If you’re constantly being bothered by these two questions, and you‘re also looking for a short 30 minute summary on the issues facing our banking markets, look no further than The European Banking & Loan Portfolio Outlook - Market Update, presented by Deloitte. Not only does it include awesome granular data on portfolio deals, there were some neat ideas to think about for Q3 & Q4 of this year, including:
Similar to what we saw in Lithuania, net profit for the major listed banks in Europe was at the highest level since 2006, driven by a large increase in net interest income and associated net interest margin (page 17) -> no surprise that the tax authorities are looking to take advantage of this despite it being a cyclical effect.
Very interesting to see how average ROE has fallen from ~20% levels in 2006, to ~8% today (page 18); this is a direct effect of deleveraging, Basel III introduction and higher equity bases for most banks (page 24 has a cool graph on average CET1 figures) -> Lithuanian average stands at 9.6%, so I’m thinking that banks which can consistently deliver over 10% ROE in the mid-long run should be golden.
Kind-of-consequentially, banks trade a very low multiples (on average 0.7x book value); so even with extremely good profitability and short-term outlook, banks are not loved by investors due to i) the banks’ direct link to the economic cycle, ii) possible impacts due to regulatory changes, and iii) the recent debacles of a few US and Swiss banks at the start of 2023.
Despite huge increase in net interest margin, its percentage as of total assets is still lower than the averages seen in 2015 and before (page 20) -> this means banks do have larger profit, but on a much larger base of equity and assets.
Cost of risk has fallen sharply, but there are huge differences between the countries (page 22) – fantastic to see Lithuania at 0.2%! Interesting to note that report states that “current consensus expectations are for cost of risk to increase to c.50bps for the sector in 2023-25”.
The NPE graph (page 23) is what I came to see, and not surprisingly NPEs have been gradually falling each year to end of Q4’22 -> hopefully no big surprises for 2023, but an uptick is expected, as currently on average NPEs are at 1.6%!
Lithuanian banks are among the top regarding capital position (page 24), and one of the leading regarding liquidity (page 26), and I love the report’s comment that “recent events have re-focused attention on bank liquidity positions, in particular the perceived ‘stickiness’ of deposits (or not as the case may be), the exposure of certain business models to wholesale markets, and unrealised losses in treasury books; for SVB and Credit Suisse (and most recently First Republic), the level of deposit withdrawals, were far in excess of the outflows expected under the LCR definition […]”.
Coming back to the topic of valuations, two fantastic graphs are on pages 29-30; the first is a long-term perspective on P/B ratios on the eve of the start of the Global Financial Crisis, where I still remember multiples in the 1.6-1.8x range (or 3.5x-4x if you were inclined to do business in Ukraine, for example), falling all the way down to 0.66x on average today, despite clearly stronger balance sheets and liquidity -> perhaps the very low NPE ratios are suspicious, as it costs the banks dearly to make provisions, though I personally believe that the main underlying reason for lower multiples is related to unpredictability, i.e. banks that have had very good figures have unexpectedly deteriorated and/or went bust, so investors find it hard to feel safe despite strong KPIs.
The second graph is the P/BV vs ROE graph, which is a great way to how the market values higher performance -> my key takeaway is that if you want to your bank to be valued at 1x book value, you need to deliver ROE of over 14%!
Cost-to-income ratios are quite stable, and are improving as of 2020, which means banks can increase costs and still have leftovers to increase profitability, thought that is likely to be harder to do in the coming years (page 36).
From page 39 onward there is great insight into implications of recent market stresses for regulation, especially focusing on liquidity vulnerabilities, which seems to be the current hot topic; also some insights on scrutiny of assets held at amortised cost (vs. market values, which is another hot hot hot topic) and Basel 3.1 implementation.
From page 51 onward there is fantastic data on portfolio transactions – suffice it to say the market are active, and will definitely become more active in the next coming years!
Link to report: https://www2.deloitte.com/uk/en/pages/financial-advisory/articles/european-loan-portfolio-banking-outlook-2023-market-update.html
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