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European banks have received a €100bn windfall from rising interest rates over the past two years, but the long-awaited boost has failed to close a persistent valuation gap.
Net interest income (NII) climbed from €270bn in 2021 to an estimated €378bn this year, according to data from UBS, after central banks began rapidly raising rates. Loans have grown only 2 per cent in that time, meaning most of the gains are from wider margins between what banks charge for loans and pay out on deposits.
The earnings fillip has allowed European banks to increase dividends and buybacks to €121bn for 2023 from €90bn in 2021. But while better capital returns have translated into double-digit stock price gains for many lenders, almost all still trade at steep discounts to the book value of their assets and their US peers.
“European banks have outperformed the market by more than 50 per cent [since year-end 2020] and yet still trade at valuations which imply earnings power 30 per cent below our forecasts,” said Jason Napier, an analyst at UBS.
The biggest concern for executives vying to attract new money is that central banks may now start to cut rates as soon as March, renewing pressure on net interest margins (NIM). NIM had only just started to recover after a decade of negative or ultra-low rates.
Fears of recession, weak loan demand, the potential for much higher capital requirements and rising defaults are also weighing on bank shares. “With policy rates next due to fall, macroeconomic growth sluggish and tax and regulation changes making life harder, for bank shareholders there’s a clear cyclical incentive to exit,” Napier said.
UBS forecasts that loan-loss provisions will hit €63bn next year, up from €31bn in 2021. That is still a manageable level given banks’ healthy capital buffers, but it will eat into cash that could otherwise be used for buybacks or dividends.
The sector is also suffering from the fallout of a shortlived banking panic earlier this year, when three US regional lenders and subsequently Credit Suisse failed, forcing governments to step in and broker rescue deals.
Giles Edwards, an analyst for S&P Global, said that “rising earnings mark a welcome normalisation after years of margin compression, but they do not alleviate all of the structural challenges to banks’ profitability”.
Some investors and executives are more bullish. Activist investor Cevian Capital bought €1.2bn of UBS stock this month, betting that the Swiss wealth manager can double its stock price and eliminate the stark valuation gap with its closest peer, Morgan Stanley.
Outgoing Morgan Stanley chief executive James Gorman last week also told the Financial Times that he expected the European discount to start to narrow. “I don’t think [over] the next decade the gap will be as large. I think there’s opportunities for the Europeans”, he said.
