Morgan Stanley has adopted a more cautious stance on European banks following its annual financials conference, warning that geopolitical uncertainty around the Middle East conflict is likely to weigh on sector valuations even as underlying earnings remain resilient.
The US investment bank upgraded Santander to 'overweight' and named it a top pick, while downgrading ING Groep to 'equal-weight' and removing Societe Generale from its top picks list.
Its UK-focused top picks remain Barclays PLC (LSE:BARC) and Lloyds Banking Group PLC (LSE:LLOY), both rated 'overweight', alongside ABN AMRO and UniCredit.
The bank's analysts argued that pre-provision operating profit across the sector should hold up, supported by higher savings rates, better deposit flows and interest rates now expected to rise to 2.5% by year-end, above previous forecasts.
Spain and Ireland were highlighted as the biggest beneficiaries of the rate environment, given their sensitivity and economic resilience.
On asset quality, Morgan Stanley warned that banks with heavy corporate loan books could face pressure to top up provisions under IFRS 9 accounting rules as early as the first quarter, particularly if the Strait of Hormuz disruption to oil supply persists.
UK-focused banks delivered a broadly constructive message at the conference.
Lloyds' chief executive, Charlie Nunn, pointed to the structural hedge as a reliable tailwind for net interest income through the end of the decade, with £1.5 billion of incremental income expected this year and a further £1 billion in 2027.
Barclays described its first quarter as positive and said current market volatility was supportive for its markets business.
NatWest chief executive Paul Thwaite highlighted the rationale behind the Evelyn Partners acquisition, which he described as creating the UK's largest private banking and wealth management business, with £100 million of cost synergies targeted.
HSBC said its Middle East exposure remains manageable at roughly 5% of group profit before tax and around 2% of loans, and reiterated full-year guidance.
Morgan Stanley said European banks are trading at around 8 times 2027 earnings, which it views as cheap in absolute terms, but noted that during the Russia-Ukraine conflict, the sector de-rated to 6 to 6.5 times.
It cautioned that a meaningful re-rating is unlikely until there is greater clarity on the Middle East situation or a credible policy response.
The bank said private credit risk across European lenders is manageable, with aggregate exposure at roughly 2% of corporate loan books compared with around 5% in the US.