Tuesday, January 3, 2012

European Bank Stocks Oversold?

     When European-debt exposed Intesa Sanpaolo and Societe Generale begin showing any signs of growth you know they've reached rock bottom. As you can see in the months leading up to November 24, 2011 Europe's twelve largest financial institutions were in a free fall, granted Canadian and Australian banks were also losing value but not nearly as fast. In the month of December top European banks nearly matched their Canadian and Australian counterparts (I use Canadian and Australian banks as the reference because they performed ok during the economic crisis and are in an enviable position rating-wise, though some like the Royal Bank have risk exposure). The comparable growth in capitalization as measured in US dollars, over the six weeks leading to January 3 even takes into account exchange rate effects and the strong US dollar. Before jumping in however, take caution; On December 15, 2011 UBS, Credit Suisse, Barclays, BNP Paribas, and Societe Generale were all downgraded by Paris based ratings agency Fitch Ratings. Before deeming that too great a risk keep in mind that those banks are also on the g20's list of 29 too big to fail financial institutions (5 of the 8 banks downgraded are European) taking away some of the perceived risk. What does too big to fail mean exactly?
Financial institutions whose distress or disorderly failure, because of their size, complexity and systemic interconnectedness, would cause significant disruption to the wider financial system and economic activity. To avoid this outcome, authorities have all too frequently had no choice but to forestall the failure of such institutions through public solvency support. As underscored by this crisis, this has deleterious consequences for private incentives and for public finances.
The g20 made the list in part to put pressure on the banks to increase their loan loss reserves. Have they done it yet? We'll find out in their 2011 annual reports which will be coming out over the next couple months. I'll report on that when they come out. European banks typically leverage about 80 times (debt used to acquire additional assets), that puts the EU in a more preciarious situation than the Canada or Australia (in the US leverage is typically 40 times).

Strength in the European market: Societe Generale gets 20% of its net banking income from less risky Russia.
For Credit Agricole cost of risk didn't increase between 2010 and the 3rd quarter of 2011.
Deutsche Bank profited 3.985 billion EUR in the first nine months of 2011. In stark contrast, it lost 612 million EUR in the second half of 2010. One thing to remember about Deutsche Bank though is that it waited until the quarter ended December 2010 to hand out a dividend of 75 cents per share. It could do the same again this year considering the company reported no losses in 2011 (pending last quarter).
Strength in the Canadian market: Canada’s top six banks currently offer a dividend yield of 4.69 per cent (average). The S&P/TSX Financial Services Index which closed at a 14-month low at the end of November, is 75% weighted in Canadian bank stocks. Canadian banks don't have much direct exposure to European debt but their stock performance seems to be tied to the situation in Europe.

BNP Paribas is by some measures the largest of the European banks (assets especially) but be warned, as of the 3Q of 2011 it had over 14 billion euro worth of soveign debt exposure in Italy (12) and Greece (2) alone. European Stability Fund bonds are not attracting as much investment as anticipated and that affects BNP's situation. If you want to invest in EU banks but want to take a less riskier approach, check to see if they own any credit default swaps (CDS): contracts made with insurance companies who have agreed to take on losses incured by the institution in the even of a credit situation (country defaults and the bank is left holding worthless bonds).

Other things to keep in mind: (from a previous post of mine)
During the month of October 2011 in Brussels, Belgium, European leaders alongside the IMF negotiated with the financial institutions that own Greek debt in the form of bonds. They struck a number of key agreements the main one being a reduction in the value of Greek bond debt by half (banks take on the 50% loss on the nominal value of those bonds) wiping out $100B worth of debt commitments, bringing debt to a more managable level (120% of GDP down from 160%). Some of the insurers affected such as France's Groupama (wrote 2 billion euro worth of CDS) could bear an even greater burden due to their issuance of credit default swaps (CDS contracts) which they'd have to honour if it's determined that a credit event has taken place (unlikely though given that the deal was not forced on either party). CDS contracts on Greek debt stand at $75 billion up 50% since 2009. To woo insurance companies, the EU made available to it a €30B+ credit.


  1. That is so true Seraphim. As an author and business man, I can relate to how you said "The S&P/TSX Financial Services Index which closed at a 14-month low at the end of November, is 75% weighted in Canadian bank stocks". I hope more people discover your blog because you really know what you're talking about. Can't wait to read more from you!

    1. that index does present investment opportunity :) I began writing the article trying to get one point across, that European banks are undervalued (even considering the risk) but now I think it's Canadian banks too especially considering the big ones like Royal Bank are still paying big dividends with TD's actually growing (TD 68c quarterly, RBC 54c quarterly not bad but number 4 bank of Montreal paying the most at 70c is a surprise) while the major European ones like Banco Santander stopped paying anything 12 months ago. Remember also that big US players like BOA and CITI pay little if anything.
      Thanks for the compliment. I'm also working on my other site too (northamericaninterests.ca) but will still try to get at least 4-5 new posts here on the blog per month. Congratulations on your book, I look forward to reading it someday.