The global banking sector has been undervalued since the financial crisis. However central banks are starting to increase rates and this should be positive for the sector as it will enable banks to make money out of the liability side of their balance sheet. It is hard to make any money taking deposits and investing them in zero yield Treasury bonds or other fixed income markets. We have seen several rate rises from the US Fed and the positive impact on the banking sector is already somewhat reflected in US bank share prices.
This effect is yet to be felt in Europe where the ECB is still dovish and looks likely to hold off raising rates until either late 2018 or early 2019. The European banking sector overall is still trading at around tangible book value. While this is well up from the lows during the European sovereign crisis or even around the time of the Brexit vote, it still makes the sector undervalued because overall the sector should be able to cover their cost of capital. While the sector overall might be at tangible book value, there are a number of banks within the sector trading at significant discounts to that.
Europe remains the region in which we are most overweight within the banking sector, but there are also parts of the Asian banking system and even some US banks that still look attractive.
If you look at banks in Australia, the environment is quite different. Loan losses have been benign supported by strong house prices, and that’s largely reflected in bank valuations. The leading Australian banks are trading above two times’ tangible book value, roughly double the valuation of the European sector.
Can you really compare banks across the globe?
The different banking markets are not identical by any means but there’s certainly plenty of similar features. They’ve all gone through a massive build-up in their capital requirements compared to the levels held prior to the global financial crisis.
If you look at Europe there are some noticeably different market structures across the region. There are some banking systems which you would describe as closely comparable to the Australian system. You’ve typically got a consolidated market with three or four major players, and those businesses should be able to generate reasonably attractive returns over time. These may be of interest to Australian investors who are very familiar with the Australian banking sector and looking to diversify.
For example, Barclays is a global investment bank, consumer credit card business as well as one of the leading UK banking franchises. The company certainly has had its issues going back to the financial crisis and since then the acquisition of the Lehman’s business, but the underlying franchises are attractive. If you look at Barclays overall, it’s trading at a significant discount to tangible book for what is a set of good businesses and we see an attractive opportunity here.
BNP Paribas is another stock we view favourably. It's a French domiciled bank but one of the largest banks in the Eurozone and is well diversified by business and geography. BNP Paribas offers both retail and commercial banking as well as investment banking and security services The bank has gone through a long phase of growing their capital base, now placed above where they need to be. We've seen rising dividend payout ratios and improving profitability which means they are now hitting their ROE targets. The shares have re-rated somewhat but they still trade at a slight discount to tangible book value which we think is attractive.