Can Eurozone Banks Continue Their Rally in Q3?

Eurozone
banking
stocks
ended
the
first
half
of
the
year
up
21.17
percent
(Morningstar
Eurozone
Large-Mid
Banks
index),
doing
significantly
better
than
the
Morningstar
Eurozone
index,
which
tracks
the
performance
of
eurozone
markets
and
gained
7.8
percent
over
the
same
period.

The
banking
stocks
that
contributed
most
to
first-half
performance
were
Italy’s
Unicredit
and
Intesa
Sanpaolo,
which
gained
48.3
percent
and
36.9
percent,
respectively.

Will
European
Banks
Continue
to
Outperform
the
Market?

Much
depends
on
how
the
round
of
corporate
results
that
will
be
published
in
the
next
few
days
will
go.

“We
expect
a
strong
quarter
from
those
eurozone
banks
with
strong
debt
underwriting
businesses
like
BNP
Paribas
and
Deutsche
Bank,”
said
Johann
Scholtz,
senior
equity
analyst
at
Morningstar,
in
a
note
on
July
19.
“Results
from
the
US
bulge
bracket
investment
banks
confirm
that
companies
are
back
in
the
debt
market
to
refinance.
Also,
we
expect
trading
revenue
to
rise
due
to
French
election
volatility.” 

How
Will
Lower
Interest
Rates
Affect
Bank
Stocks?

After
June’s
initial
rate
cut,
the
European
Central
Bank
left
interest
rates
unchanged
at
its July
18
meeting,
but
markets
assign
an
80%
likelihood
that
the
bank
will
cut
rates
by
another
0.25
percentage
points
at
its
next
meeting
on
September
12.
Lower
interest
rates
could
weigh
on
interest
margins.

“First
quarter
2024
results
confirmed
that
the
higher
interest
rate
bonanza
is
over
and
that
net
interest
margins
for
most
Eurozone
banks
have
peaked,”
said
Scholtz.
“That
said,
we
do
not
anticipate
net
interest
margins
to
narrow
materially.
Interest
rate
swap
rates
are
slightly
higher
for
the
second
quarter
than
the
first,
delaying
the
transmission
of
lower
policy
rates.
Switching
into
term
deposits
from
overnight
deposits
has
slowed,
lowering
margin
pressure.”

Main
Sources
of
Revenue
for
European
Banks

Sonja
Forster,
Senior
Vice
President
European
Financial
Institutions
at
Morningstar
DBRS,
expects
solid
profits
that
are
driven
by
higher
fee/non-interest
income
and
relatively
low
credit
costs
in
the
second
quarter
and
beyond.
Meanwhile,
net
interest
income
(NII)
will
likely
display
varying
performance
by
geography
but
remain
at
relatively
elevated
levels,
she
said.

“We
expect
better
non-interest
income
mostly
driven
by
strong
capital
markets,
which
supports
revenues
in
areas
such
as
investment
banking,
asset
management,
brokerage
activities
and
insurance,”
said
Forster
in
a
comment
for
Morningstar
on
July
19.
“A
gradual
improvement
in
economic
activity
and
pickup
in
lending
volumes
also
drives
fee
income
through
higher
transaction
fees.”

“NII
development
is
expected
to
benefit
from
gradually
increasing
loan
demand,
but
the
net
interest
margin
(NIM)
development
will
be
more
mixed
by
country,
albeit
at
a
high
level,”
she
added.

“Banks
in
the
Nordics
and
the
Netherlands
have
passed
on
a
large
part
of
interest
rate
hikes
to
their
customers
and
are
experiencing
NIM
pressure,
partly
offset
by
gradually
increasing
loan
volumes.
Southern
European
banks
have
been
able
to
pass
on
significantly
less
of
the
rate
hikes,
so
NII
is
expected
to
remain
strong.
Despite
the
higher
proportion
of
variable
rate
loans
in
these
countries,
we
do
not
expect
a
major
impact
from
the
first
rate
cut. 
And
subsequent
cuts
are
not
expected
to
be
fully
reflected
in
NII
due
to
hedging.”

Risks
for
Banks
Are
Receding

“Lower
spreads
on
European
high-yield
bonds
show
that
the
credit
market
is
taking
a
more
benign
view
of
corporate
default
risk”,
said
Scholtz,
adding
that
“with
unemployment
at
record
lows
in
most
of
the
eurozone,
we
do
not
believe
household
credit
quality
will
deteriorate.

Regarding
costs,
banking
income
statements
do
not
reflect
the
full
impact
of
negotiated
salary
increases.
However,
the
Morningstar
analyst
expects
that
regulatory
costs
will
decline,
because
the
ramp-up
phase
of
contributions
to
the
Single
Resolution
Fund
–
the
emergency
fund
that
can
be
called
upon
in
times
of
crisis
–
is
now
complete.

Strong
Asset
Quality
with
Some
Pockets
of
Weakness

Analyst
expect
that
asset
quality
will
remain
strong
for
banks
in
most
countries
with
some
pockets
of
weakness,
especially
in
commercial
real
estate,
construction,
retail
and
consumer
finance.

“We
do
not
expect
the
small
cut
in
policy
rates
to
have
a
major
impact
on
asset
quality.
Not
only
because
the
cut
has
been
relatively
small,
but
also
because
the
rate
increases
have,
with
the
exception
of
certain
sectors,
had
a
limited
effect
so
far,
helped
by
low
unemployment
and
prudent
loan
underwriting”,
said
Forster.
“However,
adverse
effects
from
higher
rates
could
still
materialize
over
the
medium
term,
especially
in
countries
with
a
high
proportion
of
variable
rate
loans.
We
therefore
expect
that
further
gradual
rate
cuts
will
lower
the
risk
of
deteriorating
asset
quality.”

Eurozone
Banks
Offer
Attractive
Dividends
and
Buybacks

One
factor
that
makes
banking
stocks
attractive
are
buyback
plans.
“They
are
returning
large
amounts
of
capital
to
shareholders
without
compromising
their
businesses,”
Lazard
Asset
Management
analysts
wrote
in
a
July
17
report
on
opportunities
in
the
sector.

“European
banks
now
generate
more
free
cash,
supporting
generous
dividend
payouts
and
share
buybacks,”
according
to
Morningstar’s
Scholtz.
“The
improvement
in
free
cash
flow
is
due
to
higher
profitability
and
limited
additional
capital
requirements.”

Unicredit
and
Intesa
on
the
Radar

Many
investors
are
focusing
on
mid-year
earnings
of
Italian
banks,
like
Unicredit
and
Intesa
Sanpaolo,
after
the
stocks
outperformed
peers
in
the
first
half
of
2024.

Morningstar
DBRS
expects
Italian
banks’
Q2
results
to
confirm
solid
performance
despite
some
slowdown
in
net
interest
income
(NII)
mainly
resulting
from
the
rate
cut,
lower
loan
volumes
and
higher
funding
costs,
as
well
as
potentially
higher
loan
loss
provisions
(LLPs)
reflecting
some
asset
quality
deterioration.

“Our
view
is
that
NII
should
remain
robust
in
Q2
2024
as
average
commercial
spreads
will
likely
remain
higher
than
in
the
corresponding
period
in
2023.
In
addition,
good
trends
in
net
fee
and
commission
income
as
well
as
cost
control
should
help
mitigate
the
negative
impact
from
NII,”
said
Andrea
Costanzo,
Vice
President
European
Financial
Institutions
at
Morningstar
DBRS.

“Some
higher
new
non-performing
exposure
(NPE)
inflows
due
to
still-high
interest
rates
and
slowdown
in
economic
activity
are
likely
to
materialise.
This,
coupled
with
weaker
new
loan
origination
in
recent
times,
might
lead
to
a
deterioration
in
asset
quality
metrics.
However,
at
this
stage
Morningstar
DBRS
expects
default
rates
to
generally
remain
at
relatively
low
levels,
below
the
level
of
default
rates
experienced
in
the
global
financial
crisis,”
he
added.

“All-in-all,
banks
should
be
able
to
preserve
good
capital
cushions
against
their
supervisory
minimum
requirements.
At
the
same
time,
Morningstar
DBRS
expects
Italian
banks
to
have
continued
to
reimburse
the
ECB’s
TLTRO
III
sources–
the
Eurosystem
operations
that
provide
financing
to
credit
institutions–
according
to
plan,
leading
to
a
further
normalisation
of
the
previously
very
ample
liquidity
levels.”

High
Public
Debt
a
Headwind
for
Italian
Banks

The
Italian
banking
system
remains
more
exposed
to
market
volatility
than
its
European
peers
because
of
Italy’s
high
public
debt
that
weighs
on
sovereign
creditworthiness.
According
to
the
latest
Bank
of
Italy
data,
public
debt
rose
to
EUR2.919
trillion
in
May,
up
13.3
billion
euros
from
the
previous
month
and
inching
closer
to
the
3
trillion
mark.

June
demonstrated
this
vulnerability
as
BTP-Bund
spreads
widened
after
European
elections
and
the
French
parliamentary
election.

European
Banks
Can
Still
Rise

Europe’s
bank
sector
is
very
close
to
the
year’s
highs,
having
recovered
most
of
the
losses
that
followed
the
first
round
of
France’s
elections–
still,
investors’
views
remain
constructive.

“We
still
see
potential
for
further
multiple
expansions
in
the
mid-term
and
we
are
optimistic
on
the
upcoming
earnings
season,
although
we
assume
that
the
recent
performance
and
the
expectation
of
further
decline
in
rates
ahead
will
test
tolerance
for
any
NII
disappointments
or
‘low
quality
beat’,”
said
Luca
Finà,
Head
of
Active
Equity
at
Generali
Asset
Management.

“With
the
peak
in
rates
behind
us
and
earnings
momentum
losing
steam
compared
to
the
last
couple
of
years,
all
eyes
will
be
on
the
net
Interest
Income
line
and
on
the
capacity
of fees
to
offset
the
P&L
effects
of rates
reduction,
above
all
in
the
Southern
Europe,”
he
added.

In
a
July
19
note
for
Morningstar,
Justin
Bisseker,
European
Large
Cap
analyst
at
Schroders,
said
they
shouldn’t
expect
many
surprises
in
the
second
quarter,
“as
falling
rates
have
only
just
started
to
take
effect
and
analysts
have
already
factored
in
lower
rates
in
their
forecasts.”

He
added
that
they
anticipate
a
strong
quarter
for
the
investment
banking
income
segment,
although
less
pronounced
than
in
US.
Also,
fee
income
trends
may
exceed
expectations,
“suggesting
we
are
more
likely
to
see
revenue
surpass
forecasts
rather
than
fall
short”.

“Overall,
European
banks
have
seen
a
significant
boost
in
profitability
over
recent
years,
driven
by
higher
rates.
Barring
an
unexpected
sharp
decline
in
rates
or
steep
recession,
this
positive
trajectory
appears
set
to
continue,”
Bisseker
added.

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