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Finally, a Payday for European Bank Investors

For more than a decade, one of the most reliable stories in global finance has been the lagging performance of European banks against their US peers — in both earnings and investor returns. Lenders in Europe are still trading at 70% below their 2007 peak before the global financial crisis, a summit US lenders reoccupied in 2018.

But things are looking up on the Old Continent. In the past three months, European banks have outperformed US banks by 20% in dollar terms. There are two principal reasons why this may be more than a false dawn.

First, their profitability is improving. For years after the crisis, European banks remained saddled with bad loans. Then, when policymakers pushed interest rates down to zero and below, net interest margins took a hit. Most found they couldn’t pass on the negative rates to their depositors. As a result, their return on equity floundered, averaging just over 3% in the past 10 years, according to central bank data.

With rates now moving up, the profit outlook has brightened. Around three-quarters of European banks have so far reported results for 2022 and on average they’ve beaten analysts’ pretax profit estimates by about 13%. The key: net interest income, which has exceeded consensus forecasts by about 6%. The two largest Italian banks, Unicredit SpA and Intesa Sanpaolo SpA, reported annual growth in net interest income of more than 40% in the fourth quarter; for the sector as a whole, average growth was around 30%.

Just as banks didn’t pass rate changes on to their customers on the way down, they are not doing so on the way back up – although this time, it’s to their benefit. Policy rates are up 300 basis points in the eurozone since July; yet, according to central bank data, Italian banks have passed on only 5% of the increase and Spanish banks, 2%. This so-called “deposit beta” is expected to inch up as banks compete to retain deposits, but they’ll still benefit. Italian banks have guided that they will likely pass on only 30%-40% of cumulative rate hikes by the end of 2023; Spanish banks have suggested 20%-25%. On his earnings call, James von Moltke, chief financial officer of Deutsche Bank AG, remarked that the deposit repricing lag “continues, in essence, to surprise on the upside.”

US banks profited from the same trend last year, but because the Federal Reserve started hiking rates earlier and more aggressively, that tailwind is weakening. And with deposits shrinking in the US, there’s greater competition for those that remain – a feature not yet apparent in Europe. JPMorgan Chase & Co. is guiding for 2023 net interest income to be down almost 10% from its fourth-quarter pace; in aggregate, US banks are guiding down around 5%.

Consequently, for the first time in a long time, European banks are showing stronger earnings momentum than US banks. After more than a decade of disappointment, analysts have begun upgrading earnings estimates.

The second reason for heightened investor interest in European banks is their increased willingness — and ability — to return excess capital to shareholders.

Between 2014 and 2022, European banks built up around €200 billion ($215 billion) of additional capital, largely at the behest of regulators. Their financial position now more secure – not least because of the upturn in profit – policymakers have given the green light to give some of it back.

“Supervisors have scrutinized banks’ forward-looking capital trajectories, finding that virtually all of them are compatible with the planned distributions,” the banks’ chief regulator, Andrea Enria, chair of the European Central Bank’s Supervisory Board, said last week. The largest European banks will this year distribute over half their 2022 gross profits.

A lot of this will be via stock buybacks, historically more of a feature on the other side of the Atlantic (Banco Santander SA has a web page explaining the concept for its shareholders). Yet with many European banks boasting higher capital levels than US banks, their buybacks could be more material. The average regulatory capital ratio for European banks is now around 14%, compared with just 10% among US regional banks. As a result, European banks are expected to go big with their buybacks, reducing share count by a tenth from the peak, which compares with a 6% reduction in the first four years of US share buyback programs, according to analysts at Autonomous Research. Indeed, this year, European banks are returning more as a share of market value to shareholders via buybacks than US banks.

Not all European banks are in the clear. Credit Suisse Group AG is guiding to a “substantial loss” in 2023 and, having just raised around 4 billion Swiss Francs ($4.3 billion) of fresh equity, it won’t be making more than a “nominal” payout to shareholders any time soon. But elsewhere, there’s a sense of confidence – that after years of playing catchup with the US, European banks are finally on the right track.

More From Bloomberg Opinion:

• Look Who’s Making Money Off Your Money: Chris Bryant

• The Gap Keeps Widening Between the US and Europe: Lionel Laurent

• European Banks Blow the Roof Off, For Now: Paul J. Davies

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Marc Rubinstein is a former hedge fund manager. He is author of the weekly finance newsletter Net Interest.

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