Finally, the Sun Is Shining on European Banks. It May Not Last.
It has been a long time since investors were bullish on European bank stocks. The iShares MSCI Europe Financials EUFN +2.18% exchange-traded fund has lost 10% over the past 10 years, while shares of U.S. peers doubled. European banks trade at an average of 0.8 times tangible book value, says Elias Chrysostomou, an analyst covering the sector for T. Rowe Price. The U.S. ratio is 1.2.
Tables may be turning. As the U.S. wraps up its third big bank rescue in seven weeks with JPMorgan Chase JPM +1.95% ’s (ticker: JPM) absorption of First Republic Bank, the European Union and the United Kingdom have remained relatively undisturbed. The continent’s one financial implosion, Swiss-based Credit Suisse, had been building for years and could safely be called idiosyncratic.
Markets have noticed. European bank shares are nearly back where they were before Silicon Valley Bank collapsed in early March. U.S. financials are down 10%.
More gains are ahead as the European Central Bank and Bank of England end a decade of near-zero interest rates, allowing banks to earn more spread on their core lending businesses, says Johann Scholtz, sector equity analyst at Morningstar. “We see a structural increase in profitability. We’re quite optimistic on a number of names.”
European banks’ deposits are stickier than those across the Atlantic, Scholtz says, not least because national barriers limit depositors’ options. In the Netherlands, for instance, three banks control virtually the whole nation’s savings. That protects them from the runs that undermined SVB, First Republic Bank, and Signature Bank in the U.S.
European and U.K. regulators also require all banks to regularly mark to market their securities holdings. This arcane nuance has become critical, as the U.S. exempted houses with less than $250 billion in assets from the requirement in 2019. The three banks that went under hid losses on bonds they bought at lower interest rates, until their sudden revelation spurred panic.
One of Scholtz’s top picks is Dutch champion ING Groep ING +3.76% (ING), because “70% of its earnings are geared to interest rates.” He also likes Spanish-based Banco Bilbao Vizcaya Argentaria BBVA +1.90% (BBVA), though mostly for its dominant franchise in Mexico. His U.K. favorite is Lloyds Banking Group LLOY +1.00% (LYG.UK) and in Scandinavia, Sweden’s Svenska Handelsbanken (SHBA.Sweden), for their standout operational efficiency.
Not everyone is so keen. Rising interest rates may give to the banks in the form of wider lending margins. But they can also take away by slowing the economy and spreading distress among borrowers. Current share prices “imply a mild recession” in Europe, Chrysostomou says. That may be too optimistic. “I would prefer that prices reflect a deeper recession to embed a margin of comfort,” he says.
Bank stocks are largely a proxy for their underlying economies, argues Manish Singh, chief investment officer at Crossbridge Capital Group. It makes little long-term sense to bet on slow-growth European economies instead of a more vigorous U.S. “European banks can probably outperform over the next three to six months, but not the next three to five years,” he says.
Singh does own one industry stock, BNP Paribas (BNP.France), which has a “strong franchise” and too-big-to-fail status in its native France. He “might feel comfortable” with U.K.-based HSBC (HSBA.UK).
Governments care less about bank profits than systemic stability for depositors and the national treasury. It’s likely that Washington will look closely at Europe’s tighter regulation in the wake of the recent debacles. Investors may want to look, too, for a change.