Reason Will Prevail And European Banks Still Look Reasonable

by: Joaquin Monfort


Italy will probably be forced to concede or face market backlash.

Easing risks will leave European equities attractively priced.

Eurozone banks are risky but undervalued buy.

A melt-down in Italy won't happen. The Italian government will concede. They will have to. If they don't the cost of borrowing will skyrocket, especially in 2019.

Assuming they rein in their spending plans, the cost of borrowing will fall to more reasonable levels. The btp-to-bund yield spread will deflate. Everyone will have a sigh of relief. The next crisis will happen somewhere else.

How can I be so sure? The irresistible logic of the markets - and the fact that come the end of the year papa ECB won't be there to lend a hand anymore. Since the financial crisis, almost all the country's borrowing has been from the ECB via its quantitative easing (QE) programme. That is set to end in December when the ECB is scheduled to end its bond purchases. After that, the Italians will have to go cap in hand to the capital markets, which are likely to be much less forgiving. That's when the cost of borrowing could really go up if the Italians aren't careful.

At the end of October, Moody's will review Italy and markets are fearing a downgrade. Clearly, that won't help Italy's cost of borrowing either.

The new radical, populist, government will soon find itself stuck between a rock and a hard place - give up their spending promises and instantly be accused of the sort of political compromise which marked out their predecessors, the old establishment elite; go ahead with a 'devil may care' attitude and they will pay the consequences in an increasingly unsustainable debt burden, which will eventually lead to hardship anyway.

They, of course, will claim the increased spending will kick-start growth and that will cover the debt service costs. They are not alone in thinking so - after all, that's what Trump said when he cut taxes last year - unfortunately, the markets don't agree.

The crisis will ease and once it does the euro and eurozone stocks will recover. Some analysts are already saying this most recent scare may have provided investors with the perfect opportunity to go long European equities. Some of the braver analysts are even recommending a punt on eurozone banks.

In many ways, their advice makes a lot of sense. European banks are very cheap at the moment - having been worked over by a financial crisis, a debt crisis, increased regulation, a decade of extremely low-interest rates and finally by myriad money-laundering and trader scams which have pretty much brought the sector to its knees.

Add to that the fact the ECB is set to start raising interest rates in 2019 and the environment may get a lot easier for the sector.

Recently I put out a note on Intesa Sanpaolo (OTCPK:ISNPY) - it had relatively strong fundamentals, was showing profitability in extremely difficult conditions, and, perhaps, more importantly, was doing all the right things - from off-loading its NPLs to diversifying away from interest-earning into commission and fee-based investment banking. Notwithstanding, a complete disaster in Italy, I stand by my call, but there are other eurozone banks as well.

For a strong heavyweight player, you could do worse than choosing Dutch bank ING (ING) which is the 10th largest bank in Europe by size, by assets and has a market cap of over €52bn. It has been lauded for its "customer-centric" approach, with "well thought out applications of new technologies." Although its figures aren't amazing for H1 2018, its assets keep growing faster than others, which is a good sign for any bank as it shows strong loan creation.

Nordea Bank (OTCPK:NRBAY) is a strong middle-weight player, with standout 'profitability' after achieving a 49% margin before tax in 2018 H1. It has also been praised for its strong wealth management division and use of new technology.

Still on the Nordic trail, we find Swedbank (OTCPK:SWDBF), a highly profitable Swedish bank, with extremely attractive financials, including a sold tier one capital ratio of 24.6, an EPS of SEK9.9, an ROA of 4.9%, an ROE of 17.1% and 62% pretax margin.

Little-known Austrian regional player BAWAG (OTC:BWAGF) is another bank with solid financials. Although total assets are only €44bn, ROA is a solid 1.09%, ROE is 11%; it has a 46% pre-tax profit margin and a tier 1 ratio of 15.2 - not bad.

Catalan player Caixabank (OTCPK:CAIXY) is the leading online player in the Iberian peninsula which, since banking is going increasingly digital is not a bad thing. Caixa owns Imaginbank, Spain's first wholly online lender. They moved their headquarters away from Barcelona after the failed referendum. Their financials are nothing spectacular but not bad either.

Finally, although German lenders have come in for a lot of stick lately, they may be worth a punt as possible takeover targets. Whilst Deutsche's (DB) financials suck - a pretax margin of only 8.0%, a 0.03% ROA, EUR0.09 EPS and tier 1 ratio of 13.7 - its global brand is surely worth something to a potential partner.

Likewise, Commerzbank (OTCPK:CRZBF) is a potential M&A target given the increasing calls for Germany to have at least one strong bank. Financials are pretty average, however, with a 31% pretax margin, 0.22% ROA, EUR1.03 EPS and a tier one of 14.1.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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