Europe's banks are set to report a resilient start to the year despite a backdrop of trouble, and how long improved capital markets revenue can outweigh rising bad debts is likely to dictate investor mood in the coming months.
European banks are expected to show a sharp improvement in investment banking business and a slower-than-expected rise in retail bad debts when they report results and trading updates in the coming weeks, in stark contrast to the gloom across the industry at the end of 2008.
Whether Q1 marks a calm spell in the eye of a storm that continues to rage, or the start of a sustained recovery is the key issue investors want answered. "In the same way that capital markets got wacked before the real economy, maybe they can recover before the real economy - that's the hope," one banking analyst said. "The fear is that all these positive comments could turn out to be a little bit temporary and low-quality."
The news from the United States has been positive, and Switzerland's biggest bank UBS will give an update at its annual shareholder meeting on Wednesday. Updates or results will follow from Credit Suisse, Barclays and others in the coming weeks. US bank Goldman Sachs on Monday reported a much higher than expected quarterly profit on the back of strong trading in fixed income, currencies and commodities.
That helped Europe's banks rally on Tuesday, and the DJ Stoxx European bank index is now up 4 percent this year after surging 78 percent from a 16-year low in early March. Recent upbeat comments have been most positive for banks active in capital markets, such as Deutsche Bank and Barclays, J.P. Morgan analysts said. But the prospect of further writedowns on structured products and losses from traditional loans as recessions deepen is a bigger concern for investors.
KBW analysts said on Tuesday they anticipate "fairly decent" Q1 results from European banks, but added that they also expect a confirmation of deteriorating asset quality. Other observers struck a similarly cautious note. According to Morgan Stanley, most European banks it hosted at a conference two weeks ago said they were profitable between January and March, aided by perkier capital markets and slower-than-expected credit deterioration.
Most major European banks attended the conference, and the investment banks said their revenues in foreign exchange, rates and credit were up 60 to 100 percent from pre-crisis levels, Morgan Stanley analysts said. Banks world-wide have benefited from investor appetite for corporate bonds combined with companies' need for cash, which is likely to sustain a flow of new bond issues into the second quarter after all-time record volumes in the first.
But arranging equity raisings and mergers and acquisitions (M&A) has been far less lucrative for banks. Overall, fees from advising on equity and debt issues, M&A and syndicated loans fell 43 percent in the first quarter against the same period last year, according to Thomson Reuters data. Citi analysts expect both Deutsche Bank and Credit Suisse to post net profits in the first quarter in constrast to losses a year previously.
Even UBS, which Citi forecasts will post a loss of 109 million Swiss francs, will show a vast improvement from a loss of 11 billion francs in Q1 2008. Some analysts doubt recovery can carry on at the pace seen in the first quarter, however. March was slower than the buoyant January and February, and Q1 results would be boosted by one-off writebacks after excessive writedowns previously.
"Overall we do not believe that the (first-quarter) run-rate will be sustained through the full year," Nomura analysts said. Exposure to monoline insurers remains a big worry, as do potential mark-downs on corporate loans, but an absence of major insolvencies in the first quarter may delay any sharp increase.
An increase in retail bad debts is likely for the first quarter, but the peak in bad debts is unlikely until late this year or even 2010, analysts reckon. That could postpone any sustained industry recovery, as investors stay wary while the scale of the downturn is unclear.