ETF Securities Research Blog

European banks remain a value trap

Now that the majority of banks in Europe have reported for Q2 we have an idea on the health of their balance sheets. European banks look cheap at present, but are probably a value trap.

Non-performing loans (NPLs) are helpful in this respect, when they are high and rising, banks tend to be in balance sheet repair mode and not undertaking their usual business of lending. Across Europe the picture is still bad with NPL’s averaging 5% as a percentage of total loans, much higher than their US peers which average 0.9% and the UK at 2.6%.

BanksNPL

Crucially, they are moving in the right direction, having peaked in the first half of 2014 at nearly 10%, consistently declining each quarter. Looking on a country-by-country basis all countries within Europe have also demonstrated falling NPLs with the exception of Austria and Norway. Encouragingly, we have also seen loan growth suggesting European banks are getting back to their usual business of lending.

So why has it been a bloodbath in banking sector performance recently? The STOXX Banking sector has fallen 28% since the beginning of the year, versus the broader market falling only 5.6%.  Italy, Ireland and Greece have high NPLs of 15%, 15% and 38%, respectively and whilst they have been declining in recent quarters they remain at alarming levels. Nine out of the 11 core banks in Italy have NPLs above 14% of total loans, problem banks also exist in Austria with two banks having NPLs over 11% and 21% respectively whilst a couple of banks in Spain are in a similar situation too.

To exacerbate the problem, the introduction of the negative bank deposit facility by the ECB has left investors very concerned about bank profitability as it is challenging for them to pass on those costs to deposit holders. Consequently, earnings and return on assets since the beginning of the year have been deteriorating in Europe.

BanksROA

Furthermore, European banks have been in the habit of regularly diluting their shareholders since the credit crisis, in contrast to their American peers, the continued threat of dilution is leaving investors reluctant to own them.

BanksShares

European banks look cheap at present, but are probably a value trap until regulatory burdens are addressed, shareholder dilution and bail-ins cease and NPLs fall to levels in line with their international peers.

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