I recently attended the Bank of America Merrill Lynch 22nd Annual Financials CEO Conference in London. With financials being such a large weighting in global, and local, equity indices and the interest rate cycle turning up, attending this conference has given me genuine insight into the prospects for UK and European financials. I’m very glad I attended.
The theme of this year’s conference is “the financial crisis 10 years on”. Yes, it’s been a decade since Northern Rock failed in the UK which was the start of the UK/EU banking crisis that saw an unprecedented response from governments and central banks. Fast forward to today and the scars from that period are evident but it’s absolutely clear that the financial sector continues to recover strongly albeit with the continued uncertainty of what “Brexit” will eventually mean.
The line-up at this conference has been exceptional and has given me a very broad insight into a wide variety of sectors and companies. For example, I’ve listened to presentations by ING, Lloyds, Standard Chartered, Barclays, HSBC, Unicredit, Commerzbank, BBVA, Metro Bank, Royal Bank of Scotland, CYBG, Credit Agricole, BNP Paribas, UBS, Nordea, Danske Bank, Erste Group, Standard Life, Zurich Insurance, Old Mutual, Hannover RE, St James Place, Legal & General, Aviva, Prudential, AXA and Allianz.
I also heard Brian Moynihan, the Chairman & CEO of Bank of America speak, which was very interesting, while an address by Sir Ivan Rogers, who was the former Permanent Representative of the UK to the EU, on “Brexit” was also very worthwhile.
At the macro level the clear takeaway was the European Banks & Insurers were far more upbeat than their UK based peers. This was absolutely clear in every presentation and it has made me consider increasing AIM’s exposure to the EU over the UK in the months ahead as it seems confidence and growth is simply stronger in the EU while the uncertainty around “Brexit” is holding back UK corporate confidence.
That said, I still think there’s about 12-18 months of reasonably clear investing air in the UK before the reality of Brexit hits and we remain invested in our stock specific high conviction UK ideas such as CYB.ASX. The simple fact is NOTHING has changed in the UK since the Brexit vote other than the value of the British Pound and lower London property prices. In terms of trade and regulation its currently business as usual, with no change to the playing field and Britain being a member of the EU. That is one reason UK economic data hasn’t collapsed.
Obviously that will start to change as we approach Brexit and have greater clarity on exactly how the exit mechanism will work, so I see the next 12-18 months in the UK as somewhat the “eye of the storm” where tranquility sets in before the real storm/volatility hits. We can make money in that interim period but we need to be very aware that the reality of Brexit hasn’t yet hit the UK economy but it will and when it does we will need to be out of there!
I suppose the biggest surprise to me was just how bearish everyone was about the UK. It’s not just uncertainty about Brexit, it’s also fear of a Jeremy Corbyn led Government in a few years’ time.
Beyond the top down macro and sentiment which clearly favoured the EU over UK, the most interesting development at the conference was the huge focus on how technology is structurally changing banking. I believe banks are becoming “tech stocks” to a degree and we are all underestimating the long-term profitability gains as banks transfer from manual to digital platforms.
As this occurs you will see bank cost to income ratios fall (branch closures, less staff etc.), which means profitability and ROE both increase. Increased ROE in turn leads to higher price to book ratios. This is before any profitability lift from the interest rate cycle turning up and driving net interest margins higher.
The best presentation I saw on digital transformation came from ING CEO Ralph Hamers. He believes you don’t wait to be attacked by fintech, you do it yourself. You invest heavily in digital platforms and your brand. In a digital world “brand “and “functionality “is everything. To give an example of how digitally advanced ING is they now have 8 million customers in Germany and not a single bank branch!! They are adding 1,500 customers per day in Germany. ING believes “branches are not for transactions, they are for advice”. They want a very “branch light” model as we head towards a “cashless society”.
The concept of “branches are not for transactions, they are for advice” is in my view 100% right and will be followed by major and minor banks around the world as the degree of digitalisation increases in banking.
In Spain, ING has only 28 branches covering 80% of the population, while local bank BBVA now has 92% of its products on mobile apps. 22% of BBVA’s sales are “without human intervention”. BBVA saw digital customers rise by +22% to 19.9 million in the last half an mobile customers rise +42% to 14.5 million, while also being awarded “world bank app of the year”. Interestingly BBVA also reports that it has achieved over 50% digital penetration rates in other jurisdictions it operates in such as Turkey, Venezuela, Chile and Argentina.
Similarly, Lloyds Bank said that 2/3rds of new transaction are now online.
CYBG, which we have a large holding, also gave an excellent presentation based on technology. CEO David Duffy said “data is the new oil”, which is a great way of thinking about it. You need to give consumers what they want in real time. There is a huge shift from “product” to “experience”. Banks have been traditionally good a product but bad at experience. This needs to change quickly. CYBG have “soft launched” a purely digital bank called “B”. It has already signed up 100,000 customers. On the other side to the equation CYBG’s branch network has fallen from 275 to 168 in just 18 months. The CYBG presentation reaffirmed my bullishness on the stock.
I could keep going with examples but the very clear theme is there is genuine technology driven structural change in banking that with both change the client/bank experience and lead, through time, to better returns being generated by banks who lead the technology revolution.
Obviously this will come to Australia but I’d have to say the mobile apps I tried of the EU banks were miles better than what any Australian bank currently offers. That’s a great opportunity for Australian banks who are some of the most “branch heavy” models in the world. The winner in Australia will be the bank who invests most in technology.
Think of the generation younger than us: they use UBER, AIRBNB, AMAZON, EXPEDIA etc. etc.. they operate in a virtual world with trusted branded platforms. There is no reason banks cant become another trusted branded real-time technology platform.
In Europe you can see the sector is embracing mobile and digital yet the sector is still priced on historic banking multiples as we are in the early stages of this structural shift to technology enhanced better sectorial returns.
If I am right you will see all forms of investment metrics improve for banks over the next decade, driven by significantly lower cost to income ratios and higher NIM.
If that happens ROE’s will rise, dividends will rise and P/E’s will expand. This is BEFORE you take into account the significant uplift in revenue from rising global interest rates.
Can banks become tech stocks?? They can certainly become technology driven financial platforms who control the client experience. They can become almost virtual banks. That’s what I saw in London and it continues to make me bullish on the banking sector globally. The AIM Global High Conviction Fund has large investments in ING and CYB.
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Charlie has more than 22 years of market experience. He is best known for his high conviction, top down and bottom up investment ideas formulated from consistently meeting with listed and unlisted companies, policymakers and regulators.