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European Banks Provide Outlook for Q3, Expect Merger Wave

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On Tuesday, at the 2020 Bank of America Annual Financials CEO Conference, some notable European banks issued mixed guidance for the September quarter. Also, the executives informed investors of the upcoming wave of mergers in the European banking sector.

Following this, shares of several major banks including Deutsche Bank (DB - Free Report) , Credit Suisse (CS - Free Report) and UBS Group (UBS - Free Report) declined in the range of 1.2-2.4% on the NYSE. However, shares of NatWest Group (NWG - Free Report) gained 3.8%, as its CEO’s comments on preparing against negative interest rates probably cheered investors.

Details

At the conference, James von Moltke — the chief financial officer of Deutsche Bank — said that the investment banking unit is performing well, benefitting from the strong momentum experienced in the first half of the year, which continued into the third quarter 2020.

Also, comparing with the guidance provided by the Wall Street biggies last week, Moltke commented that “We’d be, at this point, at least in line with or ahead of what our peers have guided so far.”

On the other hand, performance of Deutsche Bank’s retail unit and the transaction bank is expected to be hurt by low and negative interest rates environment.

On the cost front, Moltke noted that despite delay in execution of layoffs due to the pandemic, the bank remains on track to achieve its cost-savings target. Also, he said that Deutsche Bank might have to incur higher compensation expenses as attrition rate is low amid the pandemic.

Further, commenting on the merger wave, Moltke said that Deutsche Bank is “working hard to prepare” for the same.

The bank is looking out for cross-border merger opportunities as Moltke cited that domestic deals seem more challenging. Failed merger talks with Commerzbank (CRZBY - Free Report) last year is an example of such deals. In the meantime, Deutsche Bank is engaged in bolstering individual business units by acquiring small businesses that complement them.

At the same conference, UBS Group’s chief executive Sergio Ermotti said the consolidation wave was "inevitable” and that the pandemic has paved the way for mergers in Europe.

Also, Ermotti stressed that the deals need to be sensible and complementary. “Scale per se means nothing. You need to have focused scale, complementary scale, where you create added value,” he said at the conference.

Among other banks, Credit Suisse’s Thomas Gottstein feels that both cross border and in-market mergers are more complicated than before due to necessary regulatory approvals and less liking toward “too big to fail” banks. Nevertheless, he too feels consolidations would rise.

Recently, both UBS Group and Credit Suisse were in the news for exploring possibilities of a merger.

Regarding outlook for the third quarter, Gottstein expects slowdown in the wealth management business to be offset by rise in trading revenues. “The investment bank is currently tracking up mid-single digits, and sales and trading is keeping pace with prior years,” he said.

Also, the capital ratio is expected to remain stable on a sequential basis and Gottstein remains optimistic that the medium-term target for return on tangible equity of 10-12% will be delivered. However,negative interest rates are expected to put further pressure on net interest margin.

Furthermore, NatWest Group CEO Alison Rose said that the bank might report total impairments of £3.5-£4.5 billion for 2020, of which £0.6-£1.6 reflects additional provisions for the second half of 2020. 

Also, Rose said that she is mulling over ways to deal with the negative interest rates. "Clearly, if negative rates come in, that would present a further challenge to our revenue outlook on top of the recent cutting of rates," she said at the conference.

Conclusion

Banks are expecting to get some respite from encouraging performance of fee income sources during the July-September period. However, low interest rates are expected to hurt net interest income, which constitute a major portion of banks’ revenues. Also, with rising probability of second wave of pandemic, business activities are expected to be hampered again.

Further, consolidation of banks will increase the size of present big-sized banks, as it would call for tighter regulations to keep them in check.

Of the above-mentioned stocks, UBS Group and Credit Suisse currently carry a Zacks Rank #2 (Buy), while Commerzbank, NatWest and Deutsche Bank have a Zacks Rank #3 (Hold).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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