Despite the rate cut, the bank still has a piggy bank for shareholders | Financial markets

European banks have had a major price scare this week, driven not only by the high geopolitical tensions surrounding the planet. Morgan Stanley decided to downgrade its recommendation on the sector to neutral. With weak growth and falling interest rates putting pressure on business profitability, banking is no longer as attractive to American firms. Morgan Stanley’s adjustment won’t be the only one in a sector that has delivered strong returns for nearly two years and that now has less potential than other sectors that have long been more punished by rate hikes or had a more defensive profile, quality valuable in times of uncertainty.

Banks will end up living in the best of all worlds, a world where interest rates have risen the most in decades while economic growth has stagnated and bad debts have soared. This scenario will lose its appeal in the coming months as the rate cuts that are expected to continue and have already begun take hold. But these declines in money prices will not jeopardize the strong demand that has fueled a rally in the bank stock market in parallel with an increase in their margins: attractive remuneration to shareholders.

Despite the rate cuts, analyst consensus compiled by FactSet predicts that pay European banking – the percentage of profits distributed to shareholders – will remain level in 2025 and 2026, or even slightly higher than the almost 50% expected this year. What pay It’s certainly up from the 35.6% consensus in 2020 – the year of the pandemic that permanently froze dividend payments – and the 43% analysts expected in 2022, the year of the interest rate move. In terms of dividend yield, the consensus points to 7.23% this year, 7.5% in 2025, and 8% in 2026. Considerable levels for companies that have already risen strongly in the stock market and are not going to achieve such huge gains.

Market consensus predicts that pay will remain at 50% in 2025 and 2026.

If the effect of share buybacks is added to the payment of dividends (another component for which the bank has developed its shareholder compensation policy in recent years), the bank’s expected return in 2025 will average about 11%. Goldman Sachs calculations. The US firm estimates returns next year for Santander and BBVA shareholders will be 9%, and for CaixaBank shareholders 12%. Among European banks, the leaders are Nordic and Irish banks, as well as Unicredit, which has launched a large share buyback program in recent years and still has excess capital to fight Commerzbank. “Analysts expect dividends paid by European banks to continue to rise in 2025 and 2026, but at a much more moderate pace than this year. I see no reason why this forecast will not materialize, unless the economy in the eurozone worsens,” says Juan Fernandez-Figares, director of research at Link Securities.

This analyst consensus includes an adjustment to Morgan Stanley’s recommendation, which Barclays joined this week with much less noise in the market. The British firm has decided to tactically collect profits in the European banking sector, in which it currently takes a neutral position, citing weak growth in the eurozone and the prospect of lower rates, among other reasons. Barclays continues to share the majority thesis of a soft landing for the economy, supported by Fed and ECB rate cuts and now fiscal stimulus from China. This is despite the enormous uncertainty caused in the short term by the escalation of war in the Middle East and the US presidential election. “Rate cuts could encourage a reallocation of cash into equities as the post-election environment improves,” they note. Barclays, which is now positioning itself in defensive values ​​with the idea of ​​adding cyclicals as 2025 approaches.

Thus, managers and research firms may choose a more neutral position in banking in favor of other sectors that provide more tactical opportunities, but this will coexist with constant demands for dividends for shareholders of financial institutions. “I don’t expect any downward revision of banking sector estimates or investor concerns about the sector. Banks are going to continue to distribute half of their profits to shareholders,” defends Nuria Alvarez, an analyst specializing in Spanish financial institutions.

The European banking sector has grown from zero to one hundred in a very short time. From an environment of zero and even negative rates to an environment of maximum rates, and now it is time for a more normal business environment, as Alvarez explains. To this end, financial institutions work to reduce the sensitivity of their business profits to changes in the price of money through formulas such as fixed-rate loans or hedging the value of liabilities. “If rates are cut by 100 basis points, the impact on interest margins will be 5% lower. Before the rate hike, a 100 basis point increase meant a 25% to 30% increase in earnings,” Alvarez says.

In favor of margins, lower rates will also reduce the cost of liabilities, which also have not risen significantly with the rise in the price of money. And the scenario of a soft landing and economic growth – in Spain clearly higher than the eurozone average, with GDP growth of 2.2%, according to Bank of Spain estimates by 2025 – will contribute to an increase in the issuance of loans, to which will eventually be added a decrease reserves in case of insolvency.

The third-quarter results presentation, which starts coming in this month, will provide the first glimpse of the end of the year and the outlook for 2025. At the moment, Spanish banks are investing the rest in paying dividends, especially BBVA and Sabadell have entered into a bitter dispute over a hostile takeover undertaken by the former. On October 10, BBVA pays a dividend of €0.29 per share, an increase of 81% on the previous year. This will be the largest payout in its history. And Sabadell is increasing shareholder compensation, quadrupling it this year and not ruling out another increase.

On November 1, Santander will pay a cash dividend of 10 euro cents per share, up 23% on the previous year. These will be the first dividends accrued based on the results of 2024. The total amount that will be returned to shareholders as milestone compensation for 2024 will be around 3,050 million euros, approximately 50% of Santander’s first-half profit, as the bank pays the reward equally through dividends and share buybacks.

Lower rates will reduce bank profitability and could stimulate corporate transactions.

A reduction in interest rates, without calling into question the payment of dividends, will mean a gradual decline in the profitability of financial institutions, which reached its peak with rising rates. The FactSet consensus forecasts that the European banking sector will close this year with a return on equity of 11.56%, falling to 11.11% in 2025 and 10.99% in 2026. And this turning point could also mark the beginning of corporate operations in this sector, which is a factor that has a decisive influence on the prices of companies, as can already be seen in the movements of BBVA and Unicredit by Sabadell and Commerzbank respectively. “Until now, the improvement in profitability that has been seen due to rising rates could act as a headwind for consolidation, not to mention the fact that the lack of a full-fledged banking union in Europe is a drag,” explains Luigi Motti, banking analyst at Standard. And the Poor.

Takeover or takeover bids can no longer be an isolated or unthinkable event in the banking industry as they have been in recent years, which also opens up new scenarios for shareholders. “Improving the profitability of European banks, which is already threatening to peak in some entities now that rates are starting to fall, and the value of the stock market could help create more favorable conditions for financing transactions of this type (capital increase). ) as there will be less dilution for the shareholder,” they conclude at S&P.