As the curtain draws on the mid-year reporting season, capturing a highly eventful first half of 2020, the spotlight turns onto banks, which have been protagonists in the Covid-19 inflicted economic saga. During the downturn in March, bank securities prices plunged together with many other industries, however following the monetary and fiscal induced recovery in most sectors, banking securities remained significantly underwhelmed. Indeed, year to date European banking stocks are down 34.1 percent compared to negative 10.8 percent for the broader market in Europe.
Issues in the banking industry pre-date Covid-19, as the low and declining interest rate environment, coupled with more onerous regulatory headwinds has consistently put pressures on operating margins. The most recent quarter has illustrated an industry whose pre-tax profit growth continued to remain well into negative territory with sector earnings declining by more than 50 percent year-on-year (YoY). This performance is the worst over the last four years in terms of bottom line and was mainly driven by the high loan losses booked by European Banks due to COVID-19 but also a material revenue decline (-5 percent YoY). On a positive note the reported figures tended to beat analyst expectations on revenues driven by fees and other income as well as disciplined cost control.
By country, UK, Benelux and Italy earnings declined the most, driven by negative jaws and higher provisions. On the other hand, Switzerland was the only region having positive YoY pre-tax growth driven by positive jaws and investment banking strength. Loan losses were higher than expected, though many banks pointed towards an improvement in 2H20 assuming no further material macro deterioration.
Positive fee income growth momentum halted in 2Q20 with growth falling to -8% YoY post a strong first quarter. All European counties bar Germany saw negative growth, with the weakest performance coming from Iberia, Italy, Austria and Nordics. Germany posted a fee income growth of 7% YoY. Nevertheless, the performance was less bad than feared. The rise in volatility boosted retail brokerage fees among others (particularly in Germany) while payment fees were under significant pressure during the lockdown and assets under management driven fees were also facing headwinds.
Capital was the major consistent positive surprise in 2Q20 with almost all banks being ahead of expectations, aided by the mandatory suspension of dividends by the European Central Bank, better than expected risk-weighted assets due to regulatory relief measures and limited risk weight inflation for the time being, as well as lower corporate drawdowns than expected.
Cost control has been the strategy of choice for banks in their quest for improved margins. Their weapon of choice has been technology, with banks like Banco Santander’s UK business reporting over 90 percent of its sales via online services. As such, generally speaking bank’s operating jaws were zero, as a material fall in revenue growth (down 5 percent YoY) was offset by significant cost efficiencies (down 5 percent) YoY as well; the best performance over the last five years. Germany and Nordics saw the most positive jaws while Italy had by far the most negative jaws.
Following the economic ramifications brought about by the Covid-19 outbreak, European banks provided for circa €31 billion of loan losses in 2Q20, more than tripling YoY. Second quarter loan losses were also 13% higher than in 1Q20. The banks’ consensus was that 2Q20 was the provisioning peak for now, though uncertainties remain material, as the situation develops daily.
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