Business Maverick

Business Maverick

The case for European banking stocks just got a complete reset

The case for European banking stocks just got a complete reset
The European Central Bank (ECB) headquarters in Frankfurt, Germany, on Monday, 23 May 2022.

Thanks to swift central bank action to stamp out financial sector troubles, the investment case for European bank shares could be set for a complete reset. One where bulls are back in charge.

Sector enthusiasts — and there are plenty — argue the shotgun deal for UBS Group AG to take over Credit Suisse Group AG has at a stroke removed a major, years-long overhang for Europe’s banking industry. They reckon that will be enough to return focus to the factors that drove European banks’ scintillating October-March rally — cheap share price valuations and their underperformance when set against bond yields.

“We take the view that in six to 12 months, European banks will be higher than what they are now,” said Alexandre Hezez, chief investment officer at Group Richelieu, a Paris-based asset manager. “One can’t say that the sector is overvalued. Results this year are expected to be good, we don’t see that changing significantly.”

Dip-buyers stepped in after early-Monday stock market falls that were sparked by concerns over parts of the emergency Sunday-night deal between Credit Suisse and UBS. Several strategists applauded the tie-up, with HSBC’s Max Kettner describing himself as “much more confident”.  

Kettner noted that Europe’s bank share prices already incorporate an awful lot of bad news, with their index down about 16% in March. 

“Sentiment has gone and de-rated sufficiently to bearish levels that I’d be very-very careful to throw in the towel on constructive views now,” he added.

The past two weeks have been a nightmarish time for European banks, which only started to emerge from the doldrums last October, after being crushed by years of sub-zero interest rates. The March sell-off slammed European bank valuations hard, taking them back to where they were in October. Average price-to-earnings ratios are now around 6.5 times forward earnings, not far off the levels seen during past crises, including in 2008 or 2011. 

The sector now offers the highest forward dividend yield in Europe, at about 7.6%.

“I think that European banks are solid and resilient,” said Simon Outin, global head of financials credit research at Allianz Global Investors. “For me, the sector is solid, in terms of solvency, in terms of liquidity. We are not in 2008, really not.”

Concerns are by no means over. US authorities are fighting to head off potential deposit runs at regional banks. Rising interest rates and tightening financial conditions likely portend recession. A rise in default insurance costs at Deutsche Bank AG shows contagion fears still linger. So whether bulls do ultimately end up on top hinges now on a few things. 

First, how well central banks navigate the next phase of their inflation battle, and how severe the anticipated recession could be. Banks typically perform well as interest rates and bond yields rise, though not during economic downturns. Analysts reckon that current euro-zone bond yields still imply some upside for bank shares, given they did not fully capture last year’s surge in borrowing costs. 

Investors are also watching to see how policymakers calm the uproar around Credit Suisse’s Additional Tier 1 bonds — the riskiest bond category whose holders were wiped out in the merger. A rout in AT1 debt of other European lenders is raising fears of a seize-up in the market, which has been a key funding source for banks since the 2008 crisis.

“The risk is that all AT1 bonds collapse – so beyond Credit Suisse. This will put major pressure on banks’ financial ratios,” said Charles-Henry Monchau, chief investment officer at Banque SYZ. BM/DM

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