As the second wave of the coronavirus pandemic gathers pace and governments unveil new lockdowns, Europe faces a bleak winter. Yet one group this week struck a jarringly sanguine note: the region’s banks.
Even with swaths of the global economy on state life support, top executives at lenders including HSBC, Santander and Lloyds were almost universally upbeat about their own prospects as they announced quarterly earnings.
Certainly, they appear to have a fair wind behind them. Mirroring the same trends on Wall Street, charges for bad loans slumped in the third quarter and trading revenues boomed, prompting many European lenders to upgrade their earnings forecasts.
This has set up a tension between executives openly lobbying for shareholder payouts to restart, with those who warn the true pain is yet to come. Meanwhile, as bankers look ahead to year-end bonuses, they are facing a need to reconcile blowout performance in some areas with a political imperative to show restraint at a time when the pandemic continues to ravage global economies.
Bullish managers point to improving economic forecasts, better than expected consumer recoveries and robust capital buffers, which leave banks in a much stronger position than they were during the financial crisis a decade ago.
“Obviously there is a high degree of uncertainty — we’ve seen a second wave taking place in Europe — but as time goes by we feel more comfortable,” Santander’s chief financial officer, Jose Garcia Cantera, told the Financial Times. “We’ve given some encouraging guidance for profitability,” adding that he is “confident” that regulators will allow dividends to restart later this year.
The chief financial officer of a large US bank said he was growing more comfortable with the lender’s loan-loss provisions by the day, as more people than the bank’s models predicted continued to make payments on credit cards and other debts.
Critics, however, warn the true fallout of Covid-19 is unknowable. They argue that executives should temper their optimism until the full repercussions of the pandemic are clearer. Instead of returning cash to investors, banks should conserve capital so they can absorb unforeseen loan losses and continue lending through the coming recession.
Further cuts to ultra-low or negative interest rates, a potential no-deal Brexit and a fractious US election only add to the uncertainty.
“We don’t know what the future of Covid is . . . and neither do they [banks] so I think it would be difficult to say whether the worst is over or not,” said Nancy Foster, president of America’s Risk Management Association, a trade body.
“We just don’t know how long it will go on, and there’s not great visibility yet around how businesses will survive because of the level of deferrals that have occurred.”
Switzerland’s banks have been among the most optimistic so far.
Just days after the Alpine country recorded its highest-ever daily tally of Covid-19 cases, UBS and Credit Suisse proposed restarting dividends and stock buybacks, after charges for future loan losses fell by two-thirds between the third quarter and the second.
“I don’t think it is reckless at all,” Credit Suisse chief executive Thomas Gottstein said in an interview, pointing out that the proposed payouts are only a third of the bank’s net profit so far this year and can be cancelled if trends deteriorate.
“I am cautiously optimistic that yes, we are well provisioned, but it is very difficult to prove that to the outside world with all that is going on,” he said.
Economies in Europe are forecast to “snap back” between 4 and 6 per cent next year, banks have strong equity bases and clients are increasingly active. “That compensates for credit provisions and ultra-low interest rates,” said Mr Gottstein. “It is not all doom and gloom.”
He is far from a lone voice. Buoyed by a sharp quarter-on-quarter slump in charges for expected credit losses, HSBC has begun lobbying to restart payouts.
Chief executive Noel Quinn told the FT that the bank’s core capital ratio was now at 15.6 per cent, more than 1.5 percentage points above the regulatory target for the loss-absorbing buffer. He is also encouraged by a “V-shaped” recovery in Asia, its largest market, and less dire forecasts for UK consumers.
“Knowing how important dividends are to investors and our equities story, we believe it would be right to consider paying,” he said.
Mr Quinn echoed Morgan Stanley boss James Gorman, who has been the most vocal on the case for restarting dividends and told investors there were no financial arguments against payouts.
At Spain’s Santander, new charges for potential bad loans also slowed. CFO Mr Cantera said the lender is basing its models and estimates on those of the IMF, which revised upwards its gross domestic product forecast for several countries this year, including its home market and Brazil.
Executive chairman Ana Botín said of restarting dividends: “we are naturally cautious, but we also need to look forward and create the right environment to support the economic recovery. Ensuring the efficient flow of capital is critically important to that.”
Other European bank CEOs, such as António Horta-Osório at Lloyds in the UK, cited lower unemployment rates, resilient house prices and more customers than expected coming off mortgage or credit card repayment holidays as reasons for their tentative optimism.
However Alison Rose, chief executive of NatWest, struck a more cautious tone on Friday, just as the UK government’s national furlough scheme came to an end. “The outlook does remain very uncertain as we continue to deal with the impact of the pandemic on the economy, and it is a very stressful time for businesses and consumers,” she said.
Accounting for losses
There is one particular area of circumspection: accounting for future bad loans. Banks are basing their provisions on new accounting standards in the US and Europe that force lenders to accrue steep reserves for potential bad loans sooner, largely based on economic forecasts and statistical models.
For some analysts, this means that today’s loan loss charges are at best a guess at tomorrow’s actual defaults, which is compounded by the unprecedented nature of the health crisis.
The boss of America’s biggest bank, JPMorgan’s Jamie Dimon, admits loan losses could be $20bn worse — or $10bn better — than the bank’s most recent estimate, depending on how the pandemic plays out.
One US bank CFO said that the improvement in the economic outlook from June, when second quarter provisions were set, to September, was strong enough to have allowed his bank to reduce its total loan loss reserves, which could have led to a profits boost from the release of prior provisions.
“We thought, hmmm, that feels a little too early, let’s use some overlays which we’re allowed to do and keep the reserves at a certain level until we see more data,” he said. The extra headroom gives the bank more confidence it won’t have to book another big whack of provisions charges if Covid-19’s second wave hits the economy hard.
In ‘limbo land’
The debate over dividends has split the sector’s beleaguered investor base.
Benchmark European and UK bank indices have plunged more than 45 per cent this year — hitting record lows last month — leaving some shareholders desperate for a fillip from restarting payouts.
“The current situation is nuts when you look at business conditions versus valuation and share prices,” said David Herro, vice-chairman of Harris Associates, a $90bn asset manager that owns top-five stakes in Lloyds, Credit Suisse and BNP Paribas.
“They have plenty of capital, the virus will fade, new lockdowns aren’t as severe and the paying of dividends is a form of stimulus,” Mr Herro added. “Capital hoarding means less money is multiplied through the economy and is destructive to growth and recovery.”
While top bank executives acknowledge the path of Covid is impossible to predict, what has rankled with them most is the indiscriminate nature of regulatory restrictions, according to Citigroup analyst Ronit Ghose.
“I wouldn’t read the third-quarter numbers as bankers saying: ‘we beat Covid, everything is fine’,” Mr Ghose said. “It’s not about letting all bank managements go crazy — allowing a bad bank to pay a dividend would be like putting lipstick on a proverbial pig — but those with higher profitability and stable capital should not be subjected to a blanket ban.”
Others investors urge caution. A financials portfolio manager at one of Europe’s largest asset managers said that “sensible shareholders should not be demanding dividends” while the sector remains in “limbo land” with regards to the true level and timing of credit losses, which remain masked by state support schemes.
“I told a UK bank chairman only pay a dividend if you are 100 per cent sure you can pay with prudent buffers in place . . . the yield on the stock will be more attractive, but compare that to phenomenal downside if you get this wrong,” he added.
“Do not over-distribute into a second leg of downturn as government support ends and loans start to go bad. No one will thank you for paying dividends then.”