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European banks hope for better 2021 after year to forget

Oscar Williams-Grut
·Senior City Correspondent, Yahoo Finance UK
·5 min read
The London headquarters various banks, including Citi, HSBC and Barclays, at Canary Wharf in east London. Many banks are moving assets from London to other EU cities in the face of uncertainty over Brexit. Picture date: Monday December 3, 2018. Photo credit should read: Matt Crossick/ EMPICS Entertainment.
The London headquarters various banks at Canary Wharf in east London. Photo: Matt Crossick/ EMPICS Entertainment/PA

Europe’s banks are heading into 2021 in a better position than many would have expected just a few months ago — but next year will likely be another 12-months defined by factors beyond banks’ control.

Brexit and the pandemic mean banks’ share prices are likely to be buffeted by the winds of fortune once again in 2021.

“The last 10 years, control of banks over their share prices, that control has slowly seeped away from bank management and COVID has just accelerated that lack of control,” said Fahed Kunwar, head of European banks equity research at Redburn.

Still, recent positive vaccine news and a relaxation of dividend bans by UK and EU regulators mean many analysts believe there is cause for cautious optimism.

READ MORE: UK regulator 'considering' deal to let banks restart dividends

“We think that the direction of travel is still positive, even if we experience a pullback in the nearer term,” Barclays team of banking analysts, led by Amit Goel, wrote in a recent outlook note.

Analysts at Morgan Stanley think banking stocks could outperform the market by as much as 40% next year.

Part of the reason things are looking up is because it would be hard to get any worse.

European lenders were among the worst performing sectors of the stock market in 2020 due to the pandemic. The Stoxx Euro Bank 30 index (SX7E.Z), which tracks the continent’s 30 biggest lenders, has fallen by 25% so far this year.

Poor performance: The Euro Stoxx Banks ETF, which tracks the share price of Europe's biggest banks, has fallen sharply in 2020. Photo: Yahoo Finance UK
Poor performance: The Euro Stoxx Banks ETF, which tracks the share price of Europe's biggest banks, has fallen sharply in 2020. Photo: Yahoo Finance UK

Share prices have rallied in recent weeks, boosted by positive vaccine news, better-than-expected recent earnings, and UK and EU regulators’ decision to lift COVID-19 dividend bans imposed earlier in the year.

READ MORE: UK stocks could shine in 2021 after years of underperformance

Whether banking stocks keep rising will likely come down to two key issues — COVID-19 and Brexit.

Banks are often seen as a proxy for the economies in which they operate and poor share price performance this year mostly reflects historic GDP declines across much of Europe. Economies went into reverse due to COVID-19, which forced governments to shut down economies for months at a time.

Recent positive vaccine news has sparked hope that life can get back to something like normal in 2021.

“We think that the vaccine news should give investors greater confidence that 2022 earnings expectations are achievable,” Barclays’ European banking team said.

If all goes to plan and vaccines are rolled out smoothly, economies will start to thaw and banks can focus on lending, advising on deals, and facilitating capital market transactions.

“Are we going to see a return to pre-pandemic levels of profitability?” said Kunwar. “I think we’ve got to assume half a recovery very crudely. The question is whether it will be better or worse than that.”

READ MORE: Fears grow for the end of free UK banking

If vaccines prove less effective that currently thought — or simply take longer to be rolled out than assumed — banks and their share prices could suffer.

Clarity could take months and even if economies do begin to recover, interest rates are unlikely to rise anytime soon.

“Overarching all of this is the one thing that always matters most, which is the yield curve,” Kunwar said. “I don’t think we can ever get away from that.”

Interest rates around the world have hit new record lows this year, putting pressure on banks’ core business model of lending. Central banks have signalled that interest rate are unlikely to rise by much in the immediate future.

READ MORE: HSBC axes 6,000 jobs so far this year as cost cutting accelerates

That forces banks to either seek income elsewhere — through fee generating activities, for example — or to cut costs.

Several major European lenders are already midway through major multi-year transformation programmes, HSBC (HSBA.L) and Deutsche Bank (DBK.DE) being the obvious examples. More restructuring plans are likely next year as banks adapt to the post-pandemic world.

Pressure on profitability could also drive M&A, given the cost-cutting opportunities presented by tie-ups. Spain’s Sabadell (SAB.MC) and BBVA (BBVA.MC) recently explored a potential merger but ultimately abandoned talks after failing to agree on a price.

WATCH: When Will Banks Bring Back Dividends?

Then there’s Brexit. With the end of the transition period looming, banks will be impacted by its resolution one way or another.

“If Brexit is messy for both the UK and Europe, then you can expect economic deterioration, which then leads to those cyclical [income] lines being worse than expect,” Kunwar said.

The Office for Budget Responsibility has warned a no deal Brexit could immediately reduce UK GDP by 2%. While the impact will be less severe for the EU, it would still be disruptive.

Brexit, ongoing pressure on profitability and the pandemic mean some analysts think banks remain a risky bet.

READ MORE: NatWest CEO promises dividends 'as soon as possible'

“Only by putting away the microscope and putting on binoculars focused on recovered earnings — 2022, say — is there significant broad-based value in the sector as a whole,” UBS’ banking analyst Jason Napier wrote in an outlook note.

But after a bombed out 2020, most believe the only way is up.

“I think the market, everyone, consensus believes you’ll see an improvement next year,” said Kunwar. “It’s all about the gradient.”