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The situation in debt-stricken Europe, which was triggered by Greece when it became financially crippled three years ago, has not improved. However, events in the coming week will have a deep impact on the continent's scenario. We believe that in the event of a European recovery, Citigroup (C) and Deutsche Bank AG (DB) are best positioned to benefit. Comparisons of their Tier 1 capital ratios with their peers reveal that both banks are adequately capitalized. Therefore, we recommend our investors to go long on the stocks, given an improvement in the European situation.

Recent Developments

The following map gives a pictorial demonstration of the debts these countries owe as a percentage of their GDPs as of 2012.


(Click to enlarge)

Source: Reuters

The eurozone's road to recovery is long, with the European Central Bank's unlimited bond buying program being one of the many steps needed to prevent the breakup of the single currency. Mario Draghi, the European Central Bank's president, has called the program "Outright Monetary Transactions." The program, aimed at stemming the continent's crisis, has forced equity markets to rally. On Friday, the FTSEurofirst 300 surged by 0.2 points, while the Euro STOXX 50 closed after rising by 0.5%. Mining and banking were among the top gainers. The continents mining and banking sector indexes surged by 3.2% and 2.1%, respectively.

Events to Watch

The European debt crisis will now face a decisive couple of days, with three major events coming up this week; each having the potential to alter the prevailing landscape. The three events are the Dutch general elections, a German court's ruling on bailout funds, and the European Union finance ministers' meeting.

This Wednesday's general elections in Netherlands will play a pivotal role in the future course of the bailout packages for Greece, and the possibility of Greece leaving the European Union. Greece was the country that triggered the prevailing crisis in the continent; the serving Dutch PM is strictly against a third bailout package. He went as far as saying that Greece's exit from the European Union might become unavoidable.

On the same day, a ruling by the German Federal Constitutional Court will decide the legitimacy of the continent's permanent emergency fund. The court will decide whether to suspend the European Stability Mechanism worth €500 billion. Additionally, the judge may attach some strings, and allow the country's parliament the power to veto aid disbursement in the future or even limit Germany's liability.

On Friday, European finance ministers will meet in Cyprus to discuss the next steps over possible additional aid to Spain and to remove differences over banking regulations in the continent.

Among the banks that will benefit from the much-awaited European recovery are Citigroup and Deutsche Bank AG. The remainder of the report will aim to look into their exposures to the troubled countries of the European continent.

Citigroup is considered to have the biggest positions overseas. It also has the largest exposure to non-U.S. sovereign debt. The bank has a vast global footprint, which has been a major source of its growth. At the beginning of the year, the bank held debt securities issued by European countries worth $33.4 billion. Fitch, a premier U.S. credit rating agency, also acknowledged the fact that among large cap U.S. banks, Citigroup has the largest exposure to the troubled continent. Gross funded credit exposure to sovereign entities and corporations of GIIPS nations (Greece, Italy, Ireland, Portugal and Spain) dropped to $20.1 billion at the end of this year's second quarter. Net exposure dropped from $9.1 billion at the end of the first quarter to $8.4 billion at the end of the second quarter of the current year. The share price appreciated by 3.6% on the news of the European Central Bank's plans to purchase unlimited bonds. The bank has a market cap of $94 billion, which means the exposure as a percentage of common equity is 21.4%. The bank has a Tier 1 capital ratio of 14.5%, as opposed to a Tier 1 capital ratio of 13.8% for Bank of America (BAC). For more detailed reports on the strengths on the bank, please click here.

In the event of a European recovery, Citigroup, among the large cap U.S. banks, will be a major beneficiary.

Among the European banks, Deutsche Bank is also considered to have significant exposure to GIIPS nations. At the end of the fourth quarter of the current year, the bank had a total net exposure to GIIPS nations of €47.5 billion, against €51.8 billion at the end of the prior year. The bank has a market cap of €28.7 billion, which means that exposure as a percentage of common equity is 165%. The net exposure to GIIPS nations' sovereign debt of €3.7 billion increased to € 3.9 billion over the same time period. The bank's shares rallied by 7% after news of the ECB's plan to buy bonds. The bank has a Tier 1 capital ratio of 13.6% as opposed to 12.7% for HSBC Holdings (HBC).

In the wake of a European recovery, we believe that Deutsche Bank AG will benefit the most among the rest of the European banks.

Valuations

Both banks are attractively valued with regards to their P/B values. Citigroup's and Deutsche Bank's stocks trade at approximately a 50% discount to their book values.

Source: 2 Banks To Buy On European Recovery