European banks face 3 main challenges as the coronavirus crisis continues

People wearing face masks walk in front of a large euro sign in Frankfurt Main, western Germany, as the headquarters of the European Central Bank (ECB) can be seen behind -plan on April 24, 2020.

Yann Schreiber | Getty Images

Question marks persist for major European banks as they enter the second half of a year marred by the coronavirus pandemic.

Overall, these lenders ended the final earnings season significantly exceeding expectations for the quarter. Profits were buoyed by falling costs, but also by higher trading volumes in equities and an overall rebound in global markets.

But, they face difficult challenges in the future.

“The outlook still looks relatively tough,” Hugh Gimber, global markets strategist at JPMorgan Asset Management, told CNBC on Friday. “The income has been better than expected,” he said, “but it was still quite low.”

Investors are wondering about the level of loan loss provisions; whether they can withstand competition from Wall Street; and how long will this crisis last.

If I put it all together, I expect the second half of the year might not be as benign as the first half, but still pretty robust.

“Provisions remain the biggest source of uncertainty,” Francesco Castelli, head of fixed income at Banor Capital, told CNBC this week, highlighting an inconsistency among European banks.

“We have seen this ratio (of loan loss provisions) increase up to five times in some banks while other institutions have remained much less conservative,” he added.

These provisions, effectively cash set aside for potential coronavirus-related loan losses, have been a feature of the past two quarters. BNP Paribas added 329 million euros ($ 389 million) in the second quarter. Deutsche Bank had allocated 761 million euros at the end of June. During this time, UniCredit in Italy recorded 937 million euros during the same period.

The second quarter figures also revealed, as is often the case, a better performance of major US lenders compared to their European peers.

“US franchises have done much better in investment banking and commerce, clearly outperforming smaller European competitors and further consolidating their leadership position,” Castelli told CNBC, suggesting that this “outperformance” would add further pressure on European lenders, “where more restructuring is to be expected.”

The Dow Jones Index of US banks is up about 2% from last month. In comparison, the Europe Stoxx 600 banks index fell slightly over the same period.

Finally, it is difficult to predict how long the health crisis and the resulting economic shock will last. While the banks managed to surprise in the second quarter, they could be on the right track for more acute pain.

“The outlook is very much tied to the (health) crisis,” said Gimber of JPMorgan Asset Management.

This was previously raised by the chairman of the supervisory board of the European Central Bank, Andrea Enria, who told CNBC in an exclusive interview that European lenders could soon run into difficulties if the current crisis worsens and erodes their positions. in capital.

The watchdog has tested 86 banks in the eurozone and concluded that they can cope with the current crisis, but if it persists there could be a “material” loss of capital.

Nonetheless, some investors are convinced that increasing the capital on the balance sheets will help them weather the storm.

“While the losses are certainly significant, European banks start off with a very strong capital position,” Castelli said, adding that the average Tier 1 capital ratio – a measure of capital strength – is more than two. times the level observed in 2007 before the global crisis. financial crisis.

This, coupled with a massive European fiscal stimulus plan, should support lenders in the medium term, Castelli also said.

“If I put it all together, I expect the second half of the year to be maybe not as mild as the first half, but still pretty robust,” Sergio Ermotti, outgoing CEO of ‘UBS, last month.