3 European Banks: A Review

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Stocks of Europe’s biggest banks have outpaced Europe’s most important market indices in the past year. This out-performance happened while the banks were working towards strengthening their balance sheets to abide by newly implemented Basel III rules. Some of these banks have been restructuring their operations by shrinking their workforce and businesses. Spanish banks are fiercely competing for market share in their home country to manage their liquidity in a sluggish economy. Their exposure to Spain’s real estate sector prompts the question of whether there could be big impairments in their equity values, since non-performing assets could be wrongly valued. The following are some cases worth mentioning.

Focusing on wealth management

UBS (NYSE: UBS) is one of Switzerland’s biggest banks. It is implementing strict cost discipline and headcount reductions. Also in line with its new business model, the management team is focusing on net new money growth in its wealth management and investment banks businesses, which delivered strong results for its first quarter. UBS’s CEO stated recently that there’s no need to raise more capital. The company’s efforts have allowed it to be well positioned ahead of Basel III required capital ratios, providing the Swiss bank some cushion to be priced above its book value, richer than the industry’s average multiples.

The bank has reduced its charges from litigation in its last quarter, contributing to its recent earnings improvement. Nevertheless, new reports stated that it will be under investigation by French authorities to verify if the bank helped French citizens evade taxes.

Focus on emerging markets

Banco Bilbao Vizcaya Argentaria (NYSE: BBVA) is Spain’s second-biggest bank. BBVA’s main issue is its exposure to Spanish real estate loans. One of the management’s main objectives is to lower this exposure, which has mildly declined in the first quarter. BBVA is also trying to reduce its liquidity gap in Spain, looking for new clients in a very competitive and economically difficult environment. Although its loans and deposits grew this last year, the bank is experiencing an uptick in non-performing assets.

Also, to manage liquidity, BBVA placed a €4.500 million debt on several markets in the first quarter. This amount is not worrisome, as it represents a 3% of its total debt amount and as BBVA has maintained a steady relationship between debt and assets. A third of its revenue is concentrated in Europe, while a total 58% is concentrated on emerging markets. This provides the bank with satisfactory regional diversification, although it has experienced some negative currency effects in the last quarters on its income statements.

Focus on dividend sustainability

Banco Santander (NYSE: SAN) is working towards normalizing its profits, but is having pressure on its revenue due to macroeconomic context. The Spanish bank is de-leveraging its business and divesting units to strengthen its capital, while putting efforts into attracting new deposits to improve its liquidity. This last strategy hasn't had a positive impact on the bank’s funding yet. Santander’s non-performing loans have been increasing in the last year, showing the deterioration of asset quality, justifying the discount in book value multiple valuation the bank is reflecting nowadays.

One of the main questions is whether the bank can maintain its current dividend yield, which is above 8% and higher than its peers’. This yield sustains part of its current valuation, amid the uncertainty surrounding its core operations.

Bottom line

Although UBS appears to be enjoying a turnaround in its operating inefficiencies and to have solved its capital problems, it would be wise to have more insight into its potential new litigation with the French authorities.

It would be wise to avoid Spanish banks until there’s a clearer view on the housing market and its impact on banks’ loans, although both Santander and BBVA have big exposures to emerging markets and have globally diversified portfolios. BBVA is a good bet for a recovery in Spain’s economy if the bank continues to reduce its exposure to the country’s real estate, while Santander showed more pressure on its operations that could hurt its high dividend yield, its main attraction in comparison to its peers. Both banks are trading at a discount with respect to their book values, justified by current uncertainty regarding their non-performing loans.

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