What investors are watching for as UBS prepares to kick off Europe’s bank earnings

• Barclays European banking analysts said market focus in the upcoming reporting season would be on lenders’ plans to mitigate the continued effects of the pandemic, including cost actions to offset revenue pressure, along with the resumption of capital distribution and asset quality risks.
• UBS will kickstart the earnings season for Europe’s major lenders on Jan. 26, having posted a 99% rise in net profit in the third quarter of 2020.

With European lenders set to begin reporting fourth-quarter and full-year earnings next week, analysts are expecting a resilient performance led by strong investment banking revenues.

Banking stocks have made a significant comeback of late, with the pan-European Stoxx 600 banking index up around 40% since the lows registered at the start of the fourth quarter of 2020.

The resurgence has been driven primarily by positive news on Covid-19 vaccines and an easing of restrictions on dividends and share buybacks from regulators.

A spike in trading and investment banking revenues helped lenders around the world to report solid earnings in the third quarter of 2020, benefiting from increased trading volumes and market volatility since the onset of the coronavirus pandemic.

Earnings this week from the Wall Street banks have indicated that the sector could be set for a strong season, with Morgan Stanley beating expectations on Wednesday with a 51% increase in net profit for the fourth quarter. Goldman Sachs and JPMorgan had already posted earnings beats on the back of robust trading and investment banking results.

In a note Wednesday, Barclays European banking analysts said market focus in the upcoming reporting season would be on lenders’ plans to mitigate the continued effects of the pandemic, including cost actions to offset revenue pressure, along with the resumption of capital distribution and asset quality risks.

While many banks have avoided announcing full-year guidance due to the uncertainty of the pandemic, Barclays Co-Head of European Banks Equity Research Amit Goel expects full-year guidance for 2021 to be announced in this cycle.

UBS will kickstart the earnings season for Europe’s major lenders on Jan. 26, having posted a 99% rise in net profit in the third quarter of 2020. Barclays analysts updated its estimates last week and now expect profit-before-tax increases of around 2.5%, 6.4% and 13.9% in 2022 for Credit Suisse, UBS and Deutsche Bank, respectively.

Revenues

Fourth-quarter revenues are expected to remain relatively subdued, albeit varied in terms of geography based on the pace of economic recovery in the fourth quarter, while retaining the bright spots in trading and investment banking.

“While the low interest rate environment continues to pressure bank profitability, we see some bright spots, such as the buoyant post-lockdown U.K. mortgage market,” Goel said.

Barclays expects trading revenues to remain elevated with several banks already providing guidance for the fourth quarter, and forecasts revenues up 18% from the same period in 2019, in U.S. dollar terms.

Total revenues for the first nine months of 2020 were down by around 5% on aggregate across a sample of banks analyzed by DBRS Morningstar, largely weighed down by lockdowns in the second quarter of 2020 along with lower net interest income and “other income.”

DBRS Morningstar expects GDP growth to be positive across Europe in 2021, but analysts suggested that the still difficult environment may lead banks to tighten lending criteria and therefore limit revenues.

“Growth in lending to corporates could continue to be supported by government financing schemes and guarantees in the short-term, partly offsetting the negative impact of lockdowns,” they said in a recent note.

“However, amid ultra-low rates, potentially higher funding costs, and other income such as net fees and commissions being penalised by lockdowns, the pressure on revenues is likely to continue.”

Provisions

An improvement in consensus macroeconomic expectations in most geographies since the third quarter of 2020 is expected to provide a supportive backdrop for banks, according to Barclays analysts, particularly with regard to cash set aside for expected loan losses.

“Our analysis suggests that the improvement in macroeconomic assumptions could result in loan loss provision write-backs,” Goel said in the note.

“However, we believe that management teams are likely to take a conservative approach at 4Q20 given ongoing risks associated with new lockdowns, and instead we expect most banks to top-up their loan loss provisions.”

While state guarantees mitigated the expected increase in non-performing loans in 2020, the unwinding of these measures and renewed lockdowns in a number of economies mean non-payments and a deterioration of banks’ asset quality are likely to rise in 2021, DBRS Morningstar anticipates.

“The impact of the pandemic on European banks’ asset quality and cost of risk in 2021 will depend on the length of economic restrictions and overall economic impact as well as on any additional support measures to prevent a major deterioration in borrowers’ payment capacity.”

Capital distribution

In December, the European Central Bank and the U.K.’s Prudential Regulation Authority, along with other regulators, lifted bans on banks paying dividends to shareholders or repurchasing their own shares, albeit with guardrails in place.

Euro zone banks regulated by the ECB are under tighter restrictions than those in the U.K. and Sweden. The ECB requested European banks refrain from or limit dividends until Sept. 30, and capped dividends below 15% of cumulated 2019-2020 net earnings.

As a result, Barclays forecast an average dividend yield of around 1.5% for lenders in the common currency bloc compared to around 5% in Sweden and 2% in the U.K.

“With the restart of dividends, we think there will be increasing focus on the potential for highly accretive share buybacks (though we think these are most likely from 2H21),” Goel said. Companies may buy back their own shares from the market when they have cash at hand, which usually boosts their stock price.

DBRS analysts expect banks to maintain solid capital cushions, but noted that while the ECB guidelines reflect generally high solvency positions for European banks, the differing measures taken by regulators outside the euro zone may pose a challenge.

“Some non-Eurozone banks will likely have flexibility to pay larger dividends. Bans on dividends were widely introduced by global regulators in 2020, but regulators in countries including the U.K., Sweden, Norway for instance have lifted their dividend bans and introduced a cap of 25% instead,” they said.