Algebris Financial Equity Fund

FY24 reporting season is well under way for European Banks and so far, the key themes have been reassuringly familiar. First, 4Q profits have typically exceeded expectations, landing >5% above consensus. The quality of the results has also been good with the overwhelming majority of names reporting NII ahead of expectations, demonstrating that banks are so far successfully managing the reduction in interest rates better than expected. Meanwhile there has been no meaningful change of trend in asset quality with provision/NPL rates remaining extremely benign.

Secondly, management guidance for 2025 has also typically been reiterated or upgraded, and again has typically landed above the prevailing consensus. That has supported positive upward revisions in earnings expectations with sector consensus forward EPS now up a further 1% YTD (vs broader market modestly lower).

Finally, alongside the supportive fundamentals, nascent signs of a valuation re-rating are coming through – the sector has made a fast start to 2025, rallying c.15% YTD. Nevertheless, the prevailing 2026 P/E of c.7.5x, still offers 30-40% upside to the long run average. As the rate cutting cycle continues towards 2%, we do expect individual bank earnings performance to increasingly diverge over time, but at a high level we continue to see good value in the European bank space. The sector is forecasted to deliver mid-teen tangible book value per share growth over the next two years with a similar contribution on top from dividends – that leads to >25% ‘in-built’ value creation before the aforementioned re-rating opportunity.

2024 was another strong year for the fund, with ~450 bps of alpha and very strong absolute returns as well. This represents the fourth year in a row of alpha generation of at least 400 bps, in what has been a volatile backdrop with sharply divergent market landscapes to navigate (post Covid recovery bounce in 2021, equity/bond market declines in 2022, bank failures and take-unders in 2023, and political volatility of 2024). Our aim as always remains to navigate whatever the market has to offer, with an intense focus on absolute return and maintaining flexibility in what is a highly mean-reverting and volatile sector. As we assess the always-evolving Financial sector landscape at the outset of another year, we continue to see highly compelling and asymmetric risk reward opportunities across European banks and US life insurance. Intriguingly, US banks are becoming increasingly attractive as well.

Briefly in terms of fund performance in 2024, it is notable that every subsector contributed positively, though banks generated the lion share (~2/3) of performance. Insurance was the other key positive contributor, at just under 20% of total performance. Geographically, Europe and the US were the largest drivers, consistent with our exposure throughout the year. By name, just three holdings cost the fund more than 15 bps in 2024, while 27 holdings contributed at least 50 bps of positive PNL. Top individual contributors were Barclays, Standard Chartered, Equitable, Unicredit, Santander, Direct Line, Beazley, and Carlyle – representing a diversified mix of our key bets across banks, insurance, and diversified financials.

Looking forward, the key active and absolute bet in the portfolio continues to be in European banks. We are highly constructive on the space as valuations remain very compelling and capital returns over the next 2-3 years will be enormous. As we have discussed extensively, even after an excellent few years for European bank stocks, they are only back to 2017 levels in absolute and valuations are stuck at prior trough levels (~6.5x forward earnings). We believe bank profitability in Europe will prove to be much more resilient than expected, which should ultimately drive a powerful re-rating in the sector. Just to go back to historical ~10x valuations would represent significant upside from current levels. Robust growth in dividends and tangible book value per share – both of which were largely absent in the past decade – should underpin continued strength in shares even in what will inevitably be a volatile macro and geopolitical backdrop in the next 12-24 months.

Another notable shift in portfolio positioning this past year is our increased exposure to Insurance, which was ~15% at the end of 2023 and now sits just above 25%. This is due primarily to our holdings across US life insurance, a space we are extremely bullish on given robust balance sheets, strong free cash flow yields, and business models that will benefit from higher rates and steeper yield curves. We have also stepped up exposure to non-life insurance in the UK as profitability has been significantly enhanced by harder markets of recent years, with capital return now likely to feature prominently. M&A is also likely to continue to feature in both subsectors in the next 12-18 months, for which we are well positioned. Where we have been most tactical over the last couple of years has been US banks, as the space has been tremendously volatile in the backdrop of the Fed hiking cycle, bank failures, regulatory changes, and most recently election uncertainty.  After a strong November which saw large and small US banks gain 13% and 15%, respectively in the wake of the US elections, a large portion of those gains reversed in December with many bank stocks now below their pre-election levels. As we wrote about in last month’s commentary, we utilized the strong initial rally to reduce our US bank exposure. But in recent weeks we have taken advantage of the dramatic weakness to rotate into names in which the outlook has become more favourable amidst the sell-off and resulting deratings. The materially steeper yield curve (the key spread between 3-month and 5-year rates steepened by over 100 basis points in 4Q24, turning positive for the first time since 2022) is supportive of the fixed asset-yield repricing dynamic which will serve as a powerful tailwind for bank net interest income growth over the medium-term. This is a sharp reversal of a major earnings headwind over the past 18-24 months. Additionally, the easing regulatory environment should lead to notably increased capital return compared to prior years. Indeed, in early January, the Fed’s Vice Chair for Supervision Michael Barr stepped down from his supervisory post; Barr was a key proponent of more stringent capital requirements. With his resignation – which was unexpected – the outlook for the Basel III Endgame proposal is likely even more favourable for the banks now, both in terms of substance and timing. Lastly, we have also invested in several banks undergoing accretive transactions such as acquisitions or securities restructurings. We certainly expect we will have more opportunities to deploy capital into similar situations, which tend to come at very attractive discounts for new investors.

In November, US banks rallied strongly in the wake of a presidential victory by Donald Trump and a Congressional sweep by Republicans. Large and small banks finished the month up 13% and 14%, respectively, while the S&P 500 advanced about 6%. Notably, post a surge on the day following the election, large banks were up just another 2%, which was in-line with the overall market, while small banks were flat. As we have written previously, there are numerous potential tailwinds for US banks under a Trump administration; these include a more favorable regulatory environment, increased M&A activity, higher levels of capital return, stronger loan growth alongside economic expansion, and a steeper yield curve. However, the size and speed of the rally, and resulting P/E expansion to levels above historical long-term averages, clearly has embedded at least some of these potential catalysts. Furthermore, it is important to compare these levers to current estimates in gauging further potential upside. Regarding loan growth, for example, consensus already expects roughly 4% growth in each of the next two years which would be a notable acceleration from the flattish growth the banks have been putting up over the last 18 months. Interestingly, post Trump’s first win in November 2016, annual loan growth of the big banks slowed from prior years – 6% in 2014, 8% in 2015, and over 6% in 2016 – to less than 4% in 2017; while there were other dynamics at play, such as rates coming off of the zero bound at that time, it is not a foregone conclusion that Trump’s policies will stimulate outsized growth. In terms of the impact of a new regulatory regime, it is quite plausible that new personnel will lead to a finalized Basel III Endgame that is capital neutral to the group overall (though the GSIBs are likely to see some increase). This would be welcome news given banks would have more flexibility to lend and return excess capital via buybacks; however, consensus is already calling for many large banks to increase payout ratios to near 100% and retire 5-10% or more of shares by the end of 2026 (not to mention that valuations are at levels deemed unattractive for buybacks by some such as Jamie Dimon at JPMorgan). A steeper curve would certainly be beneficial to most banks all else equal, especially after the earnings pain caused by the lengthy inversion of the last two years. Here too, though, estimates are already reflecting at least some of this benefit, especially those most positively geared to a steeper curve. For instance, numerous banks are expected to see 15-20% expansion in the run-rate of their quarterly net interest income by 4Q26 vs. current levels (with small banks even higher). Lastly, cost of risk is expected to stay benign with 2025 in-line with 2024 levels before improving from those already low levels in 2026. 

To be clear, we are not suggesting that the expected catalysts under Trump will not play out, and that may not be further upside estimates and the stocks. To that point, we continue to own shares in banks that we believe are positioned well, both for idiosyncratic reasons and also relative to the likely environment under this administration. Additionally, M&A activity is likely to pick up, and indeed there already has been an increased pace of smaller deals. We expect that owning well-positioned strong buyers will be a sound strategy this cycle, and we are also focused on owning small banks with valuable deposit franchises. Overall, however, we believe some caution is warranted after this rally and have rotated some of the fund to segments offering more clear value such as US life insurance.

For all the talk about US M&A surging post the election, we have yet to see much in the way of meaningful transactions yet – except in Europe, where deal activity has truly taken off. Following the activity from BBVA and UniCredit in Spain and Germany respectively, November brought more action in European financials M&A with UniCredit placing a bid on domestic peer Banco BPM, and then in the UK, Aviva placed no fewer than three bids in a week to force the hand of the board at Direct Line. We are shareholders of both targets, and think UniCredit will have to similarly up its bid but expect this to play out over the next several months. Direct Line was perhaps the more notable deal as unlike the bank deals, Aviva is paying a very meaningful premium (over 70%), and yet the acquiring stock is still performing fine (roughly flat since announcement). The market is clearly in favor of the deal for Aviva, viewing it as a sensible strategic and financial transaction that should provide significant earnings accretion. We would be quite surprised if there were not similar deals in the insurance space, particularly in the small/midcap arena where we have concentrated our exposures.