this year by lowering capital requirements for cross-border exposure in the region.

But Europe’s relative attractiveness also reflects the fact that there are not many alternatives. Russia was at a standstill after this year’s invasion of Ukraine, which forced banks to exit or cut back to comply with sanctions. SocGen has sold its local unit, resulting in a €3.3 billion hit, and is shifting its focus to boosting profitability in Europe. UniCredit SpA and Raiffeisen Bank International AG, the other two European lenders with major operations in Russia, are slowly scaling back their local businesses.

China, long seen as a growth market by lenders around the world, looks less profitable after its economy slowed, while some European firms cashed out of what has become a crowded U.S. market. BBVA, which doubled its investment in a Turkish lender after its bid to buy Sabadell fell through, has seen its shares penalized amid runaway inflation in that country and a falling currency.

This means lenders can once again visit local targets such as Commerzbank, in which the German government holds a large stake. BNP, UniCredit and ING Groep NV were all considered potential suitors in previous years. ABN Amro Bank NV has also attracted interest from firms such as BBP in the past due to its retail and corporate franchise, Bloomberg reported. The French bank has since said it favors bolt-on deals, rather than buying a full-fledged bank.

Other banks are also likely to focus on smaller deals and shareholder payouts unless European governments forge closer ties between their markets, said Flora Bocahut, an analyst at Jefferies.

“Given European banks’ valuations, buying back their own shares remains much more profitable than any other M&A deal, and there is no execution risk,” said Bocahut.

Nicholas Comfort and Alexandre Rajbhandari report for Bloomberg News.

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