Zacks Industry Outlook Highlights: Banco Macro, Erste Group Bank, Deutsche Bank, Mitsubishi UFJ Financial Group and Mizuho Financial Group

Chicago, IL - October 14, 2015 - Today, Zacks Equity Research discusses the Foreign Banks, including Banco Macro S.A. ( BMA ), Erste Group Bank AG ( EBKDY ), Deutsche Bank AG ( DB ), Mitsubishi UFJ Financial Group, Inc. ( MTU ) and Mizuho Financial Group, Inc. ( MFG ).

Industry: Foreign Banks


Will Global Economic Setbacks Render Foreign Banks Insolvent?

Dreary growth in economies across the world -- one of the major reasons for the U.S. Federal Reserve not raising interest rates last month -- has taken a toll on foreign banks. The prospects have dulled further after influential economies - primarily China - rapidly cooled down.

The alarming slowdown of factory output in China and manufacturing growth in the Eurozone raises further concerns over repercussions in the global economy.

While economic activity remains stable in the U.S., the picture looks gloomier elsewhere. China being a major importer of raw materials, a worldwide slowdown in demand is imminent. In particular, commodity-producing economies such as Australia, Brazil and Canada will bear the brunt.

Lower commodity prices resulting from continued low oil prices should eventually lead to global growth. But the long-awaited interest rate hike in the U.S., which though not expected anytime soon, would make borrowing costlier for other economies. This, coupled with strong dollar, will keep global economic growth subdued.

Key Factors to Resist a Downfall

Lower Oil Prices: A dramatic drop in oil processing has given the global economy a new lease on life. In fact, the consequent growth in income of oil importing countries should contribute to the global output. However, the overall benefit will significantly depend on whether weak oil prices are a result of global demand weakness or just a consequence of excess supply.

Low Interest Rates: Central banks of the developed nations (except U.S.) - particularly in Europe and Japan - are expected to keep the monetary policy loose for a longer stretch to support their economies. In fact, continued ripples of loss emanating from China are likely to prompt central banks of many other economies to loosen their monetary policies.

Impact on the Banking Industry

While growth driven by low oil prices will definitely support global banks with spurred business gains, a low interest rate environment as a result of loose monetary policy will continue to mar the rate-sensitive portion of their revenues.

On the other hand, any action to lower interest rates in emerging markets that have a tight monetary policy and high inflation (like Brazil) could heighten inflation issues. This in turn would take a toll on their banks.

Further, the expected interest rate increase in the U.S. will lead to a capital flight from emerging markets that will dry up their banking liquidity.

These aside, the ever-increasing regulatory restrictions triggered by continued wrongdoings by banks to offset economic pressure might soften the industry's upturn.

Overall, the weakness in the global financial system is likely to keep the backdrop cluttered.

Fundamental Challenges

Non-U.S. banks keep repositioning business fundamentals to guard against further crises. Though defensive actions like limiting expenses through contracting operations and retrenching workforce are still in place, and the focus on noninterest income is increasing, margin compression and slothful loan growth remain serious dampeners.

Capital efficiency remains the key to survival, and most foreign banks have adopted reconstruction-by-asset-sale strategies to strengthen their capital ratios. While this will make their business safer, growth prospects appear bleak with thinning sources of income.

Pressure on Top-Line Growth

The interest rate environment in developed nations, save the U.S., is expected to remain low for some time. Naturally, revenues from interest income for banks in these regions are also unlikely to get a boost. At the same time, their non-interest revenue sources will be limited by regulatory restrictions.

Banks in consumption-driven economies, however, may not be significantly challenged by interest income due to a not-too-low interest rate environment which is needed to keep inflation in check. However, these banks will have no respite from nagging non-interest revenue challenges. In fact, the expected capital outflow from these economies after the interest rate increase in the U.S. and strong dollar will add to their woes. Also, intense competition from domestic and foreign players will continue to hinder revenue generation.

Evolving Issues

FinTech Posing Threat to Banks: The emergence of financial technology companies (known as FinTech), which offer users an array of financial services through mobile and cloud computing, is a significant threat to banks. Experts predict growth of FinTech to make traditional branch-based banks redundant in the next 10 years.

Cyber-Crime to Increasingly Hurt Banks: As banks have been gradually transforming to become more technology dependent for the changing mindset of a new generation with money, the threat of cyber-crime is evolving.

What's Down the Road?

While the no-rate-hike decision of the Fed has removed any near-term concern over funding insufficiency in the other economies, the not-so-effective cost-control measures, and limited access to revenue sources will keep bottom-line improvement under pressure in the upcoming quarters.

Moreover, the impact of tighter regulations is yet to be fully felt, with many rules pending implementation across jurisdictions. Continued attempts by regulators worldwide to agree on strict capital standards so as to clip the risk-taking attitude of banks and prevent the recurrence of a global financial crisis will restrain the growth potential of industry players.

The full implementation of the Basel III standards - the risk-proof capital standard agreed upon by regulators across the world - is due in 2018. The majority of non-U.S. banks have already started complying with the requirements, but a lot has to be done by many to fully comply with the standards. So the pressure on capital structure will continue for some time and banks will be less flexible in terms of their business investments.

Changing Regulatory Requirements

In addition to maintaining higher capital levels, global banks might see some new regulations down the road, given the proactive approach of regulators in seeking ways to keep a check on arbitration, overdraft and debt collection issues.

Further, as a number of banks are struggling with increasing data breaches like the major LIBOR and FX rigging scandals in 2014, lawmakers are likely to come up with rules for banks to invest more in compliance, risk monitoring and protecting their payment systems.

In any case, banks will have to strengthen their compliance departments to tackle any pressures ahead of time.

Bottom Line

Accumulating larger capital buffers over the cycle and reducing pointless complexity in business will be crucial to the performance of non-U.S. banks. Though cost reduction by job cuts and asset sales have been instrumental in staying afloat, these strategies may no longer be enough. Instead, the aim should be to enhance operational efficiency through fundamental changes in business models.

It's not easy to deal with the unfavorable macro backdrop, but it's actually time to play defensive and modify products to meet evolving customer preferences.

Investment Opportunities

The industry might not be able to tide over the economic quagmire anytime soon, but this is perhaps the right time for long-term investors to build positions in fundamentally strong foreign bank stocks that are looking dirt cheap now. Here are a few stocks that have been witnessing positive estimate revisions and carry a favorable Zacks Rank:

Currently, our foreign bank universe includes Zacks Rank #1 (Strong Buy) stocks like Banco Macro S.A. ( BMA ) and Erste Group Bank AG ( EBKDY ).

The stocks carrying a Zacks Rank #2 (Buy) are Deutsche Bank AG ( DB ), Mitsubishi UFJ Financial Group, Inc. ( MTU ) and Mizuho Financial Group, Inc. ( MFG ).

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BANCO MACRO-ADR (BMA): Free Stock Analysis Report

ERSTE GROUP BNK (EBKDY): Free Stock Analysis Report

DEUTSCHE BK AG (DB): Free Stock Analysis Report

MITSUBISHI-UFJ (MTU): Free Stock Analysis Report

MIZUHO FINL-ADR (MFG): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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