Marathon-London has had a longstanding antipathy to European banks. Thankfully so – they have been the worst performing sector over the last ten years. The justification for this negative stance has been rehearsed a few times in this review: a lack of a level playing field in some countries (most particularly Germany) has depressed banking profitability, whilst little progress towards banking union has meant that banks cannot harness continent-wide economies like their US counterparts. Balance sheets have been in constant need of strengthening due to the global financial crisis (GFC), eurozone sovereign crisis and litigation/regulation, whilst, more recently, dividends had been banned in a sector whose investment attractions are often driven by yield considerations. In addition, negative interest rates have not provided a favourable environment for earning net interest income. All of the above factors are, however, reversing, and Marathon-London has gone fully weighted for the first time.
Given Marathon-London’s capital cycle approach, the sudden lack of equity dilution in the banking sector is a very positive factor. Banks issued fresh capital constantly in the period 2007-18, to the tune of about €600bn, to cover losses from the GFC and the later eurozone sovereign crisis. Heightened regulation and supervision also required considerable recapitalisation. However, despite the pandemic, there has been no net capital issuance since 2018, and indeed in 2021 the sector is expected to be a net retirer of capital – something that would previously have been very out of character for European banks.
Aside from a refreshing change of attitude from managements, capital buffers have been significantly exceeded as covid-related provisioning and suspended dividends have led to excess capital build up. The common equity tier 1 ratio was around 15.3% at the end of Q2 – very strong.
One of the main reasons for the improvements in capital ratios has been the reduction in non-performing loans: at the end of Q1 only 2-3% of overall loans were impaired. Indeed, in Q1 credit losses fell by 58% YOY. Any meaningful cross-border consolidation, as mentioned, has failed to materialise due to the lack of progress in European banking union; however much more synergistic in-market mergers continue and have, if anything, accelerated as a result of the improving outlook. Caixa took over
Bankia in Spain last year, whilst UniCredit now looks likely to assume control of Monte dei Paschi in Italy. In Ireland, effective consolidation continues with AIB assuming Ulster Bank’s loan book and BOI buying KBC’s loan and deposits books. Even in Norway, DNB has recently agreed to acquire Sbanken (the largest independent digital bank there).
Another previously negative factor that has started to reverse is the shape of the yield curve. The relentless decline in long yields has weighed upon net interest income for several years now, but there are signs that this process has stopped and is beginning to reverse. Inflation expectations have risen, albeit by a relatively small amount, whilst long rates have also broadly moved higher. Bank reports generally show slightly improved net interest margins, although the big improvement is coming from fee activity and from an increase in loan growth.
The European banking sector has performed very strongly over the last several months as a result of the above factors and, after autos, is the best performing sector in Europe over one year, rising by some 49% in local terms. However, over the longer term it has still performed poorly. It is interesting to note that despite recent strong performance, the sector looks very cheap on a price to earnings relative basis at or near 20 year lows, whilst on a price-to-book basis versus US banks, the sector stands at a 50% discount.
Overall, European banks have never looked so compelling with positive cyclical, structural and behavioural indicators all aligned. Ironically, the discipline enforced by the authorities during the pandemic has played into the hands of the banks and the immediate post-covid era should be something of a golden period. Of course, they will still be vulnerable to some of the structural handicaps they have faced in the past; however, it seems, at long last, time for Marathon-London to start feeling the love.
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Performance data shown represents past performance and is no guarantee of future results.
All charts and data are for illustrative purposes only. Views expressed herein are those of Marathon-London Asset Management, LLP and may not be reflective of their current opinions or future actions, are subject to change without prior notice, and should not be considered investment advice.
The information provided in this presentation is for informational purposes only. The information provided in this article should not be considered as a recommendation to purchase or sell a particular security. The weightings, holdings, industries, sectors, and countries mentioned may change at any time and may not represent current or future investments.
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