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Why is the banking sector is currently unattractive?

  • Financial Analyst
  • Blog post submitted on 20th February 2019
06744 CC Trader Talk V2

Stocks of European banks are currently lagging behind market indices. 2018 saw roughly 300 billion euros in shareholders’ money wiped out across the European banking sector, down 25.8% compared to 11.0% for the wider market. Despite a more positive start to the year, European banks are still lagging other sectors, up 5.6% compared to 6.7% for the wider market.

European Banks are indeed facing a double-edged sword, whereby they are caught in a situation where the European Central Bank, via its monetary policies, has instilled negative interest rates on high grade fixed income assets. Concurrently, it has sequentially implemented a host of stricter capital requirements, essentially forcing the bank’s hand to hold very high grade assets as well as limiting risk. This has inevitably resulted in the tightening of net interest margins, reducing operating income.

Given that the outlook for growth in the European Economic Area remains tepid, there is little hope for a material rise in interest rates in the short term. Indeed, in the ECBs most recent comments they expect the Eurozone’s path of inflation will be shallower while its economic slowdown will be “stronger and broader” than expected. Germany, the Eurozone’s largest economy, avoided slipping into a technical recession by the narrowest of margins in recent figures.

On the cost side, the push by regulators for a crusade against money laundering practices as well as tighter risk management controls has resulted in banks increasing headcount and investment in technology to cope with the task. This, coupled with the push to digitalise banks further, in order to create a competitive edge, has led to banks facing a significant amount of investment in human as well as capital resources, in a long process to overhaul legacy systems.

The banking sector is also concurrently facing a new dimension of competition in the shape of FinTech companies. Indeed the other main source of income for traditional banks is fees and commissions generated, which are quickly being blind-sided by these leaner companies who are able to offer an attractive proposition to consumers.

Several calls by analysts claiming banks to be cheap remain by the wayside, as stock buy-backs and dividend announcements can’t seem to spur the sector back into favour.

On Tuesday, HSBC Bank (Malta) plc reported its preliminary annual results for 2018, which showed symptoms of all of the above concerns. Adjusted Profit Before Tax, which excludes the effect of notable items, was €36.5m, a decrease of €19.1m or 34% over the previous year. This was mainly affected by a reduction in Net Interest Income of 10%, while Net Fee and Commission Income remained largely flat at an increase of 0.2%. Of significant concern is the large increase in the adjusted Cost Efficiency ratio, which increased further to 73% compared with 66% in 2017 and 58.7% in 2016. The bank’s Return on Equity in 2018 fell to 6.1% from 6.5% in 2017. As result, net dividends for the full year were slashed to €0.038 per share compared to €0.0561 per share in 2017 (excluding extraordinary dividend of €0.0555 per share).

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