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Key heavyweight lenders in Spain, Italy and Greece are due a share price revival after being oversold when they were tarred by the same brush as sovereign debt issued by those countries, according to fund managers.
Well-funded and internationally focused banks such as Banco Santander and BBVA have been hit hard by a peripheral euro zone debt crisis but, with the European Central Bank acting as backstop, the mood could turn.
"The larger banks like Banco Santander and Intesa Sanpaolo are very well funded, valuations are below book value and there are opportunities emerging," David Moss, director of European Equities at fund manager F&C Investments, said.
"They are pretty high-quality banks but have been tainted by the fact they have been listed in Spain and Italy. There is scope for some of them to outperform core European banks."
Banking sector investor jitters have arisen since Ireland was forced to accept a European Union and International Monetary Fund bailout, with fears Portugal or Spain could be next.
Fund flows into euro zone peripheral debt and stocks are picking up as investors bet against default, after the euro zone core pledged to support the periphery. Tightening spreads are adding weight to any banking uptick.
European officials are reportedly considering plans to overhaul the euro zone's 440 bln euro ($580.4 bln) rescue fund and use it to buy the bonds of distressed governments.
"How bonds perform is a strong indicator on how investors view equities. Proactive action by the ECB in its continuing purchase of peripheral bonds is helping soothe the market, and if bond spreads tighten the winners will be banking stocks," Matthew Brown, trader at Catalyst Markets, said.
"Banking stocks could outperform other sectors, as fears over the future of peripheral bonds begin to wane. Banks based in peripheral countries will certainly strengthen if the outlook for the financial health of the EU brightens."
Other winners could include National Bank of Greece (NBG). Its Tier 1 capital ratio could be boosted above 15% after the sale of Finansbank in early 2011.
As that takes it above the 7% requirement of Basel III, a tougher set of global bank capital rules being introduced in 2013, it should weather any fresh lurches in the debt crisis.
BBVA also has a buffer, with a Tier 1 capital adequacy ratio at 9.2%, and is in the Royal London Asset Management European Income fund portfolio due to its capital raising. Its latest November rights issue was 4.2 times oversubscribed.
Those buffers are visible elsewhere as the Greek and Spanish banking systems become less dependent on the ECB for funding.
ON THE MEND
Spanish bank borrowing from the ECB fell to its lowest level in more than a year in October, while Greek bank borrowing was down 2% month on month, suggesting both financial systems are on the mend.
Such a trend has prompted a number of positive broker notes, with NBG, and Spanish duo BBVA and Banco Santander, in favour.
Attractive valuations will also lure investors, analysts said. NBG's one-year forward price-to-earnings ratio is 6.5 compared with the FTSE Greek Bank index 10-year average of 11.8, Thomson Reuters Datastream showed.
That trend is also evident in BBVA and Banco Santander's one-year forward P/E ratios of 6.7 and 7.2 respectively, against the FTSE Spanish Banks index's 10-year average of 11.4.
"Banks with high exposure to retail — where the margins are higher — and investment banking, that are exposed to emerging economies and have a tight grip on costs will be the winners," Heino Ruland, strategist at Ruland Research in Frankfurt, said.
The banking system in Italy, perceived by some to be the soft underbelly of core Europe, was also hit by sovereign debt risk aversion, but initial fears have been misplaced, analysts said.
Intesa Sanpaolo, for example, has a solid capital base as well as predictable earnings, they added, with a one-year forward P/E ratio of 8.9 compared with the FTSE Italian Banks index's 10-year average of 11.9.
"We think the market has got it a little bit wrong here and banks have been oversold," Ian Scott, European strategist at Nomura, said. "Italian bank lending growth is among the strongest in developed economies. There is demand for loans."
Datastream figures showed bank lending rose to 2.44 bln euros in September from 2.42 bln euros in August, while lending in Germany was little changed between the second and third quarters.
The improved outlook for banks such as Banco Santander is in sharp contrast to the outlook for certain banks in the euro zone core, many of which have not been sold off to the same extent. German lender Commerzbank, for example, has heavy exposure to the peripheral region and its shares are 0.8% higher this year, against a 28.1% drop for Santander and 53.8% slump at NBG.
Commerzbank's one-year forward P/E ratio is also a more healthy 10.07.
French banks, which have high exposure to Greece and Spain, have also fallen less. Shares in BNP Paribas and Societe Generale are down 7.3 and 15.8%, respectively.
