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Whither interest rates? This is the question that most European bank investors would like answered. Higher rates have benefited those banks with higher proportions of variable-rate loans on their books. These include Italian and Spanish banks whose share prices have been top performers this year.
Both the European Central Bank and the Bank of England are edging towards cutting rates — albeit slowly. Investors should be considering switching their allegiances to UK and French lenders.
There is a problem, though. Stronger than expected economic activity and stickier inflation have surprised most observers. This has made the decision by shareholders to shift away from this year’s winners, such as Spain’s Caixa and Italy’s BPER Banca, tougher. Last year, the pair’s net interest income (NII), roughly the gap between what banks pay account holders and receive on loans, jumped by more than 60 per cent on a per share basis, says UBS.
Higher rates for longer can help these banks via their variable-rate loan pricing. BPER shares are up 60 per cent year to date, helped by bid rumours. Some of that is due to hope that any excess capital will be distributed to shareholders via share buybacks and dividends.
Yet, if the market sees plenty of per-share profit potential, most analysts do not. Neither NII nor operating profit estimates for these two banks, according to collected data on Visible Alpha, suggest more than 10 per cent growth. Bank earnings outlooks by country are similarly muted, according to UBS data. UniCredit of Italy is an exception, boosting earnings per share at a double-digit pace using buybacks.
This so-so earnings outlook probably coincides with expectations for lower interest rates. If rates do start to fall, then UK and French banks merit greater consideration. Barclays, NatWest and Lloyds tend to hedge their interest rate risks to reduce potential NII volatility. As these older hedge positions, done at low interest rates, roll over into higher rate ones, the NII of these banks should lift. Analysts expect Barclays’ NII will climb 13.5 per cent between 2024 and 2026 to more than £14bn.
French banks, such as Société Générale, also have loan books more insulated from interest rate declines. For contrarians, SocGen trades at about 7 times forward earnings and not even 40 per cent of its tangible book. Unloved, its share price has trailed the sector by a wide margin. By 2025, its EPS should double, according to Visible Alpha consensus data.
Central bankers seem more likely to ease monetary tightness in the next year than otherwise. Those embracing this year’s comeback of European banks will need to adjust their approach accordingly.
