Markets May Be Undervaluing European Financial Sector

Snapshot of European financial sector' structureEuropean financial sector

Bankinter analysts have done a study of the European financial sector in of of its latest notes for investors. In their opinion, the market is undervaluing the sector’s capacity for improvement in terms of efficiency, capital management, technological transformation and profitability. The bank’s investment strategy focuses on entities with good fundamentals, growth expectations above the average and attractive multiples of valuation.

The fundamentals of the sector – business volume, current results, solvency and returns on tangible equity (ROTE) – are evolving positively despite an adverse interest rate environment and a demanding regulatory framework.

The indices of credit quality – Default and Coverage – have significantly improved and increased the interest of institutional investors like Blackstone, Cerberus and Oaktree, among others, in the non-performing loans sector. The probability of default in the major corporations segment remains at historical lows and the indicators in the housing sector are pointing in a positive direction. The increase in the general price index is accompanied by an increase in the volume of transactions generalized throughout the Eurozone.

Santander and BBVA lead the sector in the reduction of non-performing loans and profitability (ROTE) while Sabadell is working to accelerate the sale of non-performing loans in the wholesale market. In Italy, Unicredit, Montei dei Paschi and BPER have been able to implement asset securitization strategies to sanitize their books despite the political situation. In Central Europe, the main entities focus their efforts in rationalizing operational costs (Deutschebank, Commerzbank, SocGen and BNP, while the Benelux entities (ING, ABN and KBC) lead the sector in reducing the cost of risk – currently close to zero.

The balances of the main bank’s are solid, the liquidity ratios high and the risk of credit reduced. The debt ratio (Debt/Ebitda) of the largest 600 listed European companies is at historical lows and the balance between rises and lowering sus of ratings for European companies is positive. The volume of non-performing loans over capital of the entities remains at reasonable levels, except in Italy, and the solvency ratio CETI FL of the sector – currently around 11.0%/14.0% – comfortably above what required by regulation.

Investment strategy: we repeat our recommendation to buy European bank’s, based on:

1) The sector is listing with attractive multiples of valuation, both in absolute terms (P/VC<1.0) and relative terms (vs Eurostoxx 600 vs bank’s in the US)

2) The macro environment is favorable – growth, employment and housing prices.

3) The private sector credit stock in the Eurozone as a whole is growing at a rate of +2.7% (above GDP) and the demand for credit remains firm.

4) The average BPA expected for the whole sector in 2018 will exceed +10% and after the energy sector is leading the EuroStoxx in growth.

5) The current stock values reflect an adverse interest rate environment, regul and competition from new technological entrants, which we consider exaggerated.

Finally the Bankinter experts signal that the consolidation of the sector (M&A) represents another option to increase efficiency and improve the risk profile through a greater geographical diversification.

“Banking Union is advancing slowly and we do not expect a large scale process of consolidation in the near future, but we do not rule out the possibility of cross-border operations which could make strategic and financial sense.”