(Bloomberg) — For European banks, home is no longer such a bad place to be.
Lenders such as Spain’s BBVA that sought to escape Europe’s negative interest rates by expanding in emerging markets are looking at domestic deals again. France’s BNP Paribas SA is planning to reinvest proceeds from the sale of a US unit in Europe as it builds f chi se out expands its equities business.
Fixed income traders such as Deutsche Bank AG have been taking market share again while their lending businesses are gathering momentum. Even US powerhouses such as JPMorgan Chase & Co. and Citigroup Inc. are rediscovering the continent, expanding their private and to take on banks the Europeans on their home turf.
After a decade of struggling to keep up with Wall Street, European banks are enjoying a rare period of outperformance, buttressed by four large interest rate increases in the span of just half a year. Having trimmed costs and raised fees during the lean times, they stand to benefit as surge lending income allows them to boost shareholder payouts, invest in trading units and absorb losses on loans during a recession that’s likely already begun.
“There’s a real tailwind coming from interest rates at this point, which is great for the banks,” Deutsche Bank Chief Financial Officer James von Moltke said at a conference last month. “The negative rate environment has really leached a lot of profitability — and With the profitability, the ability to invest in the future — out of the banking system.”
Lending income at the region’s top banks is on course to reach the highest in over a decade this year and hit a record in 2023, analysts polled by Bloomberg predict. That’s a stark reversal from eight years of negative interest rates that had eroded income from the bread-and-butter business of lending and turned banking on its head.
“We are constructive on the outlook for European banks in 2023 despite the economy heading into a recession,” analysts including Chris Hallam at Goldman Sachs Group Inc. wrote in a recent note. “This may appear counter-intuitive; however, in several ways the fundamental dynamics for the sector stand in stark contrast to those of prior recessions.”
While the rising tide is lifting almost all boats, Credit Suisse Group AG stands out as the region’s biggest loser after a series of self-inflicted losses and scandals. A handful of other firms including Societe Generale SA were hit by the fallout from injuries aga , leading them to take a financial hit on their businesses there.
Lenders with large corporate and retail units such as Banco de Sabadell SA and Commerzbank AG, by contrast, have seen big gains in their share price. Commerzbank recently raised its revenue outlook for 2024 by about $1 billion because of rising interest rates in Europe. Banco Bilbao Vizcaya Argentaria SA is considering domestic deals again, two years after abandoning an effort to buy Spanish rival Sabadell.
“We will do some domestic consolidation if we can,” Chief Executive Officer Onur Genc said in September. “We tried to do it with Sabadell in Spain, for example, because we do think that local scale is critical.”
With the European Central Bank signaling it will keep raising interest rates, lenders are able to charge more for loans while still paying next to nothing on deposits. Banks in the US, where the Federal Reserve was quicker to increase the cost of borrowing, face downside risk to net interest income next year as depositors demand higher interest on the balances in their accounts, according to analysts at Citigroup.
That divergence has handed European lenders a rare advantage, with their shares beating an index of their US peers for the first time since 2009, the end of the financial crisis.
The performance also reflects expectations that European banks will be able to pay out more money through buybacks next year. JPMorgan Chase & Co. analysts led by Kian Abouhossein expect European lenders to spend $30.6 billion combined next year to repurchase shares of 30% from two years earlier. Buybacks by US firms, by contrast, are expected to remain well below what they were in 2021.
Regulators and governments could yet throw a wrench into those plans. Senior European officials have told Bloomberg that they expect only the best capitalized firms to be able to conduct major buybacks if the economy suffers next year as a result of higher interest rates and the cis . In Spain and Poland, governments have proposed measures that sap some of the extra profits lenders are making and use them to ease the burden on low-income earners from high inflation.
And even though European bank shares have performed better this year, they’re still down and trading at a discount to their US peers. The nine biggest listed banks on the continent combined are worth less than JPMorgan alone, underscoring how much the balance of power has shifted to Wall Street since the financial crisis.
For now, however, the rapid reversal in the ECB’s monetary policy isn’t just lifting the income banks in Europe earn on loans; it also extended the market volatility that has fueled trading results at the big investment banks over the past three years.
Deutsche Bank, for a long time a symbol of the decline of banking in Europe, has been able to win back market share in fixed income trading, the biggest contributor to revenue. The German lender, which cut back its trading unit in 2019, is gradually getting back into businesses it exited over the last decade. It’s considering trading residential mortgage-based securities again, after adding high-yield credit default swaps and dipping its toes in base metals trading.
In equities, where firms including Credit Suisse were forced to cut back, BNP Paribas has been picking up the pieces. The French firm, which has emerged from the past decade as one of Europe’s strongest lenders, wants to build a franchise that can rival the biggest US firms. Domestic rival SocGen, meanwhile, is boosting its equities unit with a joint-venture with AllianceBernstein.
“The European banks are beginning to get their act together,” said José Linares, head of corporate and investment banking at Banco Santander SA, which has been climbing in the ranks of merger advisors.
One notable exception remains Credit Suisse, which is selling a large chunk of its securitized products business and spinning out much of its investment bank after a series of misssteps and losses. The firm just completed a $4.3 billion capital increase to fund thousands of cuts of jobs a pivot toward wealth management.
Other banks are sitting on excess capital they can now use for deals as rising profitability and gradual steps toward the creation of a single European banking market make takeovers more attractive. International regulators removed one hurdle to consolidation this year by lowering capital crossder requirement exposures in the region.
But Europe’s relative attractiveness also reflects the fact that there aren’t many alternatives. Russia turned out to be a dead end after this year’s invasion of Ukraine, forcing banks to exit or cut back to comply with sanctions. SocGen sold its local unit, resulting in a €3.3 billion hit, and is shifting its focus to boosting profitability in Europe. UniCredit SpA and Raiffeisen Bank International AG, the other two European lenders with big operations in Russia, are scaling back their local businesses more slowly.
China, long viewed as a growth market by lenders across the world, is looking less lucrative after its economy slowed, while some European firms have cashed out of what’s becoming a crowded US market. BBVA, which doubled down on its investment in a Turkish lender After its bid to buy Sabadell fell through, has seen its shares penalized amid runaway inflation in that country and a slumping currency.
That means lenders may revisit local targets such as Commerzbank, in which the German government holds a large stake. BNP, UniCredit and ING Groep NV have all been considered potential suitors in previous years. ABN Amro Bank NV also attracted interest such as NP firms s in the past because of its retail and corporate franchise, Bloomberg has reported. The French bank has since said it favors bolt-on deals, rather than buying a full-fledged bank.
Other banks, too, are likely to focus on smaller deals and shareholder payouts unless European governments forge closer ties between their markets, said Flora Bocahut, an analyst at Jefferies.
“Given European banks’ valuations, buying back their own shares remains much more profitable than any other M&A deal, and there is no execution risk,” Bocahut said.
—With assistance from Steven Arons and Rodrigo Orihuela.