* European bank sees first earnings upgrades in 6 years
* Negative factors that have long weighed on sector ebbing
* German yield curve steepens: : reut.rs/2iY4VjL
* Banks & yields: reut.rs/2iXHcjP
* Europe vs U.S. bank profits: reut.rs/2a27exm
* European bank EPS revisions: reut.rs/2hZS2XS
By Dhara Ranasinghe and Vikram Subhedar
LONDON, Jan 6 Improving economic conditions, a
steeper government bond yield curve and an overall decline in
bad debts suggest 2017 is shaping up as the healthiest year for
Europe's banks in almost a decade.
The brighter outlook for the sector has in recent
weeks prompted the first upgrades to analysts' earnings
forecasts since 2010 while banking stocks, underperformers for
three straight years, have raced to their highest levels since
This marks a sharp contrast to a year ago when concerns
about weak economic growth, the impact of negative interest
rates on bank profits and higher regulatory costs provoked sharp
falls in banking stocks across the region.
The steeper curve, which shows a rise in long-dated bond
yields, is a boon for banks as they make money by borrowing
short-term funds cheaply from central banks and lending them to
clients at higher rates over the longer term. reut.rs/2iY4VjL
"Banks had faced a perfect storm, which was low growth,
concerns around asset quality, low levels of trading volumes,
regulation, negative interest rates and an ever flatter yield
curve that was destroying their net-interest margin," said David
Riley, head of credit strategy at BlueBay Asset Management in
London. "Each of those has now dissipated."
Companies in Europe rely heavily on banks for financing; a
study by the Centre for European Policy Studies, a think tank,
estimates that 77 percent of their funding needs are met by bank
lending. That compares with just 40 percent in the United
States, where firms make greater use of corporate bonds.
On a relative basis, that makes the health of Europe's banks
far more important for the region's companies and wider economy.
Profits at European banks have more than halved since 2008,
while those at U.S. peers have recovered from the crisis that
followed the collapse of Lehman Brothers and hit record highs
last year. reut.rs/2a27exm
Now, better economic growth in Europe along with a healthier
banking system would reverse trends that have plagued the
region's prospects in recent years.
While risks remain, in particular high levels of bad debts
at Italian banks and uncertainty around Britain's exit from the
European Union, the backdrop for the banks as a whole has
Net interest income, a key gauge of bank profitability, is
likely to trough in the first half of the year for European
banks, according to analysts at Morgan Stanley. They rate UBS
of Switzerland, along with Spain's Bankia and
CaixaBank as among their top stock picks in the
"Three Rs - Reflation, Restructuring and Regulations - will
make 2017 a pivotal year," the analysts said in a note to
Steepening government bond yield curves across the globe as
investors bet on higher inflation, economic growth and greater
state spending are also turning into a tailwind for banks.
The curve steepens when the gap between long-and short-dated
yields widens, often reflecting a broadly healthy economy and
The gap between two-year and 10-year yields in Germany, the
euro zone's benchmark issuer, is at 96 basis points - almost
double where it was six months ago.
That spread shares a close relationship with banking stocks
in the euro area. reut.rs/2iXHcjP
Typically, investors demand higher yields for lending to
governments for longer periods to compensate for the greater
inflation and credit risks.
While banks benefit from a rise in long-term yields, the
curves, especially between two- and 10-year debt, have until
recently been the flattest in many years. This was due to
central banks' policies of stimulating economies through buying
bonds and a perception that growth and inflation would stay low
A recognition by central banks that negative interest rates
are harmful to the banking sector and outweigh the benefits of
lower rates has underpinned investors' optimism, analysts say.
The European Central Bank said last month that bonds with
maturities of between 1 and 2 years will be included in its
purchases and that it would buy debt yielding less than its -0.4
percent deposit rate, if necessary. Those measures, targeting
buying at the short-end of the yield, had an immediate
steepening impact on the yield curve.
That followed a more explicit change in policy by the Bank
of Japan in September to target government bond yields.
Nicolas Forest, global head of fixed income at Candriam
Investors Group, sees the hand of ECB President Mario Draghi.
"At the end of the day it is very clear that Draghi wanted
to steepen the yield curve to help the banking sector," Forest
said. "He knows that a negative deposit rate has distortions in
the markets and negative rates are like a taxation for the
banks, so to balance that they decided to remove the yield
(Additional reporting by Andrew MacAskill; editing by David