Opportunities in European Banks
Opportunities in European Banks
In a year when global markets were influenced at various times by a range of macro factors such as politics, policy, growth and oil, stock-specific drivers allowed those companies who were able to focus on and overcome their own business challenges to outperform.
“Focus on Change” investment philosophy
With a bottom up investment approach, it is important that we look for companies where there is a positive change in their business or operating environment, but the stock market valuations and forecasts are not fully reflecting the implications of such change. Such change can be found across regions and industry.
Naturally, global equities, with thousands of investible companies, represent the widest and the most diverse set of opportunities. One area where we see a lot of opportunity is the European banking sector.
Consensus view is that changes affecting European banks are mostly negative. After the global financial crisis we have seen relentless regulatory pressure, demand for more capital, lawsuits and fines. European government policy towards banks has not been favourable. Naturally, investor sentiment is cautious and European banks valuations reflect that.
However, looking into the details, some opportunities arise among this negative backdrop. Pressure on capital meant that banks had to increase their capital base, often suspending dividends in the process. Many are now in stronger capital positions. Litigation issues are being resolved. Many banks are refocusing on their core business - some on corporate banking, some on consumer banking, some on wealth management - and exiting legacy assets and business lines. Greater cost discipline means any top-line growth leads to strong operating leverage.
One example is UBS. Under new management, it has exited a number of business and product lines. It is refocusing on its core areas, including global wealth management, where it has one of the strongest brands in the world. It benefits from growth in wealth management industry in Asia, where it is a leading player. Overall invested assets in the wealth management business had been growing 8% per year, with even higher growth in Asia Pacific region. The margin in that business is increasing, as they offer more value added services to their high net worth clients. Meanwhile, it has bolstered its capital, becoming one of the best capitalised banks in the world, is cutting costs, and has resolved most of its legal issues. It is becoming a high quality, growing financial services business, and market is slow to recognise that change.
New Italian policy favours banking stocks
While generally European government’s policy towards banks has been unfavourable, some policy measures have positive implications.
UIn Italy an ambitious reformist government programme includes changes in bankruptcy regulations, privatisations, consolidation of fragmented regional banks, and greater economic openness.
This is good for the banking sector. Bankruptcy process has been slow and ineffective in Italy. Sometimes it took up to seven years to resolve bankruptcy cases in courts, to give bank control over the collateral for the defaulted loan. This had made the process very costly. Under the new rules, the process is faster, around two years, saving costs and time. This means that lending business becomes more profitable, and value of existing "bad loans" goes up.
Mikhail Zverev, Head of Global Equities, Standard Life Investments
First published in Hong Kong Economic Journal November 2015