European Banks – could now be the right time to invest? 

For those seeking investment opportunities in European Banks, Carraighill is in a unique position to help you navigate the risks and identify the companies best positioned as the ECB raises rates. In our last post, A Bloc in a Hard Place – The ECB’s Dilemma, we wrote about the challenges the ECB faces in raising rates. Here we look at how a tightening of monetary policy and other factors will influence the banks.  

In the current rising interest rate environment, there is a debate around the opportunities in European banks, with bulls seeing an optimum time to invest while bears are foreboding several risks that may limit returns. With the broader equity market down significantly year-to-date, and investors grappling with what to do next, the financials sector is in the spotlight for the first time in many years.  

We believe that there are significant investment opportunities in the European banking sector but also several risk factors that investors need to pay particular attention to.  

Since Carraighill was founded in 2013, the core of our business has been focused on understanding, in enormous detail, the environment within which European financials companies operate. This, in turn, influences our assessment of the prospects of these companies in the coming years. One key factor in this environment is the direction of interest rates.  

In July, the European Central Bank raised interest rates by 50bps, the first time they have raised rates in 11 years. Markets are now pricing in a further 50bps at the next two ECB meetings.  

Put simply, banks are one of the few sectors that benefit from higher interest rates as margins increase. In the Eurozone, where rates have been in negative territory for so long, this looks like an opportunity that investors in the sector have not seen since well before the Global Financial Crisis.  

We are already witnessing back book loan and bond rates rising in most regions. The front-back book loan rate differential has reversed in most regions. This is important as it should drive higher incremental interest income on new loans and banks’ holdings of government bonds. 

What we are now witnessing is a reversal of a near 15-year trend. This is important. 

However, alongside rates, other factors also influence the outlook for European banks. While rising rates are a positive, they can be less so for other sectors of the economy. This increases the risk of a provision cycle and other factors, including: 

  • Political risk (rising as consumers become fed up with higher costs and politicians seek to capture any incremental gains from companies) 
  • Recession risk (companies/households default probability will rise) 
  • Bond market fragmentation (unique to Europe) 
  • Inflation and cost pressures (higher wages for staff) 

All of these are modelled with the data and followed in exceptional detail. To date, we have been somewhat sanguine about an early-stage provision cycle. Why? 

  • Full employment  
  • High household and corporate savings balances (net worth rose significantly during COVID-19) 
  • Governments subsidies to assist with energy costs 

At Carraighill, we have seen many highly rated European bank analysts in our team come and go without ever seeing a change in ECB interest rates. The opportunity in the sector is one we have not seen in over a decade. Being aware of change, assessing all the risks, and choosing the right companies is important.  

We have developed a product set to do this.  

Our monthly reports allow us and our clients to evaluate all the factors influencing banks across the region – positively and negatively. This has put us in a unique position to identify the companies that offer the most upside in this rising rate environment and avoid those where risks either at the macro or company level are too great.  

Examples include limiting our investments where there is political tax risk and favouring banks with expense programmes in place to counter cost pressures. 

For investors looking to deploy capital to the sector, get in touch to discuss how we can help identify the best investment opportunities.  

Regular Carraighill European banks offering: 

  • European Banks Analysis: Our latest thoughts and fundamental forecasts  
  • Eurozone Banking System: Top-line Drivers 
  • UK Banking System: Top-line Drivers 
  • European Asset Management: Revenue Drivers 
  • Global Inflation and Rates 
  • Food, Energy, and Rates  
  • ECB: Regular updates on ECB policy  
  • Ad hoc updates – Examples include looking at gas, bond exposures, rising net worth, and insights from other sectors we follow.  

If you would like to access our work, Carraighill Research Access enables you to access these and other thematic and sectoral research through our secure online portal. If you would like to speak to a partner or analyst on the topics raised in this piece, you can contact us here.