Barclays And Deutsche Bank Need To Chase More Equity Deals

(Bloomberg Opinion) --Barclays Plc and Deutsche Bank AG have both benefited from interest rates staying higher than expected this year, supporting revenue and helping them lock in more income for future years. But both still need to prove their investment banks can compete with US rivals. If their rainmakers can’t catch a growing share of next year’s dealmaking and stock sales by companies, both European banks will struggle to hit ambitious revenue growth targets and risk missing profit goals, too.

The pair each beat forecasts in third-quarter results this week in key areas including net interest income, which is essentially the difference between what banks earn on assets and what they pay to depositors. Central banks have been slower to ease monetary policy than was expected at the start of 2024, as inflation and growth in many countries have proven relatively robust. That helps Barclays and Deutsche Bank in two ways — by protecting income from existing loans and securities with floating rates, and by delivering much higher yields in interest-rate derivatives markets. Banks use big interest-rate swap trades to hedge the revenue they get from lending and depositors.

The win that lenders have enjoyed can be seen clearly in the difference between Barclays’s assumptions for five-year swap rates in the UK for 2024 and the rates that have prevailed. The UK lender expected a rate of just below 3.6% in 2024; but in the first nine months it’s averaged nearly 3.9%. That helped Barclays upgrade its guidance on interest income at both its second- and third-quarter results. It’s locked in £12.4 billion ($16 billion) of revenue from its hedges up to the end of 2026. For next year, those will generate the equivalent of nearly one-third of its forecast interest income.

The story is similar for Deutsche Bank, which had a much smaller hedging program historically but has built it up significantly in the past two years. It’s locked in €7.4 billion ($8 billion) through the end of 2026 ,and reckons it can get another €700 million from older hedges it plans to roll over at higher rates. In 2025, as much as 21% of its forecast interest income will come from its hedges.

Both lenders have also seen deposits stabilize and are anticipating faster growth in lending next year and beyond; so even though the Bank of England and European Central Bank are poised to cut rates further, their net interest income will grow. And with Barclays adding in its recent acquisition of Tesco Plc’s banking business, too, further upgrades to its interest revenue could be coming.

Third-quarter results for their investment banks weren’t quite so positive in the context of how US rivals performed. Yes, Barclays and Deutsche Bank beat expectations for advisory fees and underwriting debt and equity raises, but the comparisons from last year for both are especially weak.

In the third quarter of last year, for example, mergers and acquisition bankers at Barclays turned in their worst quarter since at least 2019. So its leap to $242 million in deal fees in the three months to September this year was bound to look strong — it was up 140%. Deutsche Bank is also rebuilding from a deal drought, although its 110% year-on-year growth in dollar terms in the third quarter looked slow next to the 400% increase in the second quarter. The two European debt specialists are keeping pace with US peers in bond market work, but in initial public offerings and other equity sales they remain stuck far behind.

Investors are yet to be convinced that either can generate the levels of activity they’re targeting. Barclays’s plan is built on trying to get more investment-banking fees out of big corporate clients that it lends money to. The UK bank has spent the past couple of years overhauling its bankers, getting rid of older advisers focused on less fashionable industries and bringing in younger people especially in health-care, technology and other trendy sectors. Now they must just win the deals. Investors will wait and see.

The bottom line for both Barclays and Deutsche Bank is that things are improving, slowly. Analyst forecasts for returns this year and next are still shy of what the banks themselves are targeting. Each still has much to deliver.