European banks are preparing for a better earnings season as bad loans stabilize

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As European banks prepare to announce their third quarter earnings as they target a sensitive rebound, analysts expect a sharp reduction in loan loss provisioning to fuel a fragile stabilization.

Throughout Europe Stoxx 600 Index, according to Refinitiv, aggregate earnings are expected to decrease 36.7% in the third quarter from the same period in 2019, with revenue declining 12.1% on an annualized basis.

Banks in particular are expected to post an overall decline in profits of 46.5% on an annualized basis, compared to -38.8% for the financial sector as a whole.

“Within the banking sub-sector group, Lloyds Bank, HSBC, Barclays, Unikredit, Intesa Sanpaolo, and ING group have the greatest impact on the aggregate growth rate, “said Tajinder Dhillon, Refinitiv’s senior research analyst.

Barclays, which reported on Friday, is expected to report a 79.8% decline in annual earnings for the third quarter, while HSBC‘s is forecast at -55.6% and Lloyds‘at -90.9%, according to refinitive data.

Elsewhere, Deutsche Bank will see earnings growth of 67.7% in the third quarter since reported a net loss of 832 million euros (924 million US dollars) for the same period last year during a mass restructuring.

Santander is expected to see earnings up 200% after seeing a 75% decline in annual earnings in Q3 2019 driven by charges of 1.63 billion euros mainly related to an impairment on goodwill in the UK

Loan book provisions

After the Wall Street giants in the first quarter 15.3 billion JPMorgan Chase and City group started the US earnings season with the allocation of just $ 2.9 billion in the third quarter. As a result, their combined net income more than doubled from the second to the third quarter.

“That gives hope that the US economy has weathered the worst and that investors in the UK’s largest lenders will be able to cheer similarly to their target markets,” Russ Mold, investment director of AJ Bell, said in a statement last week.

Barclays, HSBC, Lloyds, NatWest and Standard Chartered wrote down their loan books by £ 7.5 billion ($ 9.7 billion) in the first quarter and by £ 10.6 billion in the second, Mold said. The latter was the highest burden since the second quarter of 2010 as their aggregate pre-tax profit plummeted 77% year over year in the first half.

“A NPL reduction, following what may have been a particularly conservative approach in the first half of the year, would help earnings and sentiment over a sector that has been in the investor’s kennel,” he added.

The reason why Wall Street banks’ share prices did not rise significantly on the third quarter results was suggested by Schimmel because loan loss provisions were only part of the tough battle for lenders; Another important factor is the consistent compression of net interest margins.

The net interest margin is a measure of the difference between a bank’s interest income and the interest it pays to its depositors. Loan loss allowance is an amount that a bank has set aside for expected non-payment of loans it has made to businesses or consumers.

In a notice to investors last week, Barclays bank analysts reiterated these expectations, suggesting that third quarter earnings reports will not include material impairment charges and management will likely wait until year end to update banks’ macroeconomic assumptions.

“In addition, we have not yet seen a significant increase in corporate defaults, with government support programs largely protecting companies so far,” said Amit Goel, head of European Banks Equity Research at Barclays.

“However, we expect the loan books to be scrutinized for signs of underlying stress, especially as many funding programs are phased out.”

Low bar, but gloomy prospects

The Stoxx 600 banks The index has fallen more than 42% since the turn of the year, but Barclays has suggested that the risks of a second wave of coronavirus infections are “over-discounted” given recent bank valuations.

“In the upcoming earnings season, we believe the focus will be on the post-lockdown revenue recovery, particularly in terms of revenue in 2021 and the implied run rate going forward,” said Goel.

Barclays expects management’s comments to provide helpful guidance on conditions for the final quarter of the year.

In addition to significantly reducing impairment charges, Barclays suggested that the strength of the rebound will be on investors’ radar to adjust sales estimates through 2021. However, analysts believe that the sustainability of this recovery given the reintroduction of Covid. likely to be put to the test -19 restrictions across Europe.

Trading income, which jumped in the second quarter due to the volume increase in the entire banking sector, is likely to normalize somewhat in the third quarter, but will continue to increase year-on-year.

“Although there have been no changes to the regulatory interventions preventing banks from paying dividends in 2020, the potential for a resumption of dividends remains a focus for banks,” Goel said in the press release.

“Given the closeness to year-end and the overall capital strength across the sector (albeit with capital relief), we expect the subject to be re-addressed in the third quarter results.”

Goel’s team recently identified their top stock picks within the sector.

With downside risks from Covid-19 continuing to increase in the fourth quarter, but with governments appearing better prepared than they were during the first wave of the pandemic, Barclays expects the banking sector to focus primarily on cost-cutting efforts and consolidation.

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