“Banks are under siege,” Vítor Constâncio, the vice-president of the European Central Bank, warned an audience at a Spanish university in early July. If that stridency is unusual in a central banker, the comments were outdone last week by the chief executive of Credit Suisse. Tidjane Thiam told a conference that European banks are “not really investable as a sector”.
The two sets of remarks might appear more puzzling given they bookended the best quarterly performance for shares of European banks since the start of 2015. In the third quarter, the Stoxx Banks Index climbed 11.2 per cent, leaving the wider market trailing.
Zoom out, however, and each remark appears less quixotic. Since the start of 2009, the same bank index is down 37 per cent compared with an advance of more than 70 per cent for the Stoxx Europe 600, Europe’s benchmark equity index. Indeed, over the past decade Europe and banks are the worst-performing combination of geography and sector of 285 tracked by Citigroup.
“They [European banks] have been the lightning rod for any bad news around the world. Not just European risk but global risk,” says Jonathan Stubbs, European equity strategist at Citi. The sector is the “the world’s biggest contrarian trade”, according to the US bank.
That eurozone banks can be framed in this way underlines the longstanding scepticism investors have of an industry upended by successive crises and then, more recently, by the ECB’s response to the anaemic growth and inflation that has followed.
The ailments afflicting the region’s banks are wearily familiar. Their return on equity (RoE) — a common measure of a lender’s performance — have been hit by regulators’ demands they hold more capital. Technology is loosening their grip on core activities such as payments, while banks blame the ECB’s adoption of negative interest rates for corroding profits.
The Stoxx Banks index of 26 members has an average price to book of 0.55, a figure that illustrates the dim view investors take of the sector’s current asset quality.
On their own, each might be a sore that can be overlooked. Together, though, they pose existential questions for investors considering buying European banks.
With more regulation and heavier capital requirements, should investors begin to see once freewheeling banks as more like utilities — less flashier returns but potentially more stable. And is there really a logic to betting on banks whose lending business is under threat from central bank policy?
For those struggling with such conundrums the simplest answer so far has been: go underweight or sell. “It’s a sector where sentiment is quite negative; ownership isn’t high; valuations are discounting a long period of low profitability,” explains Paras Anand, head of European equities at Fidelity International.
However, given that financials account for more than 10 per cent of the value of the Stoxx Europe 600, Europe’s benchmark equity index, there are pressures — and incentives — for money managers to gain exposure to the banks with better prospects while skirting the most troublesome.
One option is to avoid nations whose banking industries are saddled with particular problems.
For most, this means Italy and Germany. “Italy’s problems are more of a cyclical nature,” says Philippe Bodereau, global head of financial research at Pimco. “In Germany the concern is that banks don’t have strong domestic businesses to rely on.” The latest squall over the health of Deutsche Bank shows angst about Germany remains real.
They are in a minority camp, but some investors are already betting the worst is over for eurozone banks. Rising inflation, runs the argument, will send long-term bond yields higher, easing some of the pressure on banks used to turning a profit from a steeper yield curve.
“It shouldn’t be much more than six months and we’ll see inflation,” says James Sym, who manages a European equities fund at Schroders and is bullish on the region’s banks.
If low inflation and low interest rates — two of investors’ governing assumptions about the eurozone in recent years — are challenged, then a sharp reversal in banks’ share prices is a possibility. “If we don’t see overwhelmingly bad news realised, there is a significant repositioning risk,” says Mr Stubbs of Citigroup.
Even so, few investors yet appear willing to embrace the contrarian trade. Years of underperformance may create a buying opportunity, but it also leaves scars.