Value Column von Hans Peter Schupp

4. OCTOBER 2022

„Many banks are coming through the crisis better than feared!“

The economic downturn is a reality. As a result, banks‘ risks are also coming more into focus, especially the extent of looming loan defaults. These could strain institutions‘ equity capital, forcing them to lend less and thus exacerbating the downward spiral of the economy. This could lead to a storm of considerable proportions. There are several reasons why we are nevertheless overweight in banks and financials in general: First, Europe’s banks are in a better position than during the last crisis, then valuations speak for financials, and last but not least, rising interest rates. But first things first.

Conditions for banks are much better than in the last crisis

First, let’s look at the underlying conditions. Banks in the STOXX 600 Banks Index have outperformed the broad market by about nine percentage points year-to-date, down 9.3 percent. Despite the low expected P/E valuation of 6.7 – which is 36 percent below the average of the past 20 years – investors are wary of the sector. After all, stock market wisdom says never to buy credit institutions into a recession. But this could be deceptive in the current environment. In the past three months, analysts have significantly raised their earnings expectations for the current year and for 2023, by 8.8 and 5.3 percent respectively. The reason for this is the expectation of rising interest rates, which will accrue on 6.2 trillion euros in deposits and increase banks‘ revenues by around 160 billion euros. At the same time, banks are better prepared for a downturn than in the past. As Deutsche Bank calculated, the proportion of non-performing loans is around 70 percent lower than in 2009, while the hard core capital ratio is six percentage points higher at 15 percent. In addition, the fiscal packages now being launched in the Eurozone countries should mean that a really deep recession will not materialize and loan defaults will remain within bounds. With our „Contrarian Value Euroland Fund“, we are mainly invested in Western and Northern European banks and insurance companies, because these have positioned themselves „weatherproof“ compared to Southern European institutions in recent years, and are thus better positioned for the coming stormy times.

Valuations are lower than they have been for years

Let’s talk about valuations. As value investors, we always look for cheap, or even undervalued stocks. And many banks in Euroland are clearly undervalued. Just two examples: Deutsche Bank, for instance, has a 2023 P/E of around 4.3. And the price-to-book ratio is around 0.3, which is very cheap. At BNP Paribas, the expected P/E ratio is below 3, while the P/B ratio is around 0.8.

High and rising interest rates boost business

Let’s turn to interest rates. There is a high correlation between interest rate development and the performance of bank stocks. This has been shown in the past. However, the market currently fears that even more aggressive interest rate steps by the ECB could stifle the economy too much. So the market is already pricing in the worst-case scenario for banks. The reasoning: What good are high interest rates if customers become unemployed as a result of a recession and can then no longer pay back their loans? This was the case in the 1970s, for example, when the oil crisis caused inflation to rise and interest rates were subsequently increased – with the corresponding negative consequences for growth. At that time, many people lost their jobs.

„Scrapes yes, but no bad wounds“.

But we expect bank stocks to be among the few immediate beneficiaries of tighter monetary policy. For many years, banks suffered from zero and negative interest rates. Their share price performance was correspondingly weak. Now that interest rates are rising again, the trend should actually be reversed. Of course, banks will also suffer in the coming recession months. However, in our view, they will only „get scratched“, but not suffer any serious injuries. They have simply positioned themselves too well for that in the past.

The author: Hans Peter Schupp is a board member of FIDECUM AG and portfolio manager of the Contrarian Value Euroland fund.

Translation for convenience only!