Profits under pressure at French banks as strong earnings run hits headwinds

Profits at France's largest listed banks face a squeeze from several directions in the coming quarters, signaling an end to a strong run of results in the past two years.

Pressure on net interest income from both the asset and liability sides, coupled with rising expenses and increasing provisions for bad loans, are weighing on the profit prospects of BNP Paribas SA, Crédit Agricole SA and Société Générale SA. BNP on Nov.3 will be the first of the three banks to announce earnings for the third quarter of 2022.

The French lenders have enjoyed a bumper period for profits since they suffered a severe hit to income at the outset of the COVID-19 pandemic in 2020. All three banks enjoyed record profits in 2021, according to S&P Global Market Intelligence data. The lenders also made a strong start to 2022 as their large corporate and institutional banking divisions benefited from the market volatility sparked by Russia's invasion of Ukraine and soaring inflation.

'Some kind of deterioration'

"One would anticipate in this second half of the year we'll see some kind of deterioration in terms of credit quality starting to filter through and revenue pressure," Johann Scholtz, European bank equity analyst at U.S.-based financial services firm Morningstar, said in an interview. "If you start seeing revenue pressure coming through, then it's going to become increasingly challenging [for the French banks' profits] with a structurally higher cost base."

CASA and SocGen declined to comment. BNP Paribas did not respond to a request for comment.

The headwinds for French banks come as other large European lenders announce surging profits for the third quarter of 2022, driven by significant increases in net interest income, or NII, due to rising interest rates. NII is the difference between interest revenues and interest expenses.

Banco Santander SA, which is similar in size to the three French banking giants in terms of total assets, said Oct. 27 that it could earn an additional €2 billion in the eurozone alone in the next 12 months as higher rates feed through to its loan book.

French banks are much less sensitive to interest rate rises in the short-to-medium term than many other European lenders due to most of their loans being set at fixed rates. As many as 90% of the loans originated by French banks are fixed-rate, according to Arnaud Journois, vice president, financial institutions at credit rating agency DBRS Morningstar.

Lenders in many other European markets tend to have many more customer loans set at variable-rate, which reprice in response to changes in the euro interbank offered rate, calculated as the average interest rate at which eurozone banks lend to each other.

The big three French banks' aggregate net interest income rose by an average of 13.6% from the first quarter of 2021 to the second quarter of 2022, an analysis of Market Intelligence and company filing data shows. This compares to an aggregate increase of 21.7% during the same time at the top 30 European banks by assets.

"The effect of rising rates won't be immediate for the French banks," said Journois. "It's much more gradual than for the Spanish and a lot of other European banks."

Liability pressure

Further pressure on French banks' NII is building from the liability side. Deposit costs have "soared" for the lenders in recent months as the interest rate on the country's regulated savings scheme, the Livret A, has risen, according to an October note from global investment bank Jefferies.

The Livret A's rate rose to 2% from 1% at the start of August in response to rising interest rates — a level not seen in 10 years. The move was estimated in June to cost French banks €2 billion. Since then, Livret A savings accounts have seen their highest monthly intake since 2009, with inflows of €5.28 billion in August.

The French lenders' income faces another headwind from slumping asset management revenues, which have been hit by a steady fall in equity, bond and other markets since the beginning of 2022. Shrinking asset management fees are a particular problem for CASA, which made up almost 30% of its revenues in 2021, according to Market Intelligence data.

Rising expenses should also see a larger bite taken out of the French lenders' revenues in the coming quarters as the highest levels of inflation in decades begins to fuel higher salary demands. BNP and SocGen both announced significant increases to employee salaries in the third quarter after negotiations with unions.

"We started seeing cost pressures coming through in the second quarter with a lot of the cost lines coming out ahead of consensus expectations," said Scholtz. "Cost pressure is the one that's going to be interesting going forward."

Government pressure

Government pressure on the banks to protect the French public from any further increases to the cost of living are limiting the lenders' options as they look to counter rising costs with higher revenues. French Finance Minister Bruno Le Maire has lobbied banks in recent months to refrain from hiking customer fees in response to rising costs.

In September, Le Maire announced an agreement with the French Banking Federation that would see banks limit increases to fees to 2% in 2023. Some banks also offered to freeze fees on some products like credit cards following the discussions.

Third-quarter revenues at the three listed French banks are expected to see some support from the lenders' auto-leasing and global markets businesses, Flora Bocahut, bank equity analyst at Jefferies, said in an Oct. 17 note. Still, income from these divisions is likely to be down quarter on quarter, Bocahut said.

"We prefer BNP given it's more geared to businesses that perform well," Bocahut added. "CIB continues to benefit versus peers from recent scope changes, and solvency is stronger, with [the sale of its U.S. lender Bancwest] due to close soon."