STOCK MARKET ANALYSIS

The banking sector is characterised as much for its ability to reflect opportunities for economic growth as for systemic tensions. Since November 2023 in the United States and since February 2024 in Europe, investors have been taking a keen interest in this sector. After a long period of stagnation (see Fig. 2), the main listed banks are now outperforming the indices (see Fig. 3). This is a very positive sign, but it should not mask the risks posed by interest rate fluctuations, the weakness of the property market and the lack of consolidation in the sector. These remain major challenges on both sides of the Atlantic.

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1. American banks

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Regional banks play a crucial role in the US financial landscape. Specialising in financing technology start-ups and venture capital, they support small and medium-sized enterprises (SMEs). In doing so, they fuel the growth of the local economy. Since 2022 and the start of the Fed's interest rate normalisation process, US regional banks have been negatively impacted by falling bond valuations and, ultimately, trapped in a liquidity crisis. The failures of Silicon Valley Bank and Signature in March 2023, followed by First Republic two months later, did not put an end to this problem. On the contrary, they revealed the poor management of interest rate risk and the banks' vulnerability to specific shocks, such as default on loans they had granted for the construction of commercial real estate (CRE). At the end of January, New York Community Bancorp (NYCB) fuelled investor fears of further weakness in the sector. The company posted substantial losses and its management team warned of weaknesses in its internal controls.

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Since the first difficulties were revealed in March 2023, the US regional banks have had to pay higher interest on deposits. This strategy has led to a fall in net interest income and a 16% drop in the KBW index of regional banks. Over the same period, the Dow Jones index of large institutional banks, including JPMorgan Chase, Bank of America, Wells Fargo and Citigroup, fared better, rising by 18%. In both cases, the banking indices lagged behind the S&P 500, which was up 27% (see Fig. 4). To overcome these challenges, regulators are encouraging small and medium-sized banks to merge. By creating regional super banks, they could broaden their customer base, improve their operational efficiency and increase their competitiveness. The merger between First Citizens and CIT Group in 2021 should serve as an example. In the meantime, it is highly likely that investors will continue to give preference to international banks.

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2. European banks

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Unlike in the United States, where companies are mainly financed on the bond market, in Europe they mainly use bank loans. The other side of the coin is that bank profits are, more than elsewhere, dependent on the lending they have granted to businesses. For more than 10 years, the profitability of the European banking sector has been penalised by the very low interest rate environment. In 2022, thanks to the economic recovery and the subsequent rise in key interest rates by the European Central Bank, banks benefited from a twofold boost: increased volumes and higher borrowing rates. Over the last 18 months, they have managed to return a large proportion of their profits in the form of dividends and share buybacks. Over this period, the index of European banks, including BNP Paribas, Société Générale and Crédit Agricole, has risen by 82%, compared with 42% for the EuroStoxx (see Fig. 5). To maintain this strong momentum, European banks will need to continue to reassure investors.

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The stakes are high because, in recent months, European banks have become very cautious in their lending process. To protect their balance sheets against an upsurge in defaults and bankruptcies, they have increased the risk premium they apply to their loans to corporates. Unfortunately, the bond market is proving to be an unfair competitor. Thanks to the stabilisation of sovereign rates and the compression of corporate spreads, the bond market offers an extremely attractive alternative to companies seeking financing. To put it simply, a European company looking to borrow for 5 years currently has a choice between taking out a bank loan at an annual rate of 4.6% or issuing a bond at a rate of 3.2%. In such an environment, it is easy to understand why bank lending volumes are contracting (see Fig. 6). If this phenomenon were to persist, it would favour the compression of banks' margins and profits, leading to an underperformance of the banking sector.

If banks are holding up well, it is also because investors are anticipating a steepening of the yield curve. In Germany, the spread between 10- and 2-year yields remains negative, but it is now only -44 basis points, compared with -82 last July. In France, after spending most of 2023 in negative territory, it turned positive again on 22 January. Banks in France can once again take advantage of their core business, which is to lend short-term capital on a long-term basis. In 2024, the steeper the yield curve, the higher the banks' margins. They will receive more interest income than they pay out. From this angle of analysis, the ECB's next rate cuts will be beneficial for European credit institutions.

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2. Swiss banks

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Following the turbulence of March 2023, the deal that enabled UBS to take over Credit Suisse not only reshaped the Swiss banking landscape, but also increased the banking giant's potential for development on the international financial stage. While it has addressed the specific challenges faced by Credit Suisse, including significant losses and scandals that had ultimately eroded the confidence of clients and investors, it also positions UBS to capitalise on new opportunities for growth and profitability. Over and above the derisory cost of this takeover, the synergies made possible by the merger are considerable. They promise economies of scale, greater diversification of financial services and a broader client base. UBS is in the process of integrating Credit Suisse's operations in order to optimise costs while broadening its product and service offering, particularly in wealth management, where the two banks already excelled separately.

These elements are important at a time when banks are facing pressure on costs, increased regulatory complexity and the challenges posed by the emergence of fintech. They are also crucial to meeting customer expectations, particularly in wealth management, where personalised services and access to sophisticated investment advice and products have become key differentiators. Investors are not mistaken. They are gradually seeing this merger as an offensive strategy, not just a defensive one. On the stock market, UBS shares are outperforming their peers.

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Conclusion :

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The banking sector faces a variety of challenges. The adage "small is beautiful" is not being respected. On the contrary, investors believe that "big is powerful". Credit institutions are just beginning to benefit from the steepening of the yield curve. In this financial landscape, and despite the setbacks of March 2023, UBS is a pioneer in terms of consolidation in the sector. It is beginning to reap the benefits of its express acquisition of Crédit Suisse, and investors are seeing the promise of further gains.

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