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Among the many areas that global sector analysts follow, the European banking European banking is among those facing the most far-reaching changes and the greatest dispersion among stocks against a backdrop of increasing differences in monetary policies, technological revolution and sector consolidation. In this article, European banking analyst Thibault Nardin shares his views on the sector and points out where potentially attractive opportunities may arise in the future.
What is hidden behind the good results of European banking?
Over the past three years, European banks have outperformed the European equity market by 65% and have gained 17% more than this year so far.
The European banking sector has already undergone significant changes, and there will be more. After 15 years of deleveragingrisk reduction and several sectoral crises, in general the banking sector has managed to weather the economic volatility of the last five years and, in my opinion, is more robust than ever. Profitability has practically doubled since 2019, balance sheets are healthy and capital and liquidity reserves are abundant. I have reasons to believe that the level of credit risk on balance sheets is much lower than the market perceives, since high-risk loans have been transferred to another type of financial intermediary, which implies that profitability should remain high for longer and less sensitive to economic cycles that are expected to become increasingly shorter and more frequent from now on.
Specifically, in the last five years the Eurozone banks Banks have significantly outperformed their non-EU peers, boosted by normalising interest rates and generous capital remuneration policies. Earnings per share revisions have been among the best of any sector in the MSCI Europe Index over one, three and five years, and the recent recovery in equity markets has further supported the dynamics of bank earnings thanks to their trading activity2. Despite the overall positive tone, compared to EU indices, bank stock valuation discounts have barely narrowed, currently standing at 40% versus the STOXX Europe 600.
Assessment of current risks and opportunities
Although I believe that, for the most part, corporate results will not continue to provide positive surprises —The wide net interest margins cannot be maintained In an environment of low interest rates and pressure to adjust prices, the combination of higher and longer-term profitability levels and low balance sheet growth means that the sector should continue to generate high free cash flows per share, supporting shareholder returns in the 10-15% range and a resumption of M&A activity in the sector. As earnings growth slows, pressure to consolidate or “buy” new growth drivers will intensify. In particular, I believe that Italy, Spain and Central and Eastern Europe could advance their national consolidation processes. There is also the possibility that banks will try to acquire insurance companies, given the strong regulatory incentives in place.
In addition, technology is completely reconfiguring the way we consumers are related to the banks and their products. On the one hand, rising rates have increased the cost of capital for fintechs, while the profitability of traditional banks has significantly strengthened their ability to invest in technology. On the other hand, while it is true that the “industrial revolution” led by artificial intelligence will increase the long-term efficiency of banks, so will customer information, which will reduce the ability of banks to profit from customer passivity. In line with this trend, which is sure to create winners and losers, identifying the management teams best able to adapt will be vital to generating long-term alpha.
As regards areas of concern, it seems to me that the main risk for the European banking sector is the policygiven the large budget deficits and high sovereign debt levels in Europe. This environment heightens the risk of sector encumbrance and the substitution or “crowding out” effect on bank balance sheets – limiting the availability of funding for private investment – as governments try to plug budgetary holes and raise money from retail investors through government bond offerings. Political uncertainty can also be expected to weigh on valuations at times even when fundamental indicators are solid, as has recently been the case in France.
Finally, as regards the regulatory context, to which I pay great attention, the problems of Swiss banking sector The risks may be exacerbated by a stricter regulatory scrutiny in the market. FINMA, the Swiss financial markets regulator, has taken on new responsibilities, but I believe it has a difficult task at hand: to ensure that any additional regulatory requirements do not put Swiss international banks at a competitive disadvantage compared to their counterparts in the rest of the world. This risk will be aggravated if Trump becomes US president, as the Republican administration would try to relax the regulatory framework for US banking.
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