The author is the founder and chief government of Algebris Investments

In recent weeks, the phrase “Shoot first, ask questions later” has aptly characterized the reactions of US and European banking institutions. As stability begins to return to the financial landscape, an important question arises: should investors consider purchasing shares in UK and European banks? Surprisingly, the answer leans towards a resounding yes. Allow me to delve deeper into this analysis.

The financial markets experienced heightened anxiety following the abrupt closure of three banks in the US, executed by regulatory authorities. Among these, Silicon Valley Bank made a significant and risky bet on rising interest rates, while the other two banks were heavily involved in the volatile world of cryptocurrency. All three institutions operated under a regime of light-touch regulation, which ultimately contributed to their downfall.

In stark contrast, the UK and Europe took valuable lessons from the under-regulation witnessed during the global financial crisis and implemented stricter measures in the years that followed. We can expect a similar pivot from US regulators soon. It’s crucial to note that the risky interest rate strategy employed by SVB would not have been allowed in Europe, where regulations enforce stringent stress tests and higher capital requirements to mitigate such risks. European banks consistently operate well within these safety thresholds, while SVB was substantially overextended.

However, Switzerland has not been immune to the recent financial upheaval. Credit Suisse has faced challenges for several years, recording significant financial losses and previously experiencing a deposit run last year that saw it lose 40% of its deposits. This troubled history set the stage for further complications.

Following the fallout from the SVB crisis, Credit Suisse’s regulator, Finma, compelled the bank to merge with UBS. We believe this could potentially be regarded as the deal of the decade for UBS. The tangible book value of UBS surged by 74% due to this transaction, allowing it to acquire valuable assets in Credit Suisse’s wealth management and Swiss banking divisions. Additionally, the merger includes essential buffers designed to fund cost-cutting measures and restructuring efforts over the next few years.

It’s important to recognize that Credit Suisse was an anomaly among European banks, as it struggled with profitability and relied heavily on an unstable deposit base. While this combination is concerning, it does not reflect the broader European banking landscape, where banks benefit from a substantial proportion of stable household deposits and enjoy high and increasing profitability levels. The liquidity coverage ratio—a metric indicating the amount of easily sellable assets banks hold to meet short-term obligations—stands at 120% in the US, while in Europe, it is a healthier 160%. These figures speak volumes about the relative stability of European banks.

Currently, the majority of the banking sector is enjoying its highest profit levels in the last 15 years. For instance, NatWest has seen its return on tangible equity double, rising from around 9% a year ago to nearly 20%. This trend is easily understandable. The prolonged period of low or negative interest rates over the past decade hindered banks from generating returns on a significant portion of their balance sheets, particularly from deposits. With interest rates now on the rise, both sides of the balance sheet are contributing to profitability, allowing banks to finally achieve returns that meet their cost of equity.

Furthermore, the prospect of capital returns has become an incredibly attractive element in the investment case for European banks. Having spent years bolstering their capital ratios from alarmingly low levels, banks now sit on vast reserves of excess capital, and regulators are increasingly approving substantial capital returns to shareholders.

For the first time in two decades, European banks are reducing their share counts. This combination of low market capitalizations and generous capital return policies has led to payout yields—including dividends and share buybacks—that can reach nearly 20% for major banks such as BNP, NatWest, ING, and UniCredit. It is evident that the market has been fixated on the historical performance of the last decade, rather than the promising outlook ahead.

Historically, avoiding UK and European bank equities from just before the global financial crisis of 2007-08 until the end of 2020 was generally wise. During this period, the European bank index underperformed significantly due to the dual challenges of capital inadequacy and negative interest rates.

However, just as it was prudent to steer clear of the sector when interest rates were at their lowest and banks required extensive restructuring, investors must now recognize the remarkable transformations that have taken place. Current capital ratios are demonstrably higher than pre-crisis levels and are notably superior to those of US counterparts. European banks now boast the strongest liquidity profiles in recent years and are actively repurchasing record amounts of shares.

With dividend yields hovering around 7% and additional buyback initiatives in place, these shares are trading at their lowest relative levels compared to broader markets in the past 15 years. It appears that banks are now positioned to outperform expectations, even as some market participants simplistically label them as uninvestable.

Algebris is an investor in financial securities