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Equities: are European banks a value trap?

Value shoppers have long eyed up the continental European banking sector, which has languished in comparison to the US. However, as the economy has sprung back to life, so have European banks.

The darling buds of May...

Even as growth in the continental European economy plateaus, there is evidence of increased demand across corporate lending, mortgages and consumer credit.

It may be some time before the central bankers help with higher interest rates, but maybe not as long as the market currently expects. Loan growth will help profitability, and loan loss provisions will continue to tick lower.

Wanted: nerves of steel

There is a distant possibility of renewed M&A. Over the last decade, the cumulative deal value among European banks has amounted to up to about a fifth of the value in the previous eight years. The reasons for this include regulatory and supervisory hurdles, the low growth environment and the lingering stock of nonperforming loans (Figure 1).

Non-performing loans are a hindrance to bank profitability

The highly fragmented regulatory framework in Europe remains a formidable barrier to cross-border deals. Some within- border M&A deals are possible and indeed necessary to reduce the considerable excess capacity in the region. However, this carrot is probably something for the more patient among you.

All in all, the sector is attractively priced (Figure 2) but risky. Steel nerves and patience are required, but likely to be rewarded in our view.

European banks look actively priced

Our Investment Themes 2018

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