By Avantika Chilkoti
Plunging bond yields have made life difficult for bank investors everywhere. For Europe's beleaguered lenders, it is heaping pain on an already tough situation.
A triple-whammy of factors has weighed on European lenders: negative rates, a slowing economy and money laundering scandals driving compliance costs higher.
The Euro Stoxx banks index has lagged behind the market, up less than 5% this year, compared with a nearly 11% rally for the broader Eurostoxx 600 benchmark index. And in a sign of investors' dreary outlook, European banks on the index trade for 70% of their book value, down from above 100% in early 2018 and far below U.S. peers.
Some investors are wary of dipping in. "The sector is a value trap now," said Fabio di Giansante, head of large-cap European equity at Amundi. Even though valuations are at "almost unprecedented levels" compared with other European stocks, he is betting economic troubles and low rates will send bank shares down even further.
The sector is being dragged down by individual names such as France's Société Générale, which has dropped 8% in 2019 and Dutch bank ABN Amro, down 6% this year. Swiss UBS Group is down 3% this year after warning earlier this month about tough conditions in its investment bank.
"The stock market is pricing either a big recession coming up or the fact that maybe the marks on some of the assets in some of those European banks are incorrect," said Filippo Alloatti, a senior credit analyst at Hermes Investment Management which has a long position on European lenders' debt. He figures that while the banks will have trouble growing profits, which hurts their stock price, they are well capitalized.
Falling interest rates tend to help companies by lowering their interest costs and thus boosting profit margins, so long as the economy is growing. But for banks it's a different story. Low and negative rates constrain banks' profits by squeezing net interest margins, the difference between what banks pay for funding and make from loans.
Long-term bond yields have returned to ultralow or even negative levels, in the case of 10-year German government bonds.
"Equities are rising partly because the cost of credit is not going to increase as quickly as people expected and that's good for everyone except for banks," Jason Napier, head of European banks research at UBS, said.
Analysts at Moody's paint a particularly gloomy situation for German banks, given net interest income makes up almost 70% of their revenues and most of their interest-earning assets are long-term, meaning the lenders would feel the benefits of any future rate rises with a lag.
The bleak outlook is partly the reason Deutsche Bank and Commerzbank, two leading German lenders, have entered into formal talks about a possible merger.
A series of money-laundering scandals is another factor driving up compliance costs and possible fines while driving stock prices lower. Scandinavia, whose lenders have generally been seen as lower risk bets, has been particularly hard hit.
"If you were hiding in some of these banks you think, "I'm in the high-quality end of the spectrum," and you have a lower tolerance for risk than if you own some of the racier investment banks," said Ronit Ghose, an analyst at Citi.
The latest high profile example is Sweden's largest bank, Swedbank, whose shares have dropped 14% this year following reports of suspected money-laundering. That follows the scandal last year involving Denmark's Danske Bank A/S after it was discovered that over $230 billion in Russia-linked transactions flowed through its business in Estonia. Danske Bank shares fell 47% last year and a further 6% this year.
One bright spot ironically has been Brexit. Domestically-focused British lenders Lloyds Banking Group and the Royal Bank of Scotland have gained 19% and 14% respectively this year as fears of a disruptive, no-deal Brexit ebbed. Though a no-deal Brexit is still possible, the U.K. and EU have pushed back Brexit several weeks in order to hash out a plan.
Europe's lenders have also struggled as digital upstarts drive down margins in everything from business loans to foreign exchange transactions, says Chris Garsten, a European equities fund manager at Waverton Investment Management, a long-only investor which has restricted exposure to European banks to Sweden's Handelsbanken.
"Whenever somebody wants a banking service they now do a Google search and by the time your product has come down to a Google search you have completely lost control of the pricing," he added.
Write to Avantika Chilkoti at Avantika.Chilkoti@wsj.com
(END) Dow Jones Newswires
March 26, 2019 08:24 ET (12:24 GMT)
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