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The countries of Portugal, Ireland, Italy, Greece and Spain were once known by the ignoble acronym Piigs when, in their collective turmoil, their government debts and bad loans in their banking systems threatened the future of the euro.
Now, after a long period of state-backed cleanup, the situation has changed: In banking, at least, Europe’s periphery may be in a better position than its centre, with banks once considered out of reach for investors suddenly becoming popular again.
The allure is a combination of low valuations, strong economic growth and high interest rate sensitivity. These factors are driving the outperformance. The total return of the banking sector index across all five countries is at least 100% from 2022 onwards. The comparable return for all euro area banks is just 60%. Investors are beginning to accept the idea that the once unimaginable days of low single-digit returns on capital for European banks are largely a thing of the past.
Indeed, when interest rates are rising, periphery banks tend to do better due to their higher share of floating-rate loans: Italy and Spain’s return on tangible equity averages 13% in 2022 and 2023, compared with 9% in France and Germany. Periphery banks are also more gradual in passing on interest rates to depositors, helping to boost margins.
But valuations aren’t very high: While most European bank share prices have risen, they still lag far behind earnings growth, and forward earnings multiples of six to seven remain close to crisis levels. This is despite the fact that returns on tangible equity are expected to remain high through at least the end of 2026.
As interest rates start to fall, German and French banks’ profits should rise, as interest margins typically benefit from higher fixed-rate loans already on their books and lower deposit rates at that point in the cycle.
But this may also be the time when cleaner loan books from peripheral countries come into their own. Government support has kept loan losses low across Europe since 2020. That could change quickly in the Nordics amid slowing economic growth, rising private sector debt levels and rumors of a struggling commercial real estate market. UBS’s Jason Napier argues that tougher lending standards and weaker borrowing demand could limit loan losses during an economic slowdown.
That may be one reason to take a contrarian view: Lower-rated banks in peripheral Europe could continue to thrive even as interest rates start to fall.
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