Europe’s Banks Step Up Profit Pledges as Higher Rates Loom

(Bloomberg) --

As interest rates finally inch up, European banks are telling investors to expect something they haven't seen in almost 15 years: returns in the teens.

Several of the region's top lenders recently raised their profitability targets as they expect higher income from lending. The upgrades range across the whole of Western Europe, from Nordea Bank Abp in Helsinki to Banco Santander SA in Madrid. Both promise a return of at least 13% on the capital provided by shareholders as higher rates buoy earnings and the impact of the pandemic eases.

Other competitors may follow suit. Lenders including BNP Paribas SA, Commerzbank AG and Deutsche Bank AG will hold events next month to lay out their future strategy, with profitability a focus of investors. Deutsche Bank has yet to reach a return on tangible equity of 8% this year, but with peers raising targets, the pressure is on to outline more ambitious goals.

While the metrics used differ slightly from bank to bank, the message is the same: They're ready to make money again, after more than a decade of low and even negative interest rates during which returns rarely topped 10% on the invested capital.

Record inflation in the euro region is one reason behind the optimism. Surging prices have driven up the likelihood of interest rate increases by the European Central Bank. The Bank of England on Thursday lifted its key rate by a quarter point, with four policy makers opting for a larger increase.

Higher interest rates typically mean higher income from lending. Spain's BBVA has said an increase in the yield curve by 100 basis points would drive up net interest income in the euro area by more than 20%. 

An indication by the ECB on Thursday that it's no longer ruling out an interest rate increase this year boosted bank shares across the bloc and lifted an index to the highest since 2018. Deutsche Bank was the biggest gainer. 

But higher rates can also lead to more defaults. The latter hasn't been a big concern for banks so far, after they stashed away billions for potentially bad loans during the pandemic. That's allowed them to actually 

release some of that money as fallout from the pandemic eases.

In addition, lenders may start reaping the benefits from painful cost-cutting efforts carried out over the past years, when profits were hard to come by. Many banks have embarked on digitalization drives while cutting staff and branches, leading to higher efficiency.

Expectations for rising profits have set off a race for the highest payout to shareholders. UniCredit Chief Executive Officer Andrea Orcel in December promised to return at least 16 billion euros over the next several years. Other lenders including UBS Group AG and Banco Santander SA have since said they want to boost payouts to investors. 

The long period of poor profits has weighed heavily on valuations of European banks, many of which are worth a fraction of their competitors in the U.S. Several bank heads in Europe have expressed their expectation that improving profitability will close the gap and strengthen their position should M&A opportunities arise.

©2022 Bloomberg L.P.