Foreign banks have been adopting reconstruction-by-asset-sale as
the means to reduce leverage and stay afloat. However, the industry
remains thwarted by non-stop challenges that are keeping its
performance under pressure.
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The latest deterrents, nagging macroeconomic issues -- the European
sovereign debt crisis in particular -- and regulatory pressures,
are continuously causing the sector's underperformance.
Moreover, the upcoming quarters look even worse, with several
negatives like asset-quality troubles, high borrowing costs, weak
revenue growth, steeper expenses and weak loan demand. But thanks
to worldwide regulatory reform, the sector has at least entered a
transformation phase with the restructuring efforts. Needless to
mention, a change is yet to be felt.
The sector showed less resilience in the first half of 2012 than
anticipated. Growing concerns related to funding and limited access
to markets along with other fundamental challenges are not expected
to bring stability anytime soon.
On the Fundamental Side
Looking at the fundamentals, a rising risk-aversion tendency has
been gradually reducing client activity, resulting in lower trading
volumes and subdued credit demand. Also, learning from past
experience, banks are now more cautious to lend money.
Consequently, lower business activities and anticipated subdued
profitability are making foreign banks less attractive to
investors. Valuation multiples of these banks will continue to
reflect the fundamental challenges at least through the remainder
Though the growth potential of some non-U.S. banks could be
restrained due to higher reserve requirements and outsized losses
related to capital markets, strict lending limits as part of the
regulatory overhaul as well as greater transparency in regulations
could strengthen the fundamentals of many banks. Eventually, these
are expected to create a less risky lane for the overall industry.
As inter-country investment walls have fallen, some large non-U.S.
banks are freely expanding beyond their domestic boundaries through
mergers and acquisitions. On the other hand, regulatory pressure to
focus more on the home market is forcing some global banking giants
to sell overseas assets. These banks are naturally trying hard to
restructure operations and address funding needs.
In fact, the sector saw a moderate recovery in 2010, but
performance in 2011 was one of the poorest in its history.
Difficulties notwithstanding, the financial crisis is finally
Now the primary headwind for global banks is regulatory pressure,
which ensued from taxpayers' money and government intervention that
banks have relied on in order to remain in business. Moreover,
government efforts to alleviate industry concerns have
significantly raised political hurdles over time.
Politics will continue to influence lending decisions of banks for
as long as these remain financially dependent on governments.
According to banking regulators, if governments withdraw their
support from banks before giving them sufficient time to restore
their financial strength, the sector could collapse again. The need
for bailouts is still felt prominently by the European banks.
The industry has been adopting tougher regulatory measures to
prevent the recurrence of a global financial crisis and restore
public confidence. In June 2011, the oversight body of the Basel
Committee on Banking Supervision proposed new rules that would
force the world's biggest banks to hold extra capital on their
balance sheets as protection and prevention against any financial
catastrophe. This extra capital requirement is an added cushion to
the set of minimum capital standards under Basel III.
With these regulatory measures, the individual capital structures
of banks will remain under constant pressure. The resulting
slowdown at some big banks could be seen as a blessing in disguise,
as it would eventually make their balance sheets more
Valuations Look Attractive
Balance sheet repair and credit environment recovery will make the
valuations of some non-U.S. banks attractive. Particularly,
valuations of the mega banks, which could comfortably maintain the
minimum capital norms mandated by the Basel Committee, will
experience the fastest valuation upside. Consequently, we believe
this would be a good time for long-term investors to consider
foreign bank stocks, as now the valuations look comparatively
Investors with short-term targets, however, should be watchful
while choosing foreign bank stocks at this point as near-term
fundamentals remain weak. Asset quality lacks the potential to
rebound anytime soon as default rates for individuals and companies
are not expected to materially subside, and revenue growth might
remain weak with faltering loan growth.
The sector is not expected to witness a turnaround at least in
2012. If any improvement occurs, it will vary from country to
country, depending on industry circumstances.
Ratings downgrades are a major threat for major global banks. In
July 2012, Moody's Investors Service downgraded credit ratings of
15 systematically important banks in the U.S., U.K. and Europe. The
foreign banks include the likes of
Credit Suisse Group
HSBC Holdings plc
Deutsche Bank AG
The downgrade was based on the agency's concern related to these
banks' significant exposure to the volatility and expected losses
from capital market activities. This rating action could compel
many of these banks to post billions in additional collateral,
which will make derivative trading costly. Also, already-high
borrowing costs for these banks will create a further increase.
European banks are most likely to underperform in the upcoming
quarters, primarily due the ongoing debt crisis in the region,
resulting capital pressure and deleveraging risk.
In early 2010, the debt crisis originating in the Greek economy
shook the stability of the European Union's (EU) monetary policies.
Starting as a solvency crisis in a single country, the turmoil
spread over to the entire Eurozone.
The situation did not stabilize to a great extent in 2011, despite
financial assurance from EU leaders. In 2012, the European debt
crisis has heightened, spreading fears of a financial collapse on
Though the funding situation in Europe has improved to some extent
with huge aid from the European Central Bank, there remain deep
concerns related to the banks' ability to meet capital
Italy and Spain showed signs of improvement with support from the
government and European Central Bank, but conditions in Greece
remain uncertain due to issues related to additional bailout funds.
Moreover, the high inflation rate will continue to force regulators
to tighten their policies in the Eurozone, making banks less
Overall, the European Union is trying hard not just to restore
investor confidence but also the health of the continent's banking
system. The issue, however, remains far from being addressed.
Coming to banks in emerging economies, the asset quality trouble is
obvious. However, these are not plagued by other serious problems
that many of the larger banks face in continental Europe and the
United Kingdom, such as toxic securities and dilution from capital
raising. Moreover, these emerging-market banks generally tend to be
well capitalized, aren't as heavily exposed to property markets,
and have significant and growing sources of non-interest income.
We believe that banks in emerging economies -- Chile, Brazil and
India -- look more attractive, akin to certain regional banks in
the U.S., Australia and Canada that have capital strength, good
funding and growth potential.
Overall, a key determinant for a quick recovery will be the quality
of risk analysis and risk-awareness in decision-making and
incentive policies. So, we believe that accumulating larger capital
buffers over the cycle and reducing pointless complexity in
business will be crucial to banking performances.
Also, the primary attention of policymakers should be on
determining how much longer fiscal stimulus should continue,
ensuring that it is not withdrawn before a clearer sign of economic
recovery is visible.
Among the non-U.S. banks, we recommend
Mizuho Financial Group, Inc.
Sumitomo Mitsui Financial Group Inc.
) that have a Zacks #1 Rank (short-term Strong Buy rating).
Banks with a Zacks #2 Rank (short-term Buy rating) that we also
BBVA Banco Frances S.A.
Banco Latinoamericano de Comercio Exterior, S.A.
Banco Macro S.A
Mitsubishi UFJ Financial Group, Inc.
We also like a few Zacks #3 Rank stocks such as
Banco Santander, S.A.
HDFC Bank Ltd.
KB Financial Group, Inc.
The Royal Bank of Scotland Group plc
The Toronto-Dominion Bank
We would suggest avoiding European banks at this point, including
banks in Great Britain and Ireland -- in particular, those that
have participated in government recapitalization programs and have
yet to repay. In return for government capital and asset quality
protection, these banks are facing regulatory intervention, like
enforcing limits on dividend payouts and board member nominations.
Currently, banks that we dislike with the Zacks #5 Rank (short-term
Strong Sell rating) include
Banco Bradesco S.A.
Itau Unibanco Holding S.A.
National Australia Bank Limited
Westpac Banking Corporation
We also dislike some stocks in the non-U.S. bank universe with the
Zacks #4 Rank (Sell), namely
Royal Bank of Canada
ICICI Bank Ltd.
Canadian Imperial Bank of Commerce
The Bank Of Nova Scotia