Non-U.S. banks have shown improvement to some extent so far in
2013, thanks to the defensive and proactive steps by the central
banks of most developed and emerging economies. However, the global
financial system must gain strength to signal an upward
With policy makers still struggling to avoid further collapse, a
flurry of banking regulations can be felt throughout the world.
This is, however, taking a toll on banks' top and bottom lines. As
a result, banks all over the world are seeking new strategies to
lessen the regulatory burden in order to plan the path to future
With capital efficiency being the key focus, most foreign banks are
adopting reconstruction-by-asset-sale strategies to strengthen
capital ratios. So the prospects for the remainder of 2013 look
better but not impressive as the sector must continue to fight
macroeconomic challenges which could keep growth muted.
Moreover, a prolonged low interest rate environment is not expected
to reverse any time soon as central banks of most of the countries
will continue to prioritize growth over inflation control. This
strategy is sustainable as inflation is the concern of only a few
Thus, banks operating in a low interest rate environment will not
be able boost revenue through interest income. On the other hand,
non-interest revenue sources will be limited by regulatory
Banks in consumption-driven economies will not, however, face
significant challenges related to interest income due to a
not-too-low interest rate environment. Still-high inflation will
continue to force the central banks of these economies to keep
interest rates higher than the low-inflation economies. However,
non-interest revenue challenges will persist for these banks as
Most of the major non-U.S. banks do not mind complying with
stringent regulation, but it would make the optimization of
business investments difficult for them. So banks will need to
reassess and restructure their operating models to improve their
financials, which will take considerable time.
The Recent Past
Despite the ongoing macroeconomic and regulatory challenges, the
majority of the world's largest banks showed impressive results in
the first quarter of 2013. Among others, giants like
HSBC Holdings plc
) ended the quarter with improved earnings. Most of the banks
witnessed strong capital ratios and improved credit quality. The
betterment was also reflected in the share price performance of
these banks in the last few months. The MSCI World Bank Index has
appreciated around 20% over the last one year.
However, a risk-aversion tendency has kept client activity
restrained, resulting in weak trading volumes and subdued loan
demand. Also, learning from past experience, banks are now more
cautious about lending money.
But thanks to worldwide regulatory reform, the sector has at least
entered into a transformation phase with the restructuring efforts
in place. Needless to mention, an essence of growth is yet to be
What to Expect Moving Forward?
Growing challenges related to funding, still-high costs despite
belt-tightening through layoffs and other measures, and limited
access to revenue sources will keep bottom-line improvement under
pressure in the upcoming quarters.
The growth potential of some non-U.S. banks could also be
restrained by higher reserve requirements and outsized losses
related to capital markets. Consequently, valuation multiples of
these banks will continue to reflect the fundamental challenges at
least through the remainder of 2013.
Moreover, regulatory pressure to focus more on the home market is
forcing these banking giants to hold back international expansion
and sell existing assets in other countries. This will ruin the
efforts to restructure their operating models and meet long-term
Nonetheless, strict lending limits as well as greater transparency
in regulations could strengthen the fundamentals of many sector
participants. Eventually, these are expected to create a less risky
lane for the overall industry.
The Persistent Challenges
The key trouble for non-U.S. banks is regulatory pressure, which
ensued from taxpayers' money and government intervention that were
required for them to remain in business. The impact of regulations
is yet to be fully felt with many rules still impending.
Additionally, government efforts to alleviate industry concerns
have significantly raised political debates over time. Politics
will continue to influence lending decisions as long as banks
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 government backing is still felt acutely by the European banks.
Adding to the concern is the tendency of regulators worldwide to
agree on strict capital standards to clip the risk-taking attitude
of banks to prevent the recurrence of a global financial crisis.
The introduction of Basel III standards is a case in point.
While the full implementation of the required capital levels under
Basel III is due in 2018, many banks have already started complying
with the requirements to fix their damaged reputation following a
number of high-profile scandals in the industry. To make matters
worse, the latest changes indicate that banks need to hold more
capital compared to what the Basel Committee mandated
With these regulatory measures, the capital structure of banks will
remain under constant pressure, though this would eventually make
their balance sheets more recession-proof.
Valuations Look Attractive
Ongoing balance sheet repair and credit environment recovery will
make the valuations of most of the non-U.S. bank stocks less
expensive going forward. However, the mega banks, which can
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 add foreign bank stocks to their investment kitty.
Investors with short-term targets, however, should be watchful
while choosing foreign bank stocks at this point as near-term
fundamentals do not look promising. Asset quality lacks the
potential to a 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 and
a low interest rate environment in most of the countries.
If any improvement occurs in the near-to-mid term, it will vary
from country to country, depending on industry circumstances.
Mixed Rating Actions
Rating downgrades remained a major threat for global banks in 2012,
but 2013 started off with better response from a few rating
agencies on a few banks. Banks that showed improvement in
liquidity, funding and capitalization earned positive rating
In May 2013, Fitch Ratings affirmed its credit ratings on 12 global
banks including non-U.S. banks like Barclays,
BNP Paribas S.A.
Deutsche Bank AG
) and HSBC. The rating agency accounted for the solid progress made
by banks to meet their regulatory capital ratio requirements.
However, in Jun 2013, Standard and Poor's (S&P) reduced its
credit ratings on 15 big global banks including Barclays, HSBC,
Royal Bank of Scotland Group Plc.
) and UBS AG. A sweeping overhaul of the agency's ratings criteria
resulted in these downgrades. Earlier, in Mar 2013, the rating
agency put Deutsche Bank's long-term credit rating on negative
watch following weak 2012 results.
According to Moody's Investors Service, the rating arm of
), the ratings of global banks are expected to be relatively stable
in 2013. The rating agency will keep an eye on excessive
risk-taking by banks to offset the negative effects of low interest
rates and regulatory reforms.
Overall, the industry may witness more positive rating actions if
banks can evade the lingering macroeconomic issues with their
smartened up business
Eurozone Concerns Easing
Eurozone woes should not be a major challenge for global banks
anymore as the downside risk of the European economy appears to be
less than what it was a year ago. The economy is showing
improvement with sharp growth in consumer confidence, streamlined
business activities in the private sector and mended manufacturing.
Consequently, the banking industry in the continent has recovered
to some extent.
The steps taken by European policymakers have significantly helped
in stabilizing the economy. Primarily, the European Central Bank's
(ECB) long-term refinancing operations have helped in injecting
liquidity into the system. Further, the setting up of a banking
union will allow the ECB to intervene directly in banking
operations within the continent.
However, with muted growth in the economy, the banking system will
continue to face challenges. Banks' will continue to face capital
pressure until the remaining issues are addressed.
Emerging Markets Look Promising
Coming to the 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 subdued
Moreover, banks in the emerging markets generally tend to be well
capitalized, less exposed to property markets, and generate steady
interest income from operating in a not-too-low interest rate
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 performances of non-U.S. banks.
Also, only cost reduction by job cuts and asset sales should no
longer be considered enough. Instead, the aim should be to enhance
operational efficiency through fundamental changes in business
models. The capital goal of global banks should be more than just
complying with regulatory requirements.
On the other hand, the primary attention of policymakers should be
on determining the span of fiscal stimulus, ensuring that it
remains till a clear sign of transition from recovery to growth is
Among the non-U.S. banks, we recommend
Mitsubishi UFJ Financial Group, Inc.
) and Sumitomo
Mitsui Financial Group Inc.
) that have a Zacks Rank #1 (Strong Buy).
We also like banks with a Zacks Rank #2 (Buy) including
Banco de Chile
Erste Group Bank AG
Industrial and Commercial Bank of China Limited
Lloyds Banking Group plc
Mizuho Financial Group, Inc.
We would suggest avoiding banks that have participated in
government recapitalization programs and are yet to repay. In
return of government capital and asset quality protection, these
banks are facing regulatory intervention, like enforcing limits on
dividend payouts and board member nominations.
Currently, a couple of banks we dislike with a Zacks Rank #5
(Strong Sell) are
Australia & New Zealand Banking Group Limited
National Australia Bank Limited
We also dislike some stocks in the non-U.S. bank universe with the
Zacks Rank #4 (Sell), including
The Toronto-Dominion Bank
Banco Santander, S.A.
Bank of Montreal
The Bank of Nova Scotia
ICICI Bank Ltd.
BARCLAY PLC-ADR (BCS): Free Stock Analysis
CREDIT SUISSE (CS): Free Stock Analysis Report
DEUTSCHE BK AG (DB): Free Stock Analysis Report
HSBC HOLDINGS (HBC): Free Stock Analysis Report
MOODYS CORP (MCO): Free Stock Analysis Report
MITSUBISHI-UFJ (MTU): Free Stock Analysis
ROYAL BK SC-ADR (RBS): Free Stock Analysis
SUMITOMO-MITSUI (SMFG): Free Stock Analysis
UBS AG (UBS): Free Stock Analysis Report
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