Investing in the equity of global banks has never been easy. Share prices typically reflect a myriad of factors, including the health or otherwise of domestic, regional and even global economic activity. The virtual collapse of the financial system a decade ago has exacerbated this challenge in recent times. In this article we summarise the investment case for global banks and highlight three of our favoured stocks.

Let’s attempt to simplify the investment case. Bank returns are driven by a combination of rates, regulation and rivals. On this basis they now score significantly much better on two fronts, but much worse on one, which helps explain why global investors have recently been returning to the sector.

Rates – Rising interest rates are good for lending spreads and allow for better reinvestment yields, which helps banking revenues.
Regulation – Deserved regulatory burdens have peaked, are now slowly lessening, leading to increased dividends and buyback activity.
Rivals – Given the low barriers to entry in core banking, competition from low-cost challengers will remain a constant threat to established players trying to compete in an increasingly digitalised market.

Despite the net tailwind, investing in the equity of European banks has not been a fruitful investment strategy of late. Interest rate curves have provided a stubborn headwind and are stifling any ability to grow margins, despite signs of life in credit demand. Capital is still tight in some circles and it is clear that market-related businesses are losing share on a global basis.

More positive on Italian banks

Recent political developments, especially in Italy, have seen peripheral bond spreads widen aggressively and bank share prices typically correlate negatively to such activity. Hence, Italian banks have recently been among the weakest performers. Notwithstanding some serious policy errors by the new establishment in Rome, we are now reasonably positive on the two largest listed Italian banks, Intesa San Paolo (ISP) and Unicredit. We are encouraged by:

  • Balance-sheet repair in terms of addressing non-performing loan portfolios is well advanced;
  • Fee income is growing smartly as savers trade-up to more sophisticated products;
  • Effective cost-control programmes are in place to protect bottom lines; and
  • Valuations are undemanding, with ISP now trading with an 8% cash dividend yield.

However, if the market sentiment suddenly thought there was any real risk of Italy leaving the Euro, then all bets would be off.

Attractive valuations

Banks are commonly perceived as perhaps the last bastion of value in global equities, trading on a prospective price-earnings multiple of 11x, or nearly 30% cheaper than the wider market versus a historical discount of closer to 15%. Offering a price-to-book multiple of 1.1x and a dividend yield of 3.7% for a double-digit return on equity of 10.4% hardly screams expensive either, unlike some other more cherished parts of the market.

Three global banking stocks we like

Three bank stocks we currently favour in our global equity income portfolios are:

  1. Australia’s Macquarie Group, with its diverse source of revenues pays a yield of 5.5% and has built a strong track record of growing dividends through time;
  2. Natixis in France, whose business model relies strongly on leveraging its multi-local boutique asset management expertise also boasts a handsome cash-return profile; and
  3. Singaporean giant DBS Group, who are extremely well placed to take advantage of low but fast rising banking penetration levels in many emerging Asian markets.

Opinions and views from the Equities team at Kames Capital are not an investment recommendation, research or advice and should not be considered as such. Content discussing investment strategies and stocks is derived from and solely relates to the investment management activities of Kames Capital.

About the author

Mark Peden is the architect of our global equity income strategy and has been the lead manager of the Kames Global Equity Income Strategy since its inception in 2011. European equities are his main area of research expertise where he has been analysing companies since joining the firm in 1992. Over his tenure Mark has held a number of positions and managed a range of both International and European equity funds. He graduated from the University of York and the University of California (Santa Barbara) with a BSc honours degree in Economics with Politics. He a CFA charterholder and is also an Associate member of the UK Society of Investment Professionals (ASIP). He has 25 years ’industry experience.*

*As at 28 February 2018.

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