European banks stocks have outperformed their global peers so far in 2023, with investors seeing reasons to be positive going forward.

The S&P Europe BMI Banks index has risen 13% since the end of 2022, compared to declines for the S&P US BMI Banks and S&P Pan Asia BMI Banks indexes. It has also outperformed the S&P 500 Energy and S&P 500 Health Care indexes, although it has underperformed the S&P 500 Information Technology index.

Many European banks are geared to book higher net interest income in 2023, and for some, the figure could be even higher in 2024. Many have also announced large shareholder payouts through dividends and buybacks.

Tailwinds prevail

Investors expecting a large dividend over the coming two years are going to behave differently, Peter Doherty, head of investment research at UK-based Arbuthnot Latham, told S&P Global Market Intelligence.

"You're going to be much more willing to hold that stock [and] wait to realize those gains than you might have been previously when there was zero outlook for those sorts of returns from European stocks," Doherty said.

There are "more tailwinds than headwinds" for European banks, Doherty said.

"The net interest margin is much more attractive, and that side of it makes it a very attractive proposition," James Beaumont, the head of Natixis Investment Managers Solutions, a multi-asset manager which invests via funds, told Market Intelligence.

A sample of 25 big European banks showed that 23 are set to record year-over-year increases in net interest income in 2023, according to analyst estimates compiled by Market Intelligence. Fifteen are expected to generate even more NII in 2024. Net interest income is the difference between interest revenues and interest expenses.

European versus US banks

Natixis Investment Managers is neutral on financials, having downgraded its position from overweight following the market fallout stemming from the collapse of US-based Silicon Valley Bank in March. However, it remains "very interested" in the European banking sector, Beaumont said.

The government-orchestrated rescue of Credit Suisse Group AG by UBS Group AG was down to idiosyncratic problems at the former and did not represent a systemic problem, Beaumont said. At the same time, European banks remain cheap versus US peers on price-to-earnings and price-to-book relative perspectives.

The median price-to-book ratio of the top 20 European banks by market capitalization, excluding Russia and Ukraine, was 0.82% as of July 10, according to Market Intelligence data. This remains below the 0.99% median ratio of their US counterparts.

Still, questions remain as to whether European bank stocks represent a value trap, Beaumont said. Interest rates are getting to the point where they could lead to customer defaults and put pressure on loan books, especially at banks with big real estate loan books, Beaumont said. The European Central Bank hiked its deposit rate to 3.5% in June, with President Christine Lagarde saying another hike in July is likely. The Bank of England increased rates by 50 basis points in June.

European banks are valued relatively low, in spite of many "Buy" recommendations from sell-side analysts, according to Sam Theodore, senior consultant at Scope Insights. Institutional investors see several reasons for this, including a difficult macro environment, insufficient profitability, an expected worsening of asset quality and a fragmented sector compared with the US, Theodore wrote in a July 10 report.

Europe's banks are trading broadly in line with, or perhaps slightly above, where price-to-book valuations should be, Arbuthnot Latham's Doherty said.

Still, they are being viewed more favorably than US peers, particularly US regional banks, partly due to stringent capital strengthening over the past decade, Doherty said. "They've already undergone a lot of the work ... to make themselves quite defensive in general, and so [they] should be relatively able to weather economic downturns."

– Access Index Summary on S&P Capital IQ Pro. – Access S&P Europe BMI Banks index on S&P Capital IQ Pro.