We are positive on the outlook for the European banking sector for the second half of this year and beyond. Our bullish view centres on an improving macro-economic backdrop in the Eurozone. The European Central Bank (ECB) has had a major economic stimulus programme in place for some time, through what is known as Quantitative Easing. This has meant buying €60bn of bonds on a monthly basis. We currently anticipate a tapering of this buying programme before the end of 2017, as the Eurozone economy continues to strengthen.
In June 2017, the ECB revised its economic growth projections higher for the Eurozone out to 2019. When this period of monetary policy tightening in Europe eventually arrives it should lift European bond yields, which in turn should support an expansion of European banks’ Net Interest Margins (NIM) as yields on assets and loans should rise at a quicker pace than rates paid on cost of funding, mainly deposits.
The European banking sector has had to contend with significant regulatory cost increases over the past decade, and increased regulatory requirements. Tight cost controls are at the centre of most European banks strategic targets in an effort to improve Return on Tangible Equity (RoTE) calculations which have been under pressure within a lower for longer yield environment. Most banks are actively engaged in updating legacy IT platforms to improve operational efficiencies and lower their Cost/Income ratios over the medium term, which requires an upfront investment with the benefits to accrue over time. The new normal target range for Return on Tangible Equity (ROTE) for European banks is between 10% to 12%, which is lower than returns achieved prior to the financial crisis. Many European banks have restructured their operations in recent years, and are looking for this process to bear fruit in the near future. The European banking sector should also be a key beneficiary of reduced political risk in, and capital inflows into Europe. We also think sentiment toward European banks should improve if future inflation expectations rise, yields increase and economic forecasts for the Eurozone are revised higher.
The Cantor Fitzgerald Ireland Euro Financials Kick Out Bond is a 5-year investment with the potential to redeem every 6 months after year 1, with a fixed bonus payment. Potential payments are linked to the performance of 4 leading European financial stocks: BNP Paribas SA, Societe Generale SA, ING Groep NV and Banco Santander SA. Each of these banks is currently A-rated by major credit rating agencies.
The Euro Stoxx 600 European Banking Index also offers an attractive dividend yield of 4.76% for 2018. The average dividend pay-out ratio for the 30 largest banks in Europe in 2018 will be in the region of 52% according to Bloomberg, making financial stocks an attractive income investment. In recent quarters European banks have stepped up dividend payments which are a sign that domestic regulators’ confidence in each bank’s balance sheet is strengthening. The broader European banking sector currently trades at 0.91x FY17e Price/ Book and 12.2x Price/ Earnings. Capital management is a top priority for all banks and capital positions have strengthened materially in recent years with a sector average of roughly 13%. There is a broad regulatory focus from the ECB on banks reducing outstanding levels of Non-Performing-Exposures (NPEs). If the outstanding balances of NPEs reduce, the market should assign a higher valuation metric to the banking sector in the future.
To speak with a Portfolio Manager or Account Executive, phone the Cantor Fitzgerald dealing desk on 01 633 3633.
Click here to download our September Investment Journal.