Standard Life Investments

Through the Lens

Focusing on the fundaments in Europe

  • Finding non-consensus views in the European banking sector
  • Italy’s reformist government is creating exciting opportunities for investors
  • Merger & acquisitions set to rise

Global equities represent the widest and most diverse set of investment opportunities, boasting thousands of investible companies. One area of particular interest is the European banking sector. Here, the prevailing consensus is that changes occurring within the industry are largely negative. This is understandable. After the global financial crisis, we have seen relentless regulatory pressure on banks, including demands that they raise evermore capital. We have also witnessed numerous lawsuits and headline-grabbing fines. Government policy – no doubt drafted with disgruntled voters in mind – has also been fairly punitive. Investors are, as a result, naturally cautious towards the sector. European bank valuations reflect this restraint.

Banking on banks?

Time to avoid European banks, then? We think not. Despite the challenges facing the sector, we continue to find numerous non-consensus investment opportunities. For one thing, given regulatory pressures, numerous banks have grown their capital bases, often suspending dividend payments in the process. This means that many are in stronger capital positions. Litigation issues have also largely been resolved. Many have exited legacy assets and business lines, and instead refocused on their core strengths. These include corporate banking, consumer banking and wealth management. In addition, thanks to greater cost discipline, top-line growth is now leading to stronger operating leverage.

Back to basics

Take UBS. Under its new management, it has exited a number of business/product lines to concentrate on its core areas of strength. This includes global wealth management, where it has one of the strongest brands in the world. Here, invested assets have grown 8% per year, with that figure higher in the Asia Pacific region. UBS has also increased its margins, primarily by offering value-added services to its high-net-worth clients.

Meanwhile, UBS has bolstered its capital base, becoming one of the best capitalised banks in the world. Costing-cutting measures are also starting to bear fruit. As a result, it is once again becoming a high-quality, growing financial services businesses. The market, however, has been slow to recognise this change.

The Italian job

In general, governmental policy towards banks has been unfavourable across Europe. However, some measures have had positive implications. In Italy, for example, an ambitious, reformist government programme has seen changes to bankruptcy regulations, privatisations, consolidation of fragmented regional banks, and greater economic openness.

This should spell good news for the country’s banks. For instance, in the past, the bankruptcy process was slow, cumbersome and frustratingly ineffective. Cases could take up to seven years to resolve. Under new rules, however, this process has been cut to around two years, saving costs and time. Such conditions also make lending to businesses more profitable, while increasing the value of existing ‘bad loans’. A bank to highlight here is Intesa Sanpaolo, where we expect to see an improvement in its earnings and valuation as a result of these reforms.

M&A on the rise

Another beneficiary should be Mediobanca, Italy’s leading mergers & acquisitions (M&A) advisor. Last year, M&A deals volume in Italy totalled only €79 billion of M&A, compared to €500 billion in 2007, and a 15-year-average of €153 billion.

However, improving business confidence, low interest rates, privatisations and regional bank consolidation could lead to a flurry of M&A deals. Mediobanca will no doubt benefit from this resurgence in activity. As a result - and thanks to its good cost discipline - we would hope to see the bank’s profits rise.

Despite market volatility over the past few months, there are still a number of exciting stock-specific investment opportunities within global equities. We will continue to focus on finding investment ideas where we believe companies are undergoing a positive change that is underappreciated by the market.