First-quarter earnings for Europe’s major banks were decent and core underlying returns held up reasonably well. Excluding downside outliers, returns on tangible equity were clustered around the high single-digit to low double-digit mark.
Most of Europe’s large banks hit or beat analysts’ expectations. Where there were misses, the reasons were idiosyncratic rather than sector-wide, and the much-feared switch to IFRS 9 had only a modest impact on capital ratios.
Market observers are starting to buy the idea that the European banking sector is in a sweet spot, even while many of the region’s major banks work through restructuring and/or business optimisation. Once those programmes reach their end-points, assuming broadly successful execution, a reasonable assumption is that the picture will improve further, barring unforeseen circumstances.
“Business volumes are gradually picking up as banks cautiously ramp up lending, leading to higher volume-driven revenues. And even though net interest margins remain slim owing to European monetary policy effects, investors have some comfort around greater predictability of earnings and their risk components,” says Sam Theodore, team leader for bank ratings at Scope Ratings.
“Having done a lot of the heavy lifting around balance-sheet clean-up over the post-crisis years, European banks are, more than ever during the last decade, focused on repositioning for future growth. Beyond the revenue story, the European banking sector’s prudential metrics are in aggregate much more reassuring for investors in terms of capital strength, liquidity and balanced funding.”
Today’s banking culture is more conservative and risk-averse than it was a few years ago, and Scope notes a relative convergence of balance-sheet fundamentals, and to a lesser extent business models as well. With few exceptions, banks are now focusing on low-risk lending and financial services.
‘Hunter’ CEOs – those with a trading or investment banking background and a penchant for risk-taking – have largely being supplanted by ‘farmer’ CEOs focusing on stable growth and avoiding excessive risk. As well as bringing this approach to business-as-usual, European banks will be more cautious about engaging in transformational transactions, be they large-scale mergers or acquisitions. That stance is unlikely to change in the foreseeable future.
Banks have undergone business simplification and are now clustered around a smaller set of core products for core clients for whom they can create value. They have also built slimmer geographical profiles ranged closer to home.
“Better financial fundamentals on the back of improving macro conditions, the positive effects of the stronger regulatory framework in terms of capital and liquidity, and more predictability around the behaviour of the banking industry are all positives for investors,” Theodore says.
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