Stronger dollar provides earnings boost for a handful of European banks

Amid a darkening economic outlook at home, some of Europe's biggest banks look set for a welcome earnings boost in the second half of 2022 due to the U.S. dollar's unrelenting strong run.

The dollar, which gained steadily against both the euro and sterling throughout 2021, has surged against both currencies in 2022. The U.S. Federal Reserve's greater speed and aggression in tightening monetary policy compared to that of its eurozone and U.K. counterparts, combined with a relatively stronger economic outlook for the U.S compared to Europe, has seen the euro fall by around 13% and sterling by more than 15% against the dollar since the start of the year.

The strong dollar will add to earnings already bolstered by additional income from rising interest rates for some of Europe's largest lenders. Barclays PLC and Banco Santander SA, which have significant businesses in the U.S., should see the biggest gains, while other banks with loans tied to the dollar will also benefit.

"Dollar strength is relatively helpful from a profitability point of view for those banks with U.S. dollar exposure and those with a large chunk of their loan books denominated in dollars," Benjie Creelan-Sandford, bank equity analyst at Jefferies, said in an interview. "That relative dollar strength has been a tailwind for earnings on the translation effect back into euro."

Weaker sterling 'actually beneficial'

Five of Europe's 20 largest banks by total assets derived more than 10% of their 2021 earnings from North America, including Canada, whose currency is closely correlated with the U.S. dollar, according to S&P Global Market Intelligence data. Barclays generated almost a third of its total income from the U.S. in 2021, while Santander drew almost a fifth of its net operating income from the country. HSBC Holdings PLC, BNP Paribas SA and Groupe BPCE are the other three banks on the list.

Barclays CEO C.S. Venkatakrishnan highlighted the prospective boost to earnings during the London-headquartered bank's Global Financial Services Conference on Sept. 12. Provided the bank's dollar revenues grow faster than dollar costs, Barclays will see "accretion to our income line in dollars, which is worth more in pounds," Venkatakrishnan said. "[A weaker sterling] is actually beneficial to the income of the bank," he added.

Barclays, BNP Paribas, HSBC and Groupe BPCE did not respond to requests for comment. Santander and BBVA declined to comment.

Rates of change

A stronger foreign exchange impact from dollar-linked earnings for the banks in the first half of 2022 looks likely to be even greater in the second half of the year as dollar strength against the euro and sterling intensifies, driven mainly by rising U.S. interest rates.

The Federal Reserve has signaled that it will continue tightening monetary policy in the U.S. until it brings soaring inflation under control. U.S. inflation remained high at 8.3% year on year in August despite the Fed having raised the federal funds rate by 275 basis points to 3.0% to 3.5% since March.

Following its August meeting at Jackson Hole, Wyo., "any idea that the Fed is going to pivot any time soon is dead in the water," said Jonas Goltermann, senior markets economist at U.K.-based consultancy Capital Economics.

The ECB and Bank of England's more timid response has helped to feed the relative weakness in the euro and sterling, said Goltermann. The ECB waited until July to raise interest rates for the first time in more than a decade, delivering 125 basis points of rises since then. The Bank of England started raising rates last December, hiking by 200 basis points in that time.

"The ECB is trying to keep up with the Fed, but they're about a million miles behind. Same with the Bank of England," said Goltermann.

'A much better place'

The dollar's longstanding safe haven status and the relative prospects for the U.S. economy versus the eurozone and the U.K. will also feed the greenback's strength in the coming quarters, Goltermann said.

"The U.S. might have a recession, but it's not going to be nearly as bad as in Europe," said Goltermann. He added that the U.S.'s energy independence was a key factor in its brighter outlook. "If you think about currency as an investment in relative economic fortunes, then the U.S. is in a much better place."

The dollar's strong run comes at a bad time for some European banks that recently decided to sell large parts of their U.S. businesses. BBVA and HSBC offloaded their U.S. retail banking operations in 2020 and 2021 respectively, while BNP Paribas expects its sale of Bank of the West to close later in 2022.

HSBC's position is further complicated by the fact that it reports its earnings in U.S. dollars, making the greenback's strengthening against most other major currencies a headwind.

BBVA's loss from exiting the U.S. retail market just prior to the dollar's strong run should be cushioned by its significant exposure to emerging markets, where a large portion of loans tend to be denominated in dollars. The weak performance of the euro and sterling against a basket of other emerging market currencies such as the Mexican peso, Brazilian real and Chinese yuan over the last year should provide it and other European banks with similar exposures with further earnings support.

"The weakening of the euro and sterling will definitely continue to benefit the banks in the second half, maybe even more so than in the first half," said Johann Scholtz, bank credit analyst at Dutch asset manager Actiam. "If the euro-to-dollar and sterling-to-dollar remain at the same level for the whole of the second half, that impact can be even more pronounced."

'Making the problem worse'

While U.K. Prime Minister Liz Truss' U-turn on a controversial plan to slash taxes and increase borrowing looks to have halted the recent rapid sell-off in sterling, the inexperience displayed by her new government in making the initial announcement could have a lasting impact on investor confidence in sterling and the U.K. economy, said Goltermann.

"The new government has a credibility problem, partly because it's new," Goltermann added. "But there is a lack of belief that their policies will work — and that they'll end up making the problem worse."

The one development that would see the biggest upturn in the fortunes of the euro and sterling is an end to the war in Ukraine, said Goltermann. "A big chunk of the euro and sterling weakness is to do with the war," said Goltermann. "If that were to end somehow and we get some kind of normalization, the outlook would change."

A stronger dollar isn't all upside for European banks with significant greenback exposure, said Creelan-Sandford. As the dollar strengthens, a corresponding increase in the euro or sterling value of the banks' dollar-denominated risk-weighted assets squeezes their capital ratios, which measure lenders' ability to withstand periods of financial stress and are calculated as a percentage of risk-weighted assets.

Moreover, currencies travel in both directions. "A currency's path doesn't necessarily continue to go in one direction," said Creelan-Sandford. The boost European banks are receiving from stronger emerging market currencies is particularly unlikely to last, Creelan-Sandford added.

"The benefit from a strong dollar and some emerging market currencies has been a recent tailwind," said Creelan-Sandford. "But it's not necessarily something that's going to prevail over the medium term."