Non-U.S. Banks Stock Update - Feb. 2011 - Industry Outlook

Aided by worldwide regulatory reform, the global banking industry has reached a phase of a transformation in 2011. Since 2010, the industry has been recovering at a moderate pace from the worst financial crisis in history that started as a credit issue in the subprime enclave of the U.S. mortgage market in mid-2007 and spilled over to every corner of the globe.

Though the malice spread by the financial crisis is behind us, banks are now dealing with regulatory pressures now that they have been rescued by taxpayers’ money and government intervention.

While non-U.S. banks are still facing liquidity and confidence challenges, government intervention to alleviate industry concerns have significantly raised political hurdles in the sector over time.

Politics will continue to influence lending decisions of banks until they repay the government money. 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.

As the industry is adopting tougher regulatory measures to prevent a recurrence of the global financial crisis and restore public confidence, there will be continuous pressure on the individual capital structures of banks. However, we believe this would be the perfect time for mid- to long-term investors to consider non-U.S. bank stocks, as valuations are now comparatively cheap.

Investors with short-term targets, however, should be very careful while choosing non-U.S. stocks at this point as near-term fundamentals remain weak; asset quality lacks potentiality to 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.

Though high unemployment and sluggish business conditions worldwide are expected to dampen demand for credit, banks are now capable of lending more. Despite top-line pressure from sluggish economic recovery, the mid- to long-term outlook for non-U.S. banks remains encouraging, given gradually growing loans, accelerated consumer lending and improving deposits.

Although the upturn in the banking sector through the first half of 2011 will vary from country to country, depending on industry circumstances, we believe that banks in emerging economies — Chile, Brazil or India — might make more attractive investments, akin to our expectations from certain regional banks in the U.S.

The same, however, cannot be said of European institutions. In early 2010, the debt crisis originating in the Greek economy shook the stability of the European Union’s (EU) monetary policies. Starting as a solvency crisis in a single country, the turmoil threatened the entire Euro-zone.

Greece adopted measures to minimize government spending and stress test results were largely reassuring, but there is no guarantee that the country is out of the woods as affluent domestic and foreign investors will not stop withdrawing their money from Greek banks anytime soon. Also, rising inflation will force regulators to tighten their policies in the Euro zone, making banks less flexible.

The European Union is in the process to restore confidence of investors and health of the European banking system, but the issue is far from fully addressed.

Quite obviously, banks in emerging economies will face asset quality issues. However, they are not plagued by other significant problems that many of the larger banks face in continental Europe and the United Kingdom, such as toxic securities and dilution from capital raising. Moreover, these emerging-market banks generally tend to be well capitalized, aren’t as heavily exposed to property markets, and have significant and growing sources of non-interest income.

Banks are finally learning from the crisis. In 2010, banks in emerging economies performed remarkably well in serving as a stabilizing force in global economic recovery.

Overall, a key determinant for 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 banking performance.

Also, the primary attention of policymakers should be on determining how much longer the fiscal stimulus should continue, ensuring that it is not withdrawn before a clearer sign of economic recovery is visible.

OPPORTUNITIES

Currently, financial institutions in the non-U.S. bank universe with a Zacks #1 Rank (Strong Buy) are BBVA Banco Frances S.A. (BFR) and Bancolombia S.A. (CIB). Banks that we like with a Zacks #2 Rank (Buy) include Banco Bradesco S.A. (BBD), Banco Latinoamericano de Comercio Exterior, S.A (BLX), Banco Macro S.A. (BMA), The Bank Of Nova Scotia (BNS), Barclays PLC (BCS), Canadian Imperial Bank of Commerce (CM) and Mitsubishi UFJ Financial Group, Inc. (MTU).

There are currently a number of stocks in the Zacks covered non-U.S. bank universe with a Zacks #3 Rank (Hold), including Banco Santander-Chile (SAN), Deutsche Bank AG (DB), KB Financial Group, Inc. (KB), HSBC Holdings plc (HBC), Royal Bank of Canada (RY) and Royal Bank of Scotland Group plc (RBS).

WEAKNESSES

We would suggest avoiding banks in Greece at this point. Also, it is better to steer clear of banks in Great Britain and Ireland, particularly those that have participated in government recapitalization programs and are still to reimburse the money. In return for government capital and asset quality protection, these banks are facing regulatory intervention, like enforcing limits on dividend payouts and board member nominations.

Currently, there are a number of stocks in the Zacks covered non-U.S. bank universe with a Zacks #4 Rank (Sell), including Banco Bilbao Vizcaya Argentaria, S.A. (BBVA), Banco Santander, S.A. (STD), Bank of Montreal (BMO), Credit Suisse Group (CS) and ICICI Bank Ltd. (IBN).

Non-U.S. Banks Stock Update – Feb. 2011 – Industry Outlook

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