Lenders face a rough second half as governments unwind the programs that cushioned the initial blow of the coronavirus crisis
By Rochelle Toplensky
Second-quarter results from Europe’s banks won’t be great, but it is in the second half that the sector faces its toughest test.
Lenders’ profits have already been crushed by the economic fallout of the global pandemic. Yet the true scale of the damage will only start to be revealed over the coming months, as European economies reopen and governments unwind some of their extraordinary support.
The U.K. announced a $38 billion stimulus plan this week to give businesses a boost as it rolls back its job-retention program between August and October.
European support programs, which contribute to the salaries of over 40 million furloughed workers in Britain, France, Germany, Italy and Spain, have so far prevented the kind of official unemployment spike seen in the U.S.
A pool of ready-to-go employees will help companies restart more quickly and has likely saved some viable jobs, but others will disappear. Insurer Allianz estimates that, of those 40 million, nine million are “zombie jobs” that will be gone by the end of next year.
That spells rough times ahead for Europe’s already struggling banks. Low interest rates and fee rebates have ravaged lenders’ second-quarter revenues, though some such as BNP Paribas and Barclaysare expected to report strong trading and capital-market earnings to compensate.
Allowances for credit losses will be up, but figures will be approximate at best. Wage-support packages and payment holidays are still cushioning the economic blow in many European countries.
Until they expire, banks can only guess the underlying level of personal and corporate distress.
In the second half, a deferred wave of defaults will likely take a sizable bite out of European banks’ meager profits.
Hardest hit will be banks with lots of unsecured consumer debt and those lending to troubled industries such as travel, discretionary consumer products and oil and gas. Barclays’ exposure to credit-card debt in the U.S. and U.K. could be a drag, for example.
European banks’ capital buffers—typically measured as the ratio of core Tier 1 capital to risk-weighted assets—will take a hit from both sides. Loan losses will reduce the core Tier 1 capital balance, while downgrades of borrowers’ credit ratings will raise the risk-weighting on loans.
Capital levels will fall and investors are likely to miss out on dividends for the rest of the year.
They might avoid additional capital calls, though: European regulators have been sympathetic and flexible in applying their rules in this crisis.
Returns on tangible equity are likely to be in the low single digits—far less than the sector’s 11% average cost of capital, as estimated by UBS —with few options to improve.
Interest rates will remain stubbornly low for years. There may be more costs to cut, even after years of restructuring. Digitizing additional services is a key lever, but requires investment and often takes time to deliver results.
Consolidation might help. Politics and a patchwork of regulation in Europe still make cross-border mergers very unlikely, but domestic deals could happen in fragmented markets like Germany and Italy. Even this may be difficult in the near term, though, as many banks don’t know what their loan books are worth, never mind the value of potential targets.
Bank investors might find little to cheer in the coming results season. Unfortunately, they’d best get used to it.
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