Europe’s big banks are enjoying a perfect moment. Rates are rising, traders are busy, and customers are repaying their debts. That dream scenario allowed Deutsche Bank, Barclays and Banco Santander to report chunky profits in third-quarter results released on Wednesday. But with recession looming, and bad-debt buffers looking low, the good times may not last.
The sector’s lost decade after 2008, in which European lenders struggled to earn their probable 10% cost of equity, seems a distant memory. Barclays generated a 12% return on tangible equity (ROTE) in the first nine months of 2022, excluding a one-off litigation charge, while Santander’s European division hit 12.5%. Strip out the bits of Deutsche that Chief Executive Christian Sewing is planning to get rid of, and the so-called core bank has churned out a handy 10% ROTE this year – quite a turnaround for the erstwhile basket case.
One major boon is rising interest rates, which lead to fatter lending margins. That has helped turn Deutsche’s corporate bank, for example, from a burden into a profit engine. The division’s net interest income in the year to Sept. 30 was one-third higher than in the same period of 2021. Busy markets also helped. Barclays’ revenue from trading fixed-income securities, currencies, and commodities in the first nine months of 2022 was 63% higher year-on-year. Finally, bad debt is low. Santander’s European business took a smaller charge for expected loan losses in the first nine months of 2022 than it did a year earlier.
The rate-rise boost should endure, since markets expect central banks to keep hiking. But it’s hard to see trading revenues staying so high. The biggest risk, however, is that tighter monetary policy leads to a recession, pushing up unemployment and tipping households and businesses into default. That would hit some banks harder than others. Barclays and Santander, for example, are more exposed than Deutsche to riskier consumer finance, like credit cards and auto loans.
Lenders have relatively slim bad-debt buffers to guard against a downturn. Deutsche, Barclays and Santander have slashed their group-wide stock of loan-loss provisions since 2020, and in the latter two cases they’re even below pre-pandemic levels. That means future charges to top up these reserves could be high, eating into earnings. Bank investors are worried. On average they mark the trio’s shares at less than half of forward tangible book value – close to 2020 levels. Until investors have seen hard evidence Europe’s banks are recession-proof, that scepticism seems apt.
Deutsche Bank on Oct. 26 reported 6.9 billion euros of revenue for the third quarter of 2022, which was 15% higher than in the same period a year earlier. Its provision for credit losses tripled to 350 million euros.
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On the same day, Barclays said its revenue was 6 billion pounds in the three months ending on Sept. 30, a 9% year-on-year rise. It set aside 381 million pounds during the quarter to cover future bad debt, which was also a threefold annual increase.
Banco Santander’s third-quarter revenue rose 5% year-on-year to 13.5 billion euros.
The Spanish bank’s shares were down 3.9% to 2.63 euros as of 0743 GMT on Oct. 26. Deutsche Bank and Barclays were down 0.5% and 0.9% respectively.
