Global bank results showing resilience

Major banks wrapped up half-year reporting. Here are five things I observed.

1.???Despite a big decline in net income, the sector remains resilient

No surprises here. After a prudent approach to provisioning in the first year of the pandemic, last year banks began to release provisions that boosted earnings. That did not repeat in FY22. The first half of this year has seen banks boost provisions as the economic outlook has weakened. For the largest US and European (including UK) banks, provisioning charges increased to US$6.8b, compared with a benefit of US$7.3b in the second quarter of 2021.

In the US, the rise in credit provisions and lower market-linked revenues weighed heavily on the sector. Across the largest US banks, net income for Q2 was 24% lower than last year. By contrast, net income for the major European banks was actually up 4%, as higher revenues offset their elevated provisions for credit losses.

The levels of profitability achieved in FY21 are going to be difficult to repeat this year in Europe and the US. Nevertheless, analysts still expect the US sector to deliver returns on equity (ROE) solidly in the mid-teens. That is double the average return expected for the European banking sector.

2.???Lending remained a positive, but loan losses are starting to rise

Despite the uncertain economic outlook, nearly all major banks reported a rise in lending to customers. Loan balances at the largest US banks increased 8.6% year-on-year to almost US$4t. This growth was driven by corporate and commercial lending activity and a rise in card balances. Loan balances across the leading European banks also grew, by an average of 4% with growth driven by an increase in corporate and commercial lending and mortgages.

After nearly a decade of ultra-low interest rates, the significant rise in the Federal Reserve rate so far this year has boosted net interest margins in the US. Compared with the same period last year, net-interest income for the largest US banks increased by 17.5% to U$54b.

Similarly, UK banks have benefited from a rise in the Bank of England base rate, with net interest income up 17% from the same quarter last year. Growth wasn’t quite as strong for continental European banks, but July saw the ECB raise rates for the first time in 11 years, so the continental lenders are likely to benefit from that in the second half of the year.

However, the expansion of credit balances was accompanied by (gradually) growing loan losses, and provisioning has dampened profitability. Going forward, banks will need to carefully walk the tightrope of repricing their asset-liabilities and growing their balance sheet in the new environment of accelerated monetary tightening.

?3.???Investment banking revenues couldn’t be sustained

The big US and European banks saw a respective average increase of nearly 15% and 8% year-on-year in FICC first half revenues, while equities trading largely held steady. Markets and businesses have benefited from continued higher volatility and business demand to manage exposures as commodity prices have increased. However, this solid performance was not sufficient to offset the slowdown in investment banking divisions.

Despite turbulent markets, advisory revenues for the first half were in line with the same period last year. This is despite that fact that global M&A volumes were down by 27% compared with the special purpose acquisition corporations (SPAC)-induced H1 2021, as several very large (greater than US$10b) deals were announced. It is also notable that while volumes were down on 1H20, they were still up 35% compared with the average for the same period between 2015 and 2019.

The real challenge for the first half of the year was in equity capital markets, where combined revenues for the big US and European investment banks were around a quarter of that in 2021. As highlighted by Refinitiv, 1H22 was the worst opening half in 10 years by volume, and 17 years on a value-raised basis.

?4.???Cost control is in focus

Management earnings calls highlighted that US and European banks have continued to execute on their efficiency initiatives. That said, a weakening economic environment is likely to keep costs under the spotlight. The overall operating expenses of the top US banks in Q2 was essentially flat when compared with the same period last year, but with revenues declining, most of the big banks saw negative operating jaws. Moreover, the aggregate view on expenses hides disparities across the sector. Costs at one large US bank fell 11% year-on-year but rose by 8% at a peer (largely driven by transformation costs).

For European banks, costs rose almost by 4.5%, although this was largely driven by strategic initiatives. Higher revenues supported a decline in the average efficiency ratio of more than four percentage points.

On costs, global banks will need to walk the tightrope of controlling total compensation costs in a tight talent market and attracting the best talent to deliver on their transformation programs and to renew their organizational skill set, especially in technology and data.

5.???Technology investment is not slowing (yet)

Management highlighted that the big US and European banks would continue with their transformation plans and their spend on technology. Overall, they indicated a moderate rise in quarterly technology spend. Around one-fifth of the expense of large US and European banks is technology related and I expect overall technology spending to be increasingly scrutinized by investors.

In a deteriorating economic environment, I anticipate more people asking whether banks are getting the right return on their investments. Are they making the right choices about where to invest? Do they have the right capabilities in-house to deliver their technology changes? Perhaps the real challenge for banks will be that in the short term they may need to spend more on technology to bring their infrastructure up to date. Hitting key milestones and setting the right priorities will be critical in the next 12 months.

The outlook is cautious; banks are preparing for a challenging year

While the banks are building reserves to counter potential losses due to macroeconomic uncertainty, their overall outlook is not that gloomy. In earnings calls, most executives predicted that while the economy would slow, it would not contract. Nevertheless, the combination of rising rates, high inflation and geopolitical conflict will challenge the world economy, and banks are battening down the hatches – including by halting share buybacks, building capital and being more selective on recruitment.

It is increasingly clear that the era of monetary easing has ended, but what this means for the sector, especially the competitive landscape, is as yet unclear.?The resilience of the sector over the past two years suggests it will find new ways to deal with any new challenges.

Disclaimer: The views reflected in this article are the author’s and do not necessarily reflect the views of the global EY organization or its member firms.