European investors are relying on banks more than ever before to revive earnings and help extend a rally that has lifted stocks 38 percent since June 2012.
The market value of lenders in the Stoxx Europe 600 Index has increased by 316 billion euros ($432 billion) during that period, with gains paced by BNP Paribas SA and Bank of Ireland, according to data compiled by Bloomberg. That gave banks a 14 percent weighting in the stocks gauge, close to the highest in almost three years. Analysts say their earnings will jump 54 percent in 2014, the most since at least 2002 and the largest increase among 19 industries.
While bank profits have disappointed investors since 2011, they’re poised to break the streak after Europe’s longest-ever recession ended and as finances improve, according to Frederic Tassin, who helps oversee $12 billion at Aviva Investors in Paris. Lenders have rallied nearly twice as much as the rest of the market on speculation profit growth will materialize in 2014, said Justin Bisseker of Schroders Plc.
“This is the turning point,” Bisseker, European banks specialist at Schroders in London, said on Jan. 23. His firm manages about $415 billion. “The European market cannot continue to rally if bank earnings drop further.”
Financial shares have climbed in anticipation of improving income growth after the euro area emerged from a two-year economic contraction in the second quarter and a manufacturing index indicated growth in July for the first time in two years. European Central Bank President Mario Draghi has reduced interest rates to a record, vowed in July 2012 to do whatever was needed to save the euro and said borrowing costs will remain low for an extended period.
Stoxx 600 banks have risen 64 percent since the month before Draghi’s pledge, when European shares began a 19-month advance. The gauge this month traded at 18.8 times analysts’ predicted earnings for this year, the highest valuation since 2002, data compiled by Bloomberg show.
European equities slid in the past three days, with the Stoxx 600 losing 4.2 percent to 322.02, dragged lower as a rout in emerging-market currencies spurred concern the global economic recovery will falter. Lenders in the gauge trimmed their 2014 advance to 0.9 percent, compared with a 1.9 percent retreat for the full index.
The Stoxx 600 gained 0.7 percent today, with banks jumping 1.1 percent, the most in almost two weeks.
Profit at European banks fell 3.1 percent in 2013, analyst estimates compiled by Bloomberg show, after declining 25 percent the two previous years. For the Stoxx 600, earnings dropped in 2011 and 2012 and gained 3.6 percent in 2013. Analysts predict Stoxx 600 profits will rise 14 percent in 2014, the average of more than 10,000 estimates compiled by Bloomberg show.
Banks will account for 15 percent of European earnings in 2014, according to estimates compiled by Societe Generale SA. Lenders represent 14 percent of the Stoxx 600, up from 9.8 percent in 2009, data compiled by Bloomberg show. That’s the highest proportion among all industries, followed by industrial-goods and services companies.
Speculation that improving finances will boost earnings led Aviva Investors to make banks its biggest investment, according to Tassin. Balance-sheet assets and total debt at Stoxx 600 lenders have halved since 2007, according to data compiled by Bloomberg. The companies raised almost 240 billion euros in new capital in the past five years, the data show.
“The banking sector has never been as safe as it is now,” Tassin said in an interview. “They did a lot in the worst possible times. Yet the risk premium implied in the stocks is still too high. The worst for banks is behind us.”
Growth in European bank earnings has so far failed to pick up following the credit crisis. Lenders made up 25 percent of the regional index in 2007 before about 1.5 trillion euros in share value was erased as the industry posted losses of more than 500 billion euros, data compiled by Bloomberg show.
European lenders tumbled a record 64 percent in 2008, more than the Stoxx 600’s 46 percent decline. The region’s banks slumped 12 percent in 2010 and 32 percent the following year as the debt crisis spread. They climbed 23 percent in 2012 and 19 percent last year.
“This time last year we were looking for 30 percent growth in bank earnings and that never happened,” Nick Xanders, an equity strategist at BTIG Ltd., said in an interview from London. “Hope springs eternal, I guess.”
Regulators are drafting measures known as Basel III that require banks to meet debt, liquidity, and capital thresholds to avoid another financial crisis. Leverage ratios are designed to curb reliance on debt by setting a minimum standard for how much capital they must hold as a percentage of assets on their books. The ECB, which takes over as the euro-area’s banking regulator in November, has said it will review the accounts of 124 banks in the 18-nation currency bloc this year to assess whether they hold enough capital.
Stricter capital requirements may restrain bank lending and push them to raise more money, hurting profitability, said Wouter Sturkenboom, who helps oversee $237 billion as investment strategist for Europe, the Middle East and Africa at Russell Investments in London.
“The overhang of regulatory measures and stress tests are all potentially quite negative for their balance sheets,” said Sturkenboom. “It is hard to see what the impact of stress tests will be, not only on profitability but also on their behavior. And if they have to raise capital to fill those holes, they will undermine the outlook for financial markets.”
Even as bond yields in Italy (GBTPGR10) and Spain have retreated from record highs during the crisis, lenders’ bad loans in the euro-area’s third- and fourth-largest economies have increased. Data this month from the Italian Banking Association showed defaults as a proportion of total lending rose to 7.8 percent in November, the highest since October 1999, while the ratio in Spain (GSPG10YR) rose to a record 13.1 percent, the Bank of Spain said.
Deutsche Bank AG’s unexpected fourth-quarter loss last week has sparked concern about the earnings season, according to Dirk Thiels of KBC Asset Management NV. Europe’s biggest investment bank fell the most in 16 months on Jan. 20 after reporting 528 million euros in litigation-related expenses and costs tied to its reorganization. The Frankfurt-based lender cited low interest rates in Europe and declining demand for banking services as headwinds for 2014.
Banks “will be the major swing factor for European earnings this year,” Thiels, who helps oversee about 65 billion euros as head of investment management at KBC Asset Management in Brussels, said by phone on Jan. 21. “What we’ve had so far from Deutsche Bank, although possibly company-specific, suggests banking earnings were not moving in the right direction in the fourth quarter.”
Even after the ECB provided banks with more than 1 trillion euros of cheap loans for up to three years, credit growth in the region remains a problem. Lending to companies and households contracted for a consecutive 19th straight month in November, according to data from the central bank.
That might be changing, as executives have signaled they are more willing to lend. A quarterly survey by the ECB showed in October that banks expected to relax corporate-lending standards, the first such response in more than six years. The central bank will disclose its next euro-area bank lending survey Jan. 30.
Stoxx 600 lenders as a group posted the second-biggest gain among 19 industries this year. Six of the 10 top performers in the lenders’ gauge came from so-called peripheral economies in Southern Europe and Ireland, which bore the worst of the debt crisis. Spain’s Banco Sabadell SA rallied 13 percent, Banco Espirito Santo SA in Portugal jumped 11 percent and Bank of Ireland gained 8.3 percent.
Lloyds Banking Group Plc (LLOY), recipient of the U.K.’s second-largest bailout, and BNP Paribas have added the most value among the 47 companies in the Stoxx 600 bank gauge since June 2012. Lloyds gained 47.5 billion euros, and France’s largest bank added 39.6 billion euros, data compiled by Bloomberg show. Banco Santander SA (SAN), Spain’s biggest bank, has grown by 31.1 billion euros, according to the data.
Analysts estimate profit at Lloyds will increase 44 percent this year to 4.4 billion pounds ($7.3 billion), according to the average projection in a Bloomberg survey. BNP Paribas’s earnings will rise 12 percent, while Santander’s will grow by 38 percent, the estimates show.
The euro-area’s improving economy will help lenders increase revenue and boost assets, according to Peter Garnry at Saxo Bank A/S. Gross domestic product in the region will grow 1 percent this year, based on the median economist forecast in a Bloomberg survey.
The International Monetary Fund said last week that the euro area is “turning the corner” from recession to recovery. Ireland exited a bailout program in December and this month’s debt sale sent the existing 10-year bond yield to the lowest for any benchmark security in almost eight years.
“Banks run with leverage in their balance sheets, so whenever there is a pop in the economy, there is an improvement in their revenues,” said Garnry, head of equity strategy at Saxo Bank in Hellerup, Denmark. “The European economy will recover gradually and as a result, the banks will be able to see more normalized operating profits.”
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