Foreign Banks Stock Outlook - January 2018

What Lies Ahead for Banks in Key Nations

Investors’ optimism over the likely easing of political instability post French election, economic growth and the expectation of higher interest rates, which allow banks to thrive, pushed European stocks higher in the first six months of 2017. But the enthusiasm waned in the second half of the year and the stocks lost ground. Shares of some of the major European banks — including Barclays (BCS - Free Report) , Deutsche Bank (DB - Free Report) and Credit Suisse (CS - Free Report) — have underperformed the S&P 500 over the past year.

However, while the sector is still grappling with huge bad loans and an ultra-low interest rate environment, efficient expense management and better business in emerging market operations have helped many European banks report improved results in the in the last three quarters.

No major support to top line is expected from the rate environment anytime soon, and the pain of bad assets on balance sheets will continue. Yet, favorable capital market activity and reducing non-core losses should help European banks show some bottom-line improvement in the quarters ahead.

The prospects of banks in Japan remain uncertain, with the central bank keeping its interest rate unchanged at negative 0.1% at its December 2017 meeting and not hinting at future rate hikes. In fact, as inflation remains way below the targeted 2%, chances of any rate hike in the near term are dim. This will keep putting pressure on the commercial banks’ interest income. While the economy is expanding moderately, it’s unlikely to materially support the banking system by offsetting the damage caused by the negative rate environment.

Among the top three Japanese bank stocks — Mitsubishi UFJ Financial Group (MTU - Free Report) , Mizuho Financial Group (MFG - Free Report) and Sumitomo Mitsui Financial Group (SMFG - Free Report) — two have underperformed the S&P 500’s 24% gain over the past year. While Mitsubishi UFJ has rallied 24.3%, Mizuho Financial and Sumitomo Mitsui have gained 6.6% and 21.4%, respectively.

Business Realignment and Strong Capital Levels to Power Financials

While foreign banks have been witnessing accelerating loan growth on the back of improving economic conditions, margin compression remains a concern. As a result, these banks are continuing with the efforts to reposition business fundamentals to tap every opportunity. Also, foreign banks are deepening their focus on noninterest revenue sources.

Capital efficiency, which most foreign banks are gaining by dumping non-core assets for quite some time, remains the key to both survival and success. Further, banks will continue to improve solvency and balance sheet liquidity as they move closer to comply with regulatory capital requirements. Though this will limit their flexibility to invest in new ventures, any growth along the way will be safe and steady.

Top-Line Pressure to Continue, But Alleviate Gradually

With monetary policy cycles in developed nations (except the United States) yet to reach turning points, the interest rates are unlikely to be favorable for their banks any time soon. Naturally, interest-sensitive revenues for banks in these regions are likely to remain under pressure in the upcoming quarters. However, despite regulatory restrictions, there will be some progress on the non-interest revenue front with increasing sources.

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Disclosure: contains statements and statistics that have been obtained from sources believed to be reliable but are not guaranteed as to accuracy or completeness. References to any ...

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