Europe’s banks on the up: Which bank stocks are interesting now

by Ralf Witzler, Euro on Sunday

LFor a long time, investors gave bank stocks a wide berth. With good reason. The economic environment with the lowest, even negative interest rates was a burden with which the industry was only able to perform below average compared to technology stocks, for example, which benefited from cheap money. But now the conditions under which the money houses operate are changing. The turnaround in interest rates has begun or is imminent in important currency areas.

In December it was the Bank of England that became the first major central bank in the western world to raise interest rates. In the US, interest rate hikes are expected to begin in March to counter record high inflation in the country. The only puzzling on the financial markets is how quickly and how many rate hikes the Fed will proceed.

Even the European Central Bank (ECB), which has been very dovish for a long time, is beginning to reconsider its stance in the face of sustained price pressure. Market participants are anticipating a turnaround in interest rates this year. This is good news for the money houses in the euro area, if interest rates also rise in their home markets. This is shown by the price development of the large European banks such as the French BNP Paribas, the Italian Unicredit, the Spanish Banco Santander, but also the domestic financial institutions Deutsche Bank and Commerzbank.

ECB in a dilemma

Compared to the big US financial institutions, the European institutions have caught up significantly in the past few weeks and months. While the share prices of the banks on the other side of the Atlantic in February are mostly well below the level of November last year, the European houses are still on the upswing and are trading well above them.

Financial markets on the move

However, it is not expected that the ECB will change its expansive course in monetary policy too vehemently, because it is in a dilemma. On the one hand, the inflation rate has been at a record level for several months now and is well above the roughly two percent target that the ECB is aiming for. On the other hand, the European currency holders do not want to cause payment difficulties for some of the heavily indebted states of the euro area by increasing interest rates because the interest on their borrowed money is getting out of hand.

In addition, the ECB, and this also applies to other central banks, must be careful not to choke off the economic recovery after the corona pandemic, which is still not very stable, by making money too expensive. The Bundesbank, for example, expects growth rates for Germany of 4.2 percent in the current year and 3.2 percent in the coming year, but these are also necessary to return to the economic level before the pandemic. According to Bundesbank board member Joachim Wrmeling, the turnaround in interest rates in the euro area will not start with the actual increase in interest rates, but as soon as the ECB reduces its bond purchases. Because even then the interest rate level would move noticeably upwards.

Be that as it may: the turnaround in interest rates, whether already initiated or imminent, is getting the financial markets moving. The switch from growth stocks to more defensive stocks is in full swing. The banking industry is a big and clear beneficiary. In principle, the earning power of financial institutions increases with rising interest rates. This is mainly because, while they have to pay higher interest rates on their customers’ deposits, the differential to the interest rates at which banks lend money tends to widen, thus widening interest margins. Banks with a high proportion of traditional customer business will primarily benefit from this.

A study by the rating agency S & P assumes that the increase in the key interest rates of the ECB by one percentage point will increase the banks’ interest income by around 18 billion euros a year. According to the Bundesbank, the amount that European banks had to pay to the central banks as negative interest last year was of a similar magnitude: a total of around 17 billion euros, of which the institutes were only able to pass on a part to customers as so-called custody fees. So if at least the negative interest rates disappeared, the banks would be helped to operate more profitably.

Interest profiteer Santander

However, it is not only the development of interest rates that speaks for the banks. In addition, Europe’s financial institutions came through the crisis quite well. Thanks to state aid, the wave of bankruptcies feared at the beginning of the pandemic – some even expected a tsunami of defaults – did not materialize for companies. Billions of dollars in bank provisions to protect against loan defaults can now be gradually released and invested as the pandemic subsides, or distributed to shareholders given the currently solid equity cushion.

All institutes benefit from the rising interest rates, but not equally. Spain’s largest bank, for example, is benefiting to a particularly large extent. Banco Santander is strong in retail and derives much of its income from Brazil and Mexico, where interest rates have been rising for some time and have never been at the low levels of the euro area. When it presented its business figures for 2021, the bank surprised above all with its strong earnings momentum. The net interest income alone rose by ten percent compared to the previous year. At the same time, the quality of the loans issued within the group improved. The earnings are expected to continue in a similarly gratifying manner. For 2022, the bank is aiming for earnings growth of five percent. On the home market in Spain, Santander has so far been rather reluctant to release risk provisions. This is mainly due to the development of small and medium-sized companies in the state, which is difficult to assess.

BNP raises payout ratio

The major French bank BNP Paribas has presented a new business plan with targets for 2025 after a delay caused by the pandemic. BNP is focusing on the expansion of asset management and high-margin special financing. Average earnings increases of 3.5 percent per year and cost reductions should increase profitability and make it possible to increase the payout ratio from the previous 50 to 60 percent of profits. There are also positive effects from disposal proceeds in the USA.

Milan’s Unicredit is mentioned again and again when it comes to the consolidation of the banking industry, also across national borders. The experts at Berenberg Bank, for example, believe that the major Italian bank is capable of taking over the third-largest Italian bank, BPM, without having to cut back on the distribution plan. It provides for around 16 billion euros to be paid out between 2021 and 2024. The bank is already represented abroad with various brands, for example in Germany with Hypovereinsbank, Bank Austria and Schoellerbank in Austria. In addition, Unicredit is active in a number of countries in Central and Eastern Europe.

The domestic banks have meanwhile become more attractive again. Deutsche Bank is on the home stretch of its corporate restructuring. Most recently, Germany’s financial leader has brought in the largest annual profit since 2011. Commerzbank, on the other hand, is still in an earlier phase of restructuring, but is gaining ground both in terms of earnings and cost reductions and is becoming increasingly interesting as an investment.

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Image sources: Commerzbank AG, Annto / Shutterstock.com