European Banks Surge to Decade Highs on Rate Hopes

Sector Recovers from “Pariah Status” Amidst Economic Optimism

Europe’s largest financial institutions are experiencing a significant upswing, reaching their loftiest valuations since the 2008 global financial crisis. This powerful rally is largely propelled by a sharp increase in long-term interest rates, which is translating into robust earnings for the sector.

Market Turnaround

Major players like HSBC have seen their London-listed shares reach unprecedented highs before releasing their latest results. Similarly, Barclays and Santander stocks have climbed to levels not seen since 2008, while Italy’s UniCredit touched a 2011 peak. This performance marks a dramatic reversal for a segment of the market long considered an underperformer.

“Europe’s banks have shifted from pariah status to market darlings.”

—Justin Bisseker, European Banks Analyst at Schroders

Justin Bisseker further explained that this transformation is due to a combination of factors: “higher interest rates” significantly impacting revenues, a generally favorable economic climate across the continent, and internal efforts by the banks to boost efficiency.

Investor Confidence Grows

Investors are increasingly drawn to European banking stocks, buoyed by growing economic confidence in the region and improved outlooks for loan portfolios. Additionally, the current valuations remain attractive compared to their US counterparts, such as JPMorgan Chase and Goldman Sachs, which trade at multiples of book value.

For instance, many European banks are only now returning to valuations at their book value. In contrast, JPMorgan Chase currently trades at 2.4 times its book value, and Goldman Sachs at double its book value, according to FactSet data. As noted by Luca Paolini, chief strategist at Pictet Asset Management, banks are “cheap and uniquely positioned for a pick-up in domestic demand.”

Factors Driving Profitability

The landscape shifted significantly after the COVID-19 pandemic. Central banks began raising interest rates to combat inflation and unwound extensive bond-buying programs. This led to a rapid rise in long-term interest rates; for example, the yield on 30-year German bonds is now 1.3 percentage points higher than two-year yields, a stark contrast to just two years ago when the differential was negative. A similar trend, with a gap exceeding 1.5 percentage points, is evident in the UK.

This widening yield gap has substantially boosted banks’ net interest income—the profit generated from lending activities versus the cost of deposits. This has been a primary driver of increased profitability. Banks with active trading desks have also benefited from market volatility spurred by recent geopolitical events.

Future Outlook and Challenges

The sustainability of this rally hinges on whether European banks can maintain momentum without the tailwind of rising long-term rates. While institutions have diversified into areas like wealth management to mitigate interest rate sensitivity, potential consolidation, such as mergers like BBVA’s bid for Sabadell or UniCredit’s interest in BPM, faces political hurdles that could limit sector growth.

“Banks appear the cleanest shirt in the basket, but there is a growing feeling the best may be past. Long-awaited sector consolidation is far from the catalyst that many analysts have hoped for.”

—Francesco Sandrini, Global Head of Multi-Asset Strategies at Amundi

Despite these caveats, European banks are still trading at a forward earnings multiple of 10, significantly lower than the over 13 times seen for their US peers, according to Bloomberg data. Return on tangible equity, a key profitability metric, now comfortably exceeds 10% for many European lenders.

Justin Bisseker of Schroders adds a positive note: “The good news is that European bank valuations remain discounted compared with banking sectors elsewhere in the world. Further convergence is likely.”