Are European Banks Escaping Their Losing Streak?

“Negative
or
zero
interest
rates
depressed
net
interest
margin
over
the
past
decade
as
European
banks
could
not
earn
a
spread
on
a
significant
part
of
their
deposit
base”,
write
Morningstar
analysts
Johann
Scholtz,
Niklas
Klammer
and
Ben
Slupecki
in
their
last
Banking
Landscape
report.

This
led
to
significant
underperformance
which
lasted
most
of
the
last
20
years.
Over
that
period
of
time,
European
banks
have
returned
-0.02%
per
annum,
compared
with
+6.6%
for
the
wider
European
market,
according
to
Morningstar
data.

Yet,
with
the
recent
rebound
in
interest
rates
caused
by
the
restrictive
monetary
policy
of
the
European
Central
Bank
(ECB)
since
July
2022,
the
tide
seems
to
be
turning,
with
European
banks
finally
reporting
better
financial
results.
But
can
this
last?

It
is
not
the
first
time
that
investors
bet
on
a
return
of
value
stocks,
including
banks.
Cyclical
sectors
benefit
from
such
a
move,
because
they
are
considered
more
sensitive
to
the
economic
cycle.

A
better
economic
environment
means
higher
interest
rates,
which
drives
net
interest
margins,
one
source
of
revenue
for
banks.
It
also
tends
to
increase
activity
in
financial
markets,
bringing
more
frequent
transactions,
including
mergers
&
acquisitions
and
IPOs
which
support
investment
banking
businesses.

The
recent
outperformance
of
European
banks
supports
this
thesis,
even
if
the
timing
seems
odd.
After
all,
investors
are
now
expecting
a
slowdown
in
economic
activity
which
would
make
the
ECB’s
policy
less
restrictive.

Between
July
2022
and
September
2023,
the
ECB
deposit
faciliy
rate
jumped
to
4%
from
0%.
Over
the
same
period
of
time,
2-year
Bund
yield
jumped
to
2.7%
from
0.4%.
This
has
helped
European
banks
charge
more
for
lending
money
and
drove
their
combined
revenue
from
260
billion
euros
in
2021
to
an
estimated
357
billion
euros
in
2023.

Glimmer
of
hope

“Banks’
shares
are
on
track
to
outperform
the
European
market
for
the
third
consecutive
year,
a
feat
last
achieved
in
the
early
2000s”,
BNP
Paribas
Exane’s
analysts
wrote
in
a
report
in
November.
“This
despite
the
relentless
bad
news
this
year:
Credit
Suisse’s
demise,
the
regional
bank
crisis,
credit
concerns
and
economic
malaise.
This
speaks
of
the
power
of
owning
a
sector
trading
near
trough
valuations,
with
generous
capital
returns
and
continued
earnings
upgrades.”

European
banks
returned
25.3%
so
far
this
year,
outperforming
the
broader
market
which
rose
13.6%
over
the
same
period.

Of
the
45
banks
in
the
Stoxx
Europe
600
Banks
index,
just
twelve
outperformed
the
sector
benchmark.
The
main
stocks
behind
the
sector
gains
were
Unicredit
[UCG],
HSBC
[HSBA],
BBVA
[BBVA],
Santander
[SAN],
Intesa
Sanpaolo
[ISP],
BNP
Paribas
[BNP]
and
Credit
Agricole
[ACA].

Despite
the
rebound,
financial
services
–
which
include
banks,
but
also
insurers
and
other
services
such
as
asset
managers
–
are
still
slightly
underrepresented
in
the
2,580
European
large
cap
funds
available
for
sale
in
Europe,
according
to
Morningstar
data
as
of
end
of
October.
On
average,
they
represent
16.2%
of
assets
under
management,
compared
with
17.7%
in
the
benchmark
index.

The
hope
of
better
earnings
growth
in
a
higher-rate
environment
partly
explains
the
outperformance
of
the
sector.
That
and
the
prospect
of
better
capital
return
to
shareholders
may
brighten
European
banks’
outlook
in
2024.

What’s
the
outlook
for
European
banks?

In
their
report,
Morningstar’s
analysts
estimate
that
“European
banks
can
generate
a
midcycle
return
on
equity
of
11%
compared
to
the
8%
average
it
generated
over
the
past
decade.
European
banks
are
not
a
growth
story;
profitability
gains
will
drive
shareholder
value.
A
structural
change
in
net
interest
margins
following
the
return
of
normal
monetary
policy
is
the
main
driver
of
increased
profitability.”

“European
banks
have
a
high
degree
of
operating
leverage,
which
amplifies
the
step
change
in
net
interest
margins”,
they
added.

According
to
consensus
estimates
cited
by
BNP
Paribas
Exane’s
analysts,
the
banking
sector
could
earn
223
billion
euros
in
net
income
this
year,
compared
with
172
billion
euros
last
year.

Even
if
valuation
multiples
are
depressed,
Morningstar’s
analysts
believe
European
banks
may
continue
to
outperform
in
2024,
provided
their
earnings
keep
growing.
“Profitability
increases
should
be
the
main
driver
of
shareholder
value”,
they
write.

The
reason
here
is
both
operational
efficiencies
and
the
absence
of
additional
regulatory
pressure.

“Digitalization
has
led
to
a
material
reduction
in
the
number
of
branches
and
employees
of
European
banks.
The
pronounced
increase
in
regulatory
and
compliance
costs
is
largely
in
the
base,
and
the
efficiency
gains
achieved
will
be
more
visible
in
the
future.”

The
most
surprising
fact
is
that
despite
the
recent
rebound,
the
valuation
gap
with
the
European
market
is
far
from
closed.
Since
2000,
when
the
sector
was
trading
at
a
valuation
multiple
close
to
the
rest
of
the
market,
European
banks
have
suffered
a
massive
derating
that
they
never
managed
to
erase.

This
means
investors
can
still
find
value
in
the
European
banking
sector
for
the
long
run.
According
to
Morningstar’s
analysts,
among
ten
banks
with
a
“Narrow
Moat”,
two
have
a
5-star
rating–
ABN
Amro
[ABN]
and
Lloyds
Banking
Group
[LLOY]
while
four
have
a
4-star
rating:
Santander
[SAN],
ING
Group
[INGA],
Svenska
Handelsbanken
[SHB]
and
KBC
[KBC].

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