In the euro area banking area, BNP Paribas (OTCQX: BNPQY) held up better than most. The largest bank in France by market capitalization announced a 13.5% drop in net profit for the year 2020, a drop much lower than that suffered by many of its peers. This reflects a strong performance from its investment bank, driven by very buoyant client activity, which offset some of the weakness in its retail and commercial divisions.

Like nearly all of its peers, the lender has had to set aside larger provisions for loans that may deteriorate due to the COVID-19 pandemic. But reflecting its conservative credit underwriting and diversified loan portfolio, the increase in the size of its provisions has been less marked. Over a full year, its cost of risk increased by 78% compared to 2019, to 5.7 billion euros and 0.66% of outstanding customer loans. By way of comparison, its competitors Societe Generale (OTCPK: SCGLY) and Crédit Agricole (OTCPK: CRARY) both reported more than doubling their respective cost of risk.

In total, the Paris-based bank recorded a 0.7% drop in revenue over the year, to 44.3 billion euros. Thanks to good cost control and the continuation of its digital transformation efforts, the group’s operating expenses fell at a faster pace, by 3.6% compared to 2019, to 30.2 billion euros . Thus, despite a difficult operating environment, the Group still manages to generate a positive jaws effect of 2.9 points.

The Group share of net income attributable to shareholders amounted to 7.1 billion euros. Excluding exceptional items, which included capital gains among other non-recurring events, adjusted net income was €6.8 billion, down 19.2% compared to 2019.

Diversification

Diversified banks are often criticized for spreading their capital too thinly across too many markets. The pandemic has, however, shown that BNPP’s diversified business model is working.

A diversity of revenue sources makes the group less vulnerable to a sharp deterioration in some parts of the bank, as stronger business divisions can offset weakness elsewhere in the group.

In a challenging environment for retail and commercial lending, 2020 provided ideal conditions for the bank’s trading desks as increased financial market volatility led to a surge in trading volumes and hedging activity.

Meanwhile, a glut of companies rushing to raise additional funds to deal with the pandemic was great news for the investment bank, given BNPP’s leading position in European bond markets. On the primary market, the value of bond issues increased by 44.5% over the year compared to 2019.

FICC revenue for the year increased 58.6% to €5.7 billion, while Corporate And Institutional Banking division revenue increased 13.9% to €13.8 billion . The division’s pre-tax income increased by 7.7% to 3.5 billion euros.

Another bright spot for the group was its small but growing wealth and asset management business. Although segment revenues decreased by 10.2% in 2020 due to lower net interest margins, assets under management increased by 3.8% compared to the previous year, following strong net inflows from Europe (particularly Germany) and Asia.

Operational divisions

Following a restructuring in 2015, BNPP reports on three operating divisions: Domestic Markets (shown in blue in the chart below), International Financial Services (red/pink) and Corporate And Institutional Banking (green). Its allocated equity and pre-tax income are more or less evenly split between the three divisions, giving the bank a high degree of diversification.

Source of data: BNP Paribas 2020 annual results

Source of data: BNP Paribas 2020 annual results

We can see that even within these three main divisions, BNPP is still diversified by geography and product category. It counts France, Italy, Belgium and Luxembourg as its main domestic markets, with more than 14 million customers combined.

Revenue decreased by 2.1% in the Domestic Markets division, penalized by the continued downward pressure on interest rates and lower commission income. Lower net interest margins offset the 5.4% growth in its loan portfolio for the year, which was supported by strong demand for government-guaranteed loans. Combined with higher loan losses, this caused the division’s pre-tax profit to fall 11.8% to 2.2 billion euros in 2020.

Apart from these domestic markets, the group also has significant retail banking activities in Turkey, Poland and the United States, through its American subsidiary BancWest based in San Francisco. Additionally, BNPP operates a significant insurance and personal finance business, which positions the group to benefit from pent-up demand when consumer spending eventually rebounds from the postponement of big-ticket discretionary items such as cars and household appliances in due to public health measures.

Overall, the International Financial Services division recorded revenue down 7.2% to 15.9 billion euros for the year, while pre-tax income fell 32.6% to 3, 4 billion euros.

Outlook

After an impressive financial performance for 2020, BNPP faces tough comparables going forward.

As trading activity normalizes, FICC’s strong performance will be hard to repeat this year, reducing the positive uptick in investment banking revenue and earnings. On the downside, there won’t be the same kind of help on the cost side either, with management guidance suggesting a stable operating expense outlook for 2021.

On the upside, this should be offset by an improved outlook for the retail and international side of the group, bolstering expectations for fee income and a return to growth in retail lending. In addition, a reduction in the cost of risk would also benefit the lender’s net income, even if operating expenses stabilize.

But the slow rollout of the vaccine in France and other key European markets poses risks to expectations of a rapid rebound in economic activity, which could hurt both earnings and credit quality. form the bank. Recent data has been somewhat disappointing, with weak consumer spending reported for January. This would seem to suggest that macro headwinds in the Eurozone may be easing more slowly than in the US and other markets.

BNPP’s cost of risk, while relatively low, is not falling as rapidly as its international peers. In the fourth quarter of 2020, the lender’s cost of risk increased further, reaching €1.6 billion, 65.5% higher than in the fourth quarter of 2019 and 28.4% higher than in the third quarter 2020.

Nevertheless, management is optimistic and expects its cost of risk to start falling this year, given its forecast of a gradual rebound in economic activity from the second half of 2021.

Moreover, much of the downside risk already appears to be priced into BNPP’s valuation. Despite a strong stock market performance in recent months, the group is valued at a 37% discount to its book value, compared to a 36% discount for the average large-cap European bank. Additionally, the stock’s price-to-earnings ratio is just under 10.0, compared to 15.5 times for the industry average.

Final Thoughts

Overall, BNP Paribas seems to offer something a little different from the rest of the European sector. It’s a well-diversified group with several strong franchises, and that was demonstrated by its resilient financial performance last year.

Even if, as things stand, the short-term growth prospects seem limited, BNP Paribas should have the necessary assets to weather the macroeconomic headwinds. Valuations, although not nearly as attractive as a few months ago, remain undemanding compared to its European peers.