European banks' 2024 results - well positioned for uncertainty

European banks‘ full year 2024 reporting season has now largely come to an end, with only a handful of issuers still to report over the next few weeks.

Unsurprisingly, as we expected (and flagged in our previous blogs - European banks on front foot heading into 2025 and European banks earnings season - the groundhog day), the results have shown resilience of the sector in terms of profitability, capital positions and asset quality. We believe European banks are prepared to weather greater uncertainty ahead, but as always, some work remains. Below are some key messages from the latest reporting season.

First, strong profitability is the first line of defence against any unexpected losses for credit investors. In this context, we believe that the main takeaway from the results season is to flag that the banks that have reported so far have seen average return on tangible equity (ROTE) around 12.5%. The results have propelled the EURO STOXX Banks Index (SX7E) by 22% since the start of the year.

More importantly, price-to-book valuations for the index are now at 0.96x – a level that we have not seen since early 2010. This is very important in our view, as a price-to-book ratio of close to 1x shows that investors consider the sector, on average, is not only delivering its cost of equity, but that the returns are viewed as being sustainable (a lower price-to-book ratio can reflect expectations that the results will deteriorate going forward). Delivering cost of equity for any bank or non-financial corporation is of critical importance – inability to do so can lead to; lower perception from equity investors, inability to raise capital and impairment of funding costs. The last consideration is particularly relevant for banks as it represents an important component of loan pricing and determines their relative competitiveness vs. their peers. As such, the current equity valuations imply sustainability of the business models and therefore support credit spreads.

Second, in terms of sustainability of the current profitability, we would note that at the index (SX7E) level, this is already the second year of double digit returns for European banks – we must go back to pre-2008 to see these sorts of metrics.

It is worth emphasising that unlike in the pre-2008 period, the latest results have been achieved after years of capital building on much higher equity positions – average CET1 as of the Financial Year end for 2024 sits just above 14% for the banks that have reported so far. Equity valuations are increasing because European banks are now able to reward equity investors through higher dividend payouts, thanks to elevated net interest margins rather than unabated re-risking of balance sheets that was evident pre-2008.

Furthermore, despite the outlook for lower rates, we would note the sector has continued to further strengthen its non-interest fee income, and often put hedges in place to lock the benefits of higher rates for longer. Despite the elevated rate environment, European banks continue to demonstrate resilience in asset quality metrics – credit provisions remain below the average for a cycle. Some weakness has been visible in the commercial real estate (CRE) segment, but worth noting here that away from a handful of smaller lenders, exposures to CRE are contained.

Third, as mentioned there is always scope for some improvement.

In terms of meeting the cost of equity, we would note that while on average the returns have been robust, a few larger banks continue to work on meeting their cost of equity as they reported ROTE below 10% – this also implies they have lower ability to meet unexpected losses, thus offering less protection to credit investors. Encouragingly, the analyst consensus expects those banks to already deliver better returns in 2025, followed by another improvement the following year when their average return is expected to be around 10%.

In addition, increasingly higher operating expenses remain a point of focus as they have the potential to erode the current high returns in the absence of strong lending growth – investment in technology, general wage inflation, ongoing compliance and regulatory spend are all relevant. Fortunately, unlike some other aspects, cost is one of the elements over which banks have a degree of control. We do note, however, this past month we have seen several announcements of further expected redundancies in the sector. We are also seeing continuing headlines around M&A – these transactions, although slow, will eventually translate to fewer banks, better competitive landscape, and more efficient business models.

All in all, European banks delivered strong results this past year. Equity investors have taken note of these strong numbers, repricing banks’ shares sharply at the start of the year, which implies that high returns are here to stay. There is a degree of fragmentation within the sector with some banks still lagging in delivering their cost of equity, but those are expected to catch up with peers over the next couple years. We believe that the sector is in a good position to face uncertain markets ahead and we are not surprised to see this increasingly reflected in valuations and tighter credit spreads.