Barclays analyzes why European banks are able to withstand macroeconomic uncertainties

Investing.com - According to a research note published by Barclays on Wednesday, the earnings risk for European banks from the stagflation fallout triggered by the conflict in the Middle East is limited, as higher interest rates are expected to offset continually rising loan loss figures.

According to Barclays research, the SX7P index is down 14% year to date this year, down 9% since the conflict broke out on Feb. 28. The forward price-to-earnings multiple has fallen from 11.2x on Jan. 1 to 9.6x on Apr. 2.

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Despite the selloff, Barclays still maintains a positive view of the sector, saying the earnings data remains within manageable bounds.

The report says that a cumulative 50-basis-point increase in interest rates would lift banks’ average profit before tax by about 3% in the first year, while a 10% increase in loan loss reserves would only reduce average profit before tax by about 1%.

Barclays calculates that reserves would need to rise by 30% to 40% to fully offset the earnings impact from the 50-basis-point rate increase.

Barclays said that in its base-case scenario, factoring in a 50-basis-point rise in rates, a 1% decline in loan growth, a 2% drop in fee income, a 1% increase in costs, and a 30% increase in reserves, the median banks’ profit before tax would fall by about 5%.

In a more severe scenario, if reserves double and business volumes weaken materially, the impact could widen to a 14% decline.

Barclays economists expect the European Central Bank to deliver two 25-basis-point rate hikes in April and June, lifting the deposit rate to 2.5% and holding it at that level through end-2027. The report says that even in the ECB’s severe scenario, assuming an oil price of $145 per barrel and a natural gas price of €106 per megawatt-hour, the euro area would still record 0.4% annual GDP growth in 2026, and 0.9% in 2027.

Shareholder returns provide additional cushioning. Barclays estimates that European banks’ median will deliver 26% cumulative returns in 2026-2028, including about a 6% annual dividend yield and a 2% annual stock buyback yield.

On private credit, which it views as the top concern, Barclays says European banks’ direct exposure is about 1% of the loan book, mainly concentrated in large investment banks.

Deutsche Bank’s private credit investment portfolio is €25.9 billion, about 43% of tangible book value, the highest among the covered banks. Barclays cites company disclosures saying that Santander’s exposure is less than 1% of total loans.

On allocation, Barclays outlines two scenarios. In a defensive upgrade scenario, it says AIB, Bank of Ireland, DNB, Danske Bank, CaixaBank, and Bank of the Netherlands are the most resilient, citing retail orientation, sensitivity to interest rates, and a low burden of sovereign debt.

In a downgrade, risk-on scenario, it believes Societe Generale, Bank of the Netherlands, United Credit Group, and Santander offer the strongest potential rebound because their valuations have fallen sharply.

Barclays says Deutsche Bank is the biggest decliner among the covered stocks, down 22% year to date based on the forward price-to-earnings multiple. Next is Erste Group, down 15%, while UBS Group, United Credit Group, and Standard Chartered Bank are each down by about 13%.

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