Financial services represent about a third of Europe’s stockmarket capitalisation and are a barometer of the health of the markets. The banks, for example, have bounced over 130% since 2003 lows; but will this continue, or have we reached a turning point for the industry? If you want to own a traditional bank’s stock, you need to believe that lending growth will remain robust, and that corporate and retail customers won’t ‘go bad’, generating bad debts. Historically low interest rates have kept the cost of borrowing down, growth has been good and bad debt is back at cyclical trough levels. Lending growth has to slow from here in most economies – the French retail banks are an early indication that competition and waning appetite for leverage is slowing revenue growth. Competition is narrowing margins, particularly as systemic growth slows, and the provisioning of bad debts can’t get any lower – we have seen two to three years of write-backs, which will disappear in the future, making earnings growth harder to come by.
Financial stocks: try Italian and Irish banks
Despite all this, I don’t think it’s time to sell – just be more selective. At about a 20% discount to the wider markets, the financial sector is at the upper end of its relative trading range. Underlying earnings growth is around 8%-9%, making the sector fairly valued. Restructuring, margin expansion and cheap growth are the way forward. We like Italian banks Banca Popolare Italiana (IM:BPI) and Banche Popolari Unite (IM:BPU). Both trade at discounts to the sector and Italian peers; both have recently taken part in mergers and acquisitions, and we should therefore look forward to positive news on synergies and restructuring over the coming quarters.
Earnings growth prospects via stocks such as Anglo Irish Bank (LN:ANGL) and Allied Irish Bank (LN:ALBK) are also attractive at current prices, but some continental retail banks, especially in Spain, look expensive and you should take profits.
Financial stocks: insurers look cheap
Insurers also benefit from rising rates and healthy stockmarkets and they are now looking inexpensive. Stocks trading at or near embedded value, or on sub-ten times forward earnings, look good – Swiss Life (VX:SLHN), ING (AS:INGA) and Allianz (DE:ALV) offer good potential upside. Historically insurance has been very cyclical, but steps taken by managements over recent years to improve balance sheets and introduce new risk systems should make results less volatile, improving the predictability of earnings and raising sector multiples. Investment banking earnings are also strong, and while there may be some concern that the environment can only deteriorate from here, exposure to private client banking, trading and the restructuring story makes Credit Suisse (LN:CRD), at less than ten times earnings, a very attractive option.
Financial stocks: European property
One other area I should mention is property. This isn’t a new story: the European property sector has benefited from rising asset prices, low interest rates and regulatory changes (the impending introduction of real estate investment trusts in many countries, for example). There are very few opportunities to get into the sector without paying a hefty premium to net assets, but some do exist. A low price-to-net-assets multiple with good yield makes for an ideal stock – Eurocastle (AS:ECT), Prologis (NYSE:PLD) and IVG (DE:IVG) are your best bets.
Some of the financial stocks that Jonathan Tyce likes
12mth high 12mth low Now
Banca Popolare Italiana e12.12 e6.91 e11.19
Anglo Irish Bank e16.80 e10.52 e15.27
Swiss Life Holding SFr335.75 SFr231.25 SFr302.75
Credit Suisse 3,915p 2,727p 3,557p
Eurocastle e44.93 e26.75 e39.00