Bank stocks get another look as climate improves

London - European banking shares, shunned by investors after the lenders accrued a spate of expensive fines and were hit by restrictive new regulation, are attracting interest again as the outlook for lending improves and valuations look to be bottoming out.

The sector has underperformed the broader European stock market since late last year, despite the introduction of an unprecedented bond-buying scheme from the European Central Bank in January that had been expected to boost bank stocks as the scheme's positive impact trickled through to the wider economy.

But Spain's Banco Sabadell prompted a rush to reconsider on Friday, when it posted a 75% jump in annual profit. The country's banks have all seen their performance boosted by better domestic economic conditions and a fall in bad debt.

Banco Sabadell's shares jumped 6%.

Trading revenues from other banks, including some of the world's biggest banks, have also been encouraging.

Morgan Stanley and Goldman Sachs said revenue rose 15% and 10% respectively year on year, boding well for next week's slew of earnings reports from large European lenders like Banco Santander.

Analysts said they expected the broader business environment to improve across Europe for banks.

Citi said in a report this month that the ECB programme had started to lift demand for loans - something that could help banks to catch up with other beneficiaries of the ECB's stimulus programme, such as carmakers, which have seen their performance and their shares rally sharply with the falling euro.

Elsewhere, Barclays published research showing that European banks are now at their cheapest ratio relative to other sectors since 2012. Many, like Sabadell, are also trading at a discount to their 10-year average price-to-book ratio.

"In terms of relative valuation, they're back at the levels of cheapness not seen since before Draghi promised to do "whatever it takes" to save the euro," Dennis Jose, European equity strategist at Barclays, said.

"While other sectors have raced ahead, banks look incredibly good value."

Not risk-free

Another cloud on investors' banking horizon has lifted as fears about the impact of a possible Greek exit from the eurozone abate.

Not only have banks have cut their Greek exposure, but they are further protected from events there because safeguards relating to financial stability have been put in place.

Now other institutions are expected to pick up the tab instead.

"In terms of who is on the hook for the debt, it's not investors any more, it's the likes of the ECB and Germany," James Butterfill, global equity strategist at Coutts, said.

"The last time Greece reared its ugly head in 2012 it had a big impact on earnings and on the markets. This time it's not at all, and I think that will continue to be the case."

That does not mean however that banks are seen as risk-free.

Regulatory pressure on the sector shows little sign of abating after Deutsche Bank was fined $2.5bn on Thursday. It settled allegations of rigging interest rate benchmarks.

And HSBC, one of the most vocal critics of the new regulations and additional taxes imposed on British banks in the wake of the financial crisis, said on Friday it was considering moving back to its former home in Hong Kong.

"I don't see pressure from the regulators coming off. That's just the world that we live in... Sentiment towards the whole sector is muted, and has been for some time," said Neil Wilkinson, European fund manager at Royal London Asset Management.

But he added that he was nevertheless less negative on the sector than on others.

"We are overweight relative to our peers which have remained steadfastly underweight over recent years... We see some evidence of credit demand growth in recent months."

In light of all of the above, some fund managers are now considering reducing their "underweight" positions.

"Maybe it is time for a bit of a reappraisal," said Andrew Parry, head of equities, Hermes Investment Management, who is "underweight" on the sector.

"Once banks have become very dull and people have given up on them, that's probably when people should take another look.