After roughly eight years of negative real interest rates, the European Central Bank (ECB) is preparing to raise its benchmark interest rate, known as the minimum bid rate, for the first time in 11 years amid sky-high inflation in the region. The ECB recently said it is preparing to increase its minimum bid rate by 25 basis points (0.25%) in July and then perhaps make a larger move in September. The ECB also recently said that in July it planned to end its bond-buying program to inject liquidity into the European economy. The broader market expects the ECB will raise rates by roughly 135 basis points by the end of 2022.
Bank stocks typically benefit from rising rates. European banks have been in a rate-starved environment since the Great Recession, taking much more of a beating than U.S. bank stocks over the past decade. Here are three European bank stocks to buy that should greatly benefit when the ECB raises interest rates.
1. Deutsche Bank
The largest bank in Germany, Deutsche Bank (DB -0.12%), has more than $1.4 trillion in assets and operates in the investment banking, private banking, and asset-management markets. The bank has had more than its fair share of regulatory headaches but is a very large benefactor of rising interest rates.
Image source: Deutsche Bank.
As you can see, the bank projected at the end of the first quarter of this year that a 1% rise in both short- and long-term rates would result in 400 million euros more in group net interest income (NII), which is the profits banks make on loans, securities, and cash after funding those assets. In year two, the benefit is 1 billion euros of NII. By 2025, management said the benefit could be as much as 2 billion euros. Deutsche Bank generated nearly 11.2 billion euros of NII in 2021, meaning the benefit to NII could be as much as 18%. Keep in mind that the ECB could very well raise rates by more than 1% by the end of 2022.
Additionally, Deutsche Bank's trading operations should benefit immensely in the current quarter and the rest of the year as market volatility persists. Most European banks trade at a discount to their tangible book value (TBV), or net worth, and Deutsche Bank trades at a very significant discount of about 30% to TBV, presenting an attractive risk-reward proposition.
2. Commerzbank
Commerzbank (CRZB.Y 0.42%) is another German lender and has roughly $550 billion of assets at the end of the first quarter of this year. The bank specializes in small-business lending and corporate banking. In 2021, Commerzbank generated more than 4.5 billion euros of NII. Similar to Deutsche Bank, it will benefit tremendously from rising interest rates. In 2023, Commerzbank expects to realize roughly 700 million euros more in NII compared to 2021 and then 1 billion euros more in 2024.
While the bank has exposure to Russia, management has done a good job of reducing that liability by 36% since February and has provisioned enough capital to cover roughly half of that position, which management described as "short term and well contained" on its recent earnings call.
Commerzbank, which is still partially owned by the German government after being bailed out during the Great Recession, has been conducting a significant restructuring effort that includes plans to cut one-third of its jobs in Germany and close half of its branches by 2024. The bank recently raised its forecast and now expects to generate a 7% return on tangible equity by 2024. That would be dismal for a large American bank, but then again, most U.S. banks don't trade at a discount like Commerzbank, which currently goes for just 32% of its TBV.
3. Bank of Ireland
Although it's one of the largest banks in Ireland, the Bank of Ireland (BKRI.F -0.90%) is a good deal smaller than Deutsche Bank and Commerzbank, holding roughly 155 billion euros of total assets. Irish banks don't necessarily get as much coverage as other large banks, but they actually collect much more revenue than your standard large bank from interest income, which generally makes them large beneficiaries of rising interest rates. In 2021, Bank of Ireland made roughly 75% of its revenue from NII.
A 0.25% hike in interest rates by the ECB, the Bank of England, and the Federal Reserve would boost the bank's NII by 60 million euros on an annualized basis. If rates go up by 1%, that would be a 240 million euro benefit. With NII at roughly 2.2 billion euros in 2021, that would mean close to an 11% benefit. Additionally, management is targeting a sustainable 10% return on tangible equity, and the bank trades at less than 60% of its TBV.
