With the majority of European banks having reported Q4 earnings, Romain Miginiac, Fund Manager and Head of Research at Atlanticomnium, reflects on the implications for bondholders.
05 March 2025
- Banks closed 2024 on a high note, delivering earnings that beat consensus estimates in Q4. Profitability remained strong over the course of the year, making it the second year of double-digit Return on Equity (RoE) post the 2008 Global Financial Crisis (GFC).
- While there are still some headwinds looking ahead, the sector’s profitability is set to remain structurally higher – and that is credit-positive.
- Other credit metrics remain rock-solid, as capital ratios are holding close to all-time highs and we have not seen any deterioration in asset quality.
Strong Q4 earnings, upbeat profitability outlook
Q4 has been a continuation of the three previous quarters for European banks – a strong showing as the majority reported earnings above consensus expectations. While the peak in net interest income (NII) is in the rear-view mirror, a combination of more resilient margins, lending growth and other effects (hedging, for example) has led to a beat on NII. Other sources of revenues also came ahead of expectations – driven by strong fee and commission growth, including a strong quarter for Investment Banking-related activities. Costs remain under pressure on the back of inflationary headwinds, investments in growth and restructuring costs. Loan loss provisions were once again below expectations, reflecting a fairly benign macro environment and tight risk management. Litigation has also made a comeback, notably in the UK where banks have set aside provisions related to UK motor finance.
Q4 confirmed the positive earnings trend of 2024, as we highlighted in a previous article in November, “Fundamentals for European Banks have never been stronger” – management teams delivering against increasingly ambitious guidances and targets. Throughout 2024 a number of banks have raised their guidance for the full year – culminating in an average circa 12%* Return on Equity (RoE) for the full year. For a second year in a row, the sector has delivered a double-digit RoE, broadly double the 10-year average (6-7%* over 2015-24) and unseen post-GFC.
Chart 1: European Banks profitability to remain structurally higher
Source: Atlanticomnium, Bloomberg, as of 25 February 2025.
Looking ahead, the sector’s earnings profile is expected to remain resilient, with an expected circa 11% RoE* in 2025 and 2026. Banks have either affirmed or raised financial targets for 2025 and onwards, a show of strength for the sector. European banks’ earnings will face headwinds, mainly from net interest margin (NIM) pressure as central banks continue to cut rates and inflationary pressures on operating expenses. This is expected to be offset by a combination of continued positive momentum on fees & commissions (F&C) revenues, lending growth – and a continued focus on cost efficiency. M&A has also picked up in the sector, another profitability tailwind, despite political headwinds.
Credit metrics remain rock-solid
Starting with capital, European banks’ capital metrics remain strong. As expected, Common Equity Tier 1 (CET1) ratios have slightly declined over the quarter from a very high base and remain around all-time highs (16.0% as of Q3 2024* for eurozone banks) and well in excess of minimum regulatory requirements – more than EUR 500 billion* of excess capital for EU banks, for example.
After more than a decade of rising capital ratios driven by tightening regulation, the regulatory environment is now expected to be more stable. Despite lingering uncertainty around the implementation of Basel 4 in Europe, the overall impact is expected to be limited, as part of the impact has been front-loaded by local regulators in certain jurisdictions on top of management action. European banks’ capital metrics are now either in line or above management targets. Looking ahead, CET1 ratios are expected to modestly decline as banks distribute excess capital (above banks’ target levels) gradually via dividends and share buy-backs. CET1 ratios are expected to remain around current very high levels, supportive for banks’ credit profiles.
On the asset quality side, loan loss provisions continue to surprise positively. The sector’s lending books remain highly resilient, reflecting a conservative lending profile and tight risk management as well as a relatively benign macro environment. Non-performing loans (NPL) remain stable to slightly lower compared to the previous quarter (Q3 EU average of 1.9%* for eurozone banks). Looking ahead, asset quality is expected to remain resilient, albeit macro uncertainty remains elevated. The uplift in earnings provides a strong buffer to absorb any macro deterioration.
Chart 2: Eurozone banks’ capital and asset quality metrics set to remain exceptionally strong
Source: Atlanticomnium, EBA, as of 25/02/2025. Atlanticomnium estimates for Dec-24.
Strong fundamentals supportive for high yielding subordinated debt of financials
In our view, European banks’ subordinated debt remains one of the most attractive areas within fixed income markets – offering high yields without compromising on credit quality. For example, USD-denominated Additional Tier 1 (AT1) Contingent Convertibles (CoCos) from European banks currently yield approximately 7%*. Demand in early 2025 has been very strong for new AT1 CoCos issued, more than USD 80 billion of demand for circa USD14 billion issued* – reflecting the high yields offered (average coupon above 7% on new deals in 2025). Looking ahead, the strong operating performance of the sector and rock-solid credit fundamentals remain supportive factors for subordinated debt of banks. While yields are high, markets are currently priced to perfection as spreads are at all-time tights on AT1 CoCos and almost no extension risk is priced in. In the current context, we believe that an active approach across the capital structure is essential, to mitigate potential downside risks as upside potential is more limited, while capturing attractive income.
*Source: Atlanticomnium, Bloomberg, February 2025
Romain Miginiac co-manages the GAM Credit Opportunities and GAM Sustainable Climate Bond strategies.
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The information contained herein is given for information purposes only and does not qualify as investment advice. Opinions and assessments contained herein may change and reflect the point of view of GAM in the current economic environment. No liability shall be accepted for the accuracy and completeness of the information contained herein. Past performance is no indicator of current or future trends The mentioned financial instruments are provided for illustrative purposes only and shall not be considered as a direct offering, investment recommendation or investment advice or an invitation to invest in any GAM product or strategy. Reference to a security is not a recommendation to buy or sell that security. The securities listed were selected from the universe of securities covered by the portfolio managers to assist the reader in better understanding the themes presented. The securities included are not necessarily held by any portfolio or represent any recommendations by the portfolio managers. Specific investments described herein do not represent all investment decisions made by the manager. The reader should not assume that investment decisions identified and discussed were or will be profitable. Specific investment advice references provided herein are for illustrative purposes only and are not necessarily representative of investments that will be made in the future. No guarantee or representation is made that investment objectives will be achieved. The value of investments may go down as well as up. Investors could lose some or all of their investments.
References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in indices which do not reflect the deduction of the investment manager’s fees or other trading expenses. Such indices are provided for illustrative purposes only. Indices are unmanaged and do not incur management fees, transaction costs or other expenses associated with an investment strategy. Therefore, comparisons to indices have limitations. There can be no assurance that a portfolio will match or outperform any particular index or benchmark.
This article contains forward-looking statements relating to the objectives, opportunities, and the future performance of the equity markets generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates with respect to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to general and local economic conditions, changing levels of competition within certain industries and markets, changes in interest rates, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting a portfolio’s operations that could cause actual results to differ materially from projected results. Such statements are forward-looking in nature and involve a number of known and unknown risks, uncertainties and other factors, and accordingly, actual results may differ materially from those reflected or contemplated in such forward-looking statements. Prospective investors are cautioned not to place undue reliance on any forward-looking statements or examples. None of GAM or any of its affiliates or principals nor any other individual or entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances. All statements made herein speak only as of the date that they were made.
This disclosure shall in no way constitute a waiver or limitation of any rights a person may have under such laws and/or regulations.
In the United Kingdom, this material has been issued and approved by GAM London Ltd, 8 Finsbury Circus, London EC2M 7GB, authorised and regulated by the Financial Conduct Authority.