Now that the third quarter banking reporting season is over, it’s worth looking at the trends defining how individual companies are responding to the issues that have plagued the industry.
It was pleasantly surprising that many European investment banks posted significantly better third-quarter results than their US counterparts, despite the latter’s advantage in fixed-income trading and deeper sources of capital. Rising interest rates are finally giving European institutions, with their hybrid business models, the interest income that their large deposit and loan bases have the potential to generate.
Deutsche Bank (DE:DBK) confounded its many critics after posting quarterly results that were the best in years, with pre-tax profits rising by 1bn euros (£862m) to 1.6bn thanks to better corporate banking activity and an increase in net interest income in all its business lines. That was enough to offset the lackluster performance of the investment banking division itself, which posted flatter pre-tax profits of 813 million euros due to a lack of deals. Deutsche Bank’s corporate deposit base grew 11% as companies took advantage of higher rates. All in all, it’s not a bad turnaround considering that Deutsche was the subject of solvency speculation earlier this year.
Another institution also beating most people’s expectations is Italy’s second-largest bank, UniCredit (IT:UCG), whose third-quarter profit generation means management has now raised its year-end profit target. to 4.8 billion euros, against 4 billion euros previously.
The opening of the Italian economy after the pandemic has been a boon for economic growth, services and tourism in particular having benefited from it. Additionally, Italy posted gross domestic product growth of 0.5% vs. 0.2% forecast, raising hopes the year will end stronger than recession forecasts suggest. . Whether Italy can survive an energy crisis over winter is unclear – but the odds are good: the country has large strategic storage facilities and good relations with North African suppliers.
The main shock of the season was the fall in the share price of Credit Suisse (CH:CS), which suffered a scandal, which suffered a drop of 16% in response to management’s radical plan for a lifting of funds of $4 billion (£3.5 billion) to finance a major restructuring of the company. The steep discount means existing shareholders will be diluted by 30%, with the Saudi National Bank taking a 9.9% stake. In addition, the investment banking business, with the exception of key trading desks, will be abandoned in favor of a return to Credit Suisse’s origins in wealth management.
The plan surprised many observers with its scope and ambition, but arguably management had little choice after the disasters of 2021 – the collapse of the Archegos hedge fund and the blockchain finance scandal. Greensill supply – destroyed the reputation of the bank.
The problem is that the overhaul will only generate a return on tangible assets (a key measure of bank returns) of 6% by 2025, which could be the best case scenario, when a bank should be able to generate 12-16% cent in normal times.
In addition to being well below the cost of capital for the average bank, this suggests that, according to standard accounting theory, Credit Suisse is liquidating. In 1990, Credit Suisse First Boston, as it was known then, was worth more than Berkshire Hathaway. These days, Berkshire could take over the bank 10 times simply by using the cash on its balance sheet.
Barclays is back
In the UK, Barclays Bank (BARC) performed well in the third quarter, driven by a combination of rising rates and a notable contribution from its investment banking arm. The addition of Lehman Brothers’ former trading business, taken over at a low price after the bank’s bankruptcy in 2008, means Barclays’ investment bank is slightly less dependent on deal flow and capital raising than its American competitors.
However, there was a noticeable slowdown in business activity in the third quarter, suggesting the race may be coming to an end, with custodial banking now taking the lead as lending spreads widen. This trend should also continue to help companies like NatWest (NWG) and Lloyds (LLOY).
All in all, it’s not been a bad season for European banks, which have consistently underperformed their US counterparts over the past decade. If the threat of windfall taxes begins to dissipate, low equity valuations can be expected to rise – as long as credit defaults in the coming quarters are manageable.