Mar 21, 2023
The Case for European Banking Stocks Just Got a Complete Reset
(Bloomberg) -- 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.
With European banks rebounding on Tuesday for the second day in a row, the Stoxx 600 Banks Index has clawed back almost half of last week’s 12% rout, as worries about US bank deposit runs ebbed, and European regulators offered reassurances to holders of the riskiest bank bonds.
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 6 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.”
Read: UBS Gains as Investors Weigh Credit Suisse Deal Upside
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 selloff 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 also 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.”
Bulls would also note the selloff has helped clear out crowded positions. European investors’ average overweight in banks has slumped to a mere 3%, compared to last month’s 27%, Bank of America’s closely watched fund manager survey showed on Tuesday.
Concerns are by no means over. US authorities still face the risk of deposit runs at regional banks. Rising interest rates and tightening financial conditions likely portend recession. An overall rise in banks’ default insurance costs 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 whether the uproar around Credit Suisse’s Additional Tier 1 bonds will subside fully. Holders of these securities, the riskiest bank debt category, were wiped out in the merger, causing investors to dump the AT1 bonds of other European lenders.
On Tuesday, these bonds rebounded in Europe and Asia as investors heeded regulators’ assurances that the wipeout in Credit Suisse’s AT1 notes wouldn’t happen in their jurisdictions under similar circumstances.
Read: AT1 Bond Rout Prompts European Officials to Try to Calm Market
“It was a surprise to see the AT1s being wiped out and not having similar terms for equities. But we can now say it was an isolated situation,” said Erick Muller, head of product and investment strategy at Muzinich & Co.
--With assistance from Sagarika Jaisinghani and Allegra Catelli.
(Adds AT1 bond moves in 14th paragraph, Muzinich quote in last paragraph)
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