This analysis is by Bloomberg Intelligence Senior Industry Analyst Jonathan Tyce and Bloomberg Intelligence Senior Associate Analyst Mar’Yana Vartsaba. It appeared first on the Bloomberg Terminal.
European banks’ current $850 billion market capitalization discounts average valuations a little below long-run averages and huge uncertainty about how looming recessions will play out in terms of bad debt. Below we have set out five key charts and datasets that we see best encapsulating the key drivers and unknowns for the sector next year.
European banks’ €54 billion boost to 2022-23 PPOP a big cushion
One of the core tenets of our Focus Idea is that even if bad debt rises more aggressively than we expect, the additional cushion — pre-provision operating profit (PPOP) — that rising rates and cost control can deliver will more than cover additional needs. This year, consensus 2022-23 pre-provision operating profit (revenue less expenses) for the Stoxx Europe 600 Banks Index has risen just shy of €54 billion, while consensus provision expectations are up a little less than €20 billion.
Since publishing our Focus Idea on Sept. 23, consensus 2022 PPOP forecasts have increased €6 billion, while loan-loss provision expectations are up less than €300 million. For 2023, PPOP estimates have only risen €2 billion more than provision charges, which we believe will prove too low.
Banks may escape the bite, delivering positive jaws
With annual expense estimates climbing 6-7% year-to-date, European banks would normally be facing pressure to implement drastic cost-cutting measures, yet new efficiency drives weren’t a key feature of recent 3Q earnings reports. An even greater uplift in revenue expectations of 9-11% — based on analysts’ median 2022 and 2023 estimates — means that the balance between revenue and cost growth (operating jaws) is expected to be positive both years.
As the exhibit shows, rising interest rates mean most lenders are expected to deliver positive jaws this year and next, despite surging cost inflation. Though about a quarter of the banks in our coverage are anticipated to register negative jaws this year — including Credit Suisse, Nordea and Danske Bank — they’re all expected to deliver positive jaws next year.
ECB’s €4.4 trillion elephant in room lurks, TLTRO run-off is key
Recent ECB commentary has remained supportive for banks, with the two-tier system for the remuneration of excess reserves no longer in use, the mutiplier set to zero and changes to TLTRO terms not as onerous as they could have been. Plans for quantitative tightening are now a focus of December’s meeting. Tracking excess liquidity — a multiyear thorn in the side of profitability for banks, and an issue for ECB policy that drove the launch of three series of TLTROs from mid-2014 — is increasingly key as rate hikes, the end of QE, and the rolloff of liquidity programs begin.
Totaling about €4.4 trillion after the repayment of €296 billion of TLTROs on Nov. 23, excess liquidity is a key delta for lenders, as it remains an inexpensive funding source as rates rise, and could fall more than 15% by end-2023, we calculate.
CaixaBank, Lloyds show difference in €14 billion credit buffers
Management overlay could be an increasingly important tool for banks to balance rising net interest income and loan-loss provisions as interest rates climb and recession risks loom. Lenders are set to rebuild these provisional buffers after gradually releasing them between 2021 and 2Q. Santander and UniCredit added about €500 million and €300 million in 3Q, respectively. Though most banks kept their buffers roughly unchanged, Lloyds and Barclays cut theirs by about £460 million combined in 3Q. Lloyds’ post-model adjustments account for about 5 bps of gross loans vs. CaixaBank’s 35 bps.
An aggregate €14 billion-plus of unutilized management overlay remained at lenders in our coverage in 3Q. That equates to about 17 bps of gross loans, on average, or 28 bps of risk-weighted assets.
BNP to UniCredit risk costs: Next stop 40, 80, or 120 Bps?
European banks’ balance sheets and profitability appear to be in far better shape than their share prices discount, with the elephant in the room the potential size of loan-loss provisions, with a revisit of 120 bps in 2008-09, or Covid-19’s near-80-bp pace, unlikely. IFRS9 — the accounting standard for expected credit losses since Jan. 1, 2018 — remains a relatively new concept. The Covid-19-driven provisioning splurge, and drip-feed releases in 2021 and the first nine months of 2022, have been early lessons in how it works.
Consensus 2022 provisions still look high, with a run rate near 30 bps more likely than near-40-bp estimates. Together with legacy management buffers from 2020’s spike in charges, we see the likes of BNP Paribas and UniCredit meeting guidance (or below it), and beating current expectations into 2024.
Bloomberg
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