Australian investors have long favoured the domestic banks. Aussie banks, insulated from real competition by the “four pillars” policy, have provided investors with strong returns for years.
However, underlying revenue growth for the major Australian banks has decelerated somewhat over the last few years, driven by moderating customer demand in a lethargic economy, increasing competition and significant regulatory activity – including the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. It is likely that this trend will continue over the medium term as the effects of regulatory change impact key product markets as well as operating conditions.
In light of these domestic developments, investor appetite for global banks and financial institutions is increasing. There are attractive investment opportunities in some of the largest and most dynamic banking institutions globally. Most importantly, many global banks are significantly cheaper than their Australian counterparts and exhibit better growth potential over the medium term.
Macrovue’s investment committee have analysed three global banks that show strong signs of future growth. They’ve also examined the European banking sector and it’s recent lacklustre performance. An excerpt from their research is below.
DBS Group (SGX: D05)
DBS Group Holdings Ltd., Southeast Asia’s largest bank, announced last month it is expanding its fixed-income business in China in a bid to capture more of the lucrative first-time bond issuers underwriting business. DBS bank recently set up a debt capital market product and advisory team in China to focus on getting more local clients. It will be run by three senior bankers in Shanghai and Beijing.
Analysts expect that China’s need for debt financing will continue to grow, driven by factors such as the country’s rising bank capital and the need for infrastructure financing. Chinese borrowers have been the dominant force for Asia’s dollar bond issuance, making up about 60 percent of the $198 billion of notes sold so far this year.
DBS currently ranks 10th among the bond managers with 81 bonds, of which more than half are from Chinese companies. Given that China is gradually opening up its financial markets and there is demand for foreign funding amid a deleveraging campaign that has kept local borrowing costs elevated, DBS timing appears appropriate.
DBS Group has returned +43.61% (AUD) in the year to 30 September 2018.
Bank of America (NYSE: BAC)
Bank of America released earnings results on 16 October 2018. Bank of America’s third-quarter profit rose 32%, as higher interest rates and last year’s corporate tax cut continued to lift bank earnings. BAC generated a quarterly profit of US$7.167 billion, versus US$5.424 billion a year ago. Q3 GAAP EPS of US$0.66 beat consensus by $0.04. Revenue of US$22.78B (+4.3% Y/Y) was US$150M ahead of estimates.
Profits rose in all of the bank’s major business segments, but retail banking and wealth-management units were the greatest contributors to the overall result. Investment banking was a bit lacklustre. A solid result overall from America’s second largest bank (by assets).
Bank of America has returned +28.14% (AUD) in the year to 30 September 2018.
China Construction Bank (HKG: 0939)
The People’s Bank of China (PBOC) announced on Sunday 7 October 2018 a 100 basis points cut to the reserve requirement ratio (RRR) for most banks, which will result in an injection of 750 billion yuan (US$109.2 billion) in cash into the Chinese banking system. The main implication for China Construction Bank and its peers is that it will lower China banks’ funding costs.
RRR cuts are the cheapest means of liquidity supply from the PBOC and carries a much lower cost than Open Market Operations or OMOs (1-yr Medium Term Funding or MLF rate is 3.3% vs. required reserve rate of 1.62%). Replacing medium term funding with lower RRR will effectively lower the funding cost for banks and the financing cost for real economy, thus reduce the risk of a potential non-performing loan (NPL) rebound.
A more stable funding source for banks via permanent injection of base money to replace the periodic MLF liquidity injection should help lower liquidity risk and encourage credit extension into the real economy. Also, it is a positive for bank earnings by improving net interest margins (NIM) as well as easing asset quality risks.
China Construction Bank has returned +19.79% (AUD) in the year to 30 September 2018.
European banks showing potential
Up until May, European banks stocks were performing more or less in line but a lack of recovery in retail banking has pressured the group. Interestingly, while European banks Price to Book ratios are approaching GFC lows, sector profitability is not.
Most industry observers predict that Euro Bank returns on tangible equity (ROTE) metrics are steadily improving. In fact, analysts expect them to increase from 7.0% in 2017 to 8.2% in 2018E and 10.6% in 2020E. Improvement will be driven by better revenues (growth recovery, potential ECB rate hikes), lower costs (restructuring / falling one-offs) and slightly lower credit costs.
Thus, given attractive valuations (Societe Generale trades at only 7.5 X 2019 EPS and has a 6.5% yield, while Banco Santander has a PE of 8.0X 2019 EPS and has a 5.5% yield) and potential for improving profitability in 2H 2018 and into 2019, we believe European banks are worth consideration.
You can invest in these companies directly through Macrovue’s Bank On It Vue.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual and does not constitute financial advice. Consider the appropriateness of the information in regards to your circumstances.
1 Past performance is not a reliable indicator of future performance.