Most large European banks posted higher income in the third quarter compared with a year earlier, with results bolstered by lower provisioning against bad loans as economies recover from the impact of the coronavirus pandemic, an analysis by S&P Global Market Intelligence shows.

In a sample of 25 large European banks, 23 reported an increase in net income, and most reported significantly lower third-quarter loan loss provisions, which banks set aside to cover potential defaults in their loan books. Seven banks released provisions in the quarter, including U.K. lenders HSBC Holdings PLC, NatWest Group PLC and Lloyds Banking Group PLC, which released €559 million, €283 million and €144 million, respectively.

Improving economic outlook

An improving economic outlook throughout the year was the main driver for the decline in expected credit losses, according to Christian Scarafia, managing director and head of Northern Europe bank ratings at Fitch Ratings. Banks had booked large provisions in 2020 and actual nonperforming loans remained lower than expected.

In a supervision newsletter published Nov. 16 — before the emergence of the latest omicron variant of the coronavirus — the European Central Bank said downside risks to economic growth have eased considerably as vaccines have been administered and restrictions have been loosened. The reduction in impairments was greater than banks had expected, driving a profit recovery, it said.

But European banks' cost of risk, a measure of funds set aside to cover potential losses, is expected to rise in the coming quarters as the impact of discontinued COVID-19-related government support measures begins to be felt, rating agency DBRS Morningstar said in a Nov. 29 note. The pace of asset quality deterioration, expected to become more pronounced in 2022, will depend on the strength of economic recovery in each country, DBRS Morningstar Senior Vice President for Global Financial Institutions Maria Rivas told Market Intelligence.

In the third quarter, Spanish banks Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA recorded among the highest provisions, along with France-based BNP Paribas SA and Groupe BPCE and Italy's Intesa Sanpaolo SpA and UniCredit SpA. Santander's totaled €2.19 billion, up from €1.76 billion in the second quarter but down from €2.50 billion a year ago.

French banks' ability to absorb credit risk has returned to pre-pandemic levels, DBRS Morningstar said in a Nov. 22 commentary. Société Générale SA's loan loss provisions fell to €196 million from €518 million a year ago, while Crédit Agricole SA's fell to €266 million from €605 million over the same period.

Recovering profits

All banks in the sample reported higher profits on a yearly basis except Credit Suisse Group AG and Intesa Sanpaolo. Zurich-based Credit Suisse was affected by its dealings with Greensill Capital (UK) Ltd. and Archegos Capital. Meanwhile, Intesa Sanpaolo's results were affected by negative goodwill related to its acquisition of Unione di Banche Italiane SpA.

Euro area bank profitability is returning to pre-pandemic levels, the ECB said in its November financial stability review. Profits are expected to continue normalizing further in 2022, albeit at a slower pace than seen this year, with much of the improvement expected to come from lower loan loss provisions.

But secular challenges such as long-term weak profitability will remain, and banks will need to address this by improving efficiency and seeking sustainable income streams, Fitch's Scarafia said. Support measures ending could trigger a "slight increase" in impaired loans, but Fitch expects this to be "easily manageable" for banks overall.

Banks in Russia and Ukraine, where government ownership means banks are subject to different market dynamics than those in Western Europe, were omitted from this analysis.