Although obscured by the very difficult market sentiment, reported earnings for the largest publicly traded European banks, representing total assets of over €25 trillion, rose by ~54% in 2015, almost exactly the same as the 55% increase the sector experienced in 2014. ‘Core’ earnings – i.e., excluding unusual items – rose a very consequential ~20% in 2015, after rising ~43% in 2014 (see chart below).
Earnings continue to recover and are now approaching “normal”, or levels generated before the credit cycle began. In 2015, the European banks generated ‘core’ earnings of ~€100 bln, which compares to the ~€110 bln reported in 2007, i.e., the last year before the downturn. In fact, consensus now forecasts a full recovery by the end of 2017 (see chart below). Also of interest, book values increased ~9% per year over the past two years. Despite this significant recovery in earnings and growth in book value, the SX7P has declined 19% since January 2014 as macro issues continue to dominate market sentiment.
Supported by Rising/Improving GDP, Decrease in Loan Losses Driving Profitability
The earnings recovery was driven primarily by a 20% decline in loan loss provisions in 2015 which – combined with loan growth – led to the ~19 bps decline in cost of risk (i.e., loan loss provisions / average loans). This credit recovery was supported by the continued improvement in GDP growth across the European Union, which is now approaching ~2% (see “ECB Easing Measures Seen as Positive; European GDP Growth Remains ~2%” for a review of GDP growth across Europe). Although many are concerned that negative rates might weigh on net interest margins, they have in fact, remained relatively stable, falling just 2 bps in aggregate during 2015.
Capital Ratios Improve, While Book Value Grows 20% in Two Years
Tangible common equity, which underpins book value, grew by ~€93 bln, or ~8%, in 2015 and has risen by ~20% over the past two years. The very important common equity tier 1 capital (CET1) ratio increased by a material 90 bps in 2015. This ratio, which is of intense focus by the regulators, surpassed 12% in aggregate at year-end (leverage ratios, i.e., tangible common equity over tangible assets, also increased by a notable 39 bps). For reference, Canadian bank common equity tier 1 ratios are closer to 10%.