Equity Research Note on EU Bank Valuations and ECB Rate Outlook

attractive valuations of EU banks vs. US peers (EU banks on 12.0x 2017E P/E vs. US Banks on ~14x and some EU banks still on a large discount vs 10-year historical median P/B valuations). What the EU banks bears are saying: EU macro declining, US lead re-flation trade cooling (tax, deregulation, healthcare headwinds) and toppy multiples/high ownership of EU banks going into Qi results. They believe the pressure will be off Draghi to act on the deposit rate if the macro starts to reverse which may cause people to push back the assumed timing of European rate hikes and tapering. The French election is also a big risk factor which is clearly holding back some global investors from buying into Europe. Consensus has started to factor in the higher rate outlook in Europe. The bears are pointing out that these probabilities have fallen a lot this week while the bulls argue it’s just a matter of timing. I monitor market expectations for ECB normalisation in rates using the World Interest Rate Probability (WIRP) function on Bloomberg. It’s been very volatile recently. I currently see the market is pricing a 16.6% probability of a EUR rate hike before the end of 2017 (row 6, column 2 below). a 32.7% probability in the next 12 months (row 9, column 2) and a 67.6% probability in the next 18 months. ) Future Implied Probability ent Implied Probabilities Meeting Prob Of Hike Prob of Cut -0.6 e Historical Analysis for Meeting As a reminder our research team estimate that euro area banks could see as much as €26bn in earnings uplift from a return of ECB rates to zero. This would represent a 25% uplift to profits - a big prize when it happens (click here for report). We remain positive on banks that can make acceptable returns in the current environment and are geared into the upside when rates begin to recover... ING, KBC, Intesa, Unicredit, SocGen, Erste, BKIR are all Buy rated. Top picks: Buy Soc Gen, PO €55 ° Still fourth worst performer in the SX7E YTD due to French election overhang. ° Yet reported a strong set of Q4 results, beating on P&L, capital and dividend which comforts our view that the stock is set for re-rating. ° Continues to tick a number of boxes offering a dividend yield of 5.1% in 2017E, an attractive valuation of 0.79x 2017e TNAV, solid capital position and has strong EPS momentum. ° Our EPS (2017 and 2018) is 10% above consensus with further upside from CIB, Russia recovery and Corporate Center ° Stronger capital position allows for growth (organic and bolt-on M&A) Buy Intesa, PO €2.80 ° On NPEs, capital, profitability, operating trends, and cash payouts, Intesa stands above other Italian banks in our view. HOUSE_OVERSIGHT_014862