In December 2011, shortly after he became the new chief of the European Central Bank (ECB), Mario Draghi opened the floodgates and offered unlimited amounts of euros to banks in three-year loans at 1% interest, with the intention that they would lend that money to businesses and spur growth.
The Basel Committee (which sets global requirements for liquidity and capital ratios for banks) announced an unexpected easing of rules. As it was then, the final rule approved by the supervisors of the Basel Committee on Banking Supervision was significantly more flexible than the prior structure. Banks were able to count a much wider variety of liquid assets towards their buffers, including some equities and high-quality mortgage-backed securities.
It was seen then as a big win for Europe, where the credit system has been mired in a state of disrepair. Crucially for the euro zone, the Basel committee watered down its liquidity requirement. European banks used to hold loans on their balance sheets, rather than securitize them. It was one of many radical measures employed to help fortify the fragile European banking system.
The driving message was that European authorities, namely the ECB and its national representatives, were doing whatever they could to help credit flow through the system along with a series of follow-on ECB rate cuts that eventually resulted in negative yields on 10-year sovereign bonds in several European countries.
In much the same fashion, as the yield curve in the U.S. Treasury market steepened these past two months, the banking sector, led by JP Morgan (JPM), has rallied sharply in response to both a more normalized yield curve and a brighter outlook for the U.S. economy in 2020.
What is most interesting is how European banks, while still mired in a negative interest rate environment, are trading higher in tandem with their American counterparts. The exception is that they are coming off of decades-low valuations in what can only be viewed as either pure speculation or the notion that the very worst of conditions is a thing of the past and business is about to get better – even infinitesimally better.
If so, investors should consider the “then and now” logic of what could be if, in fact, this is the beginning of a banking recovery in Europe.
As a historical reference, U.S. banks traded as follows from 2008 to present:
JPMorgan (JPM) traded from $15 to $138
Wells Fargo (WFC) traded from $9 to $65
US Bancorp (USB) traded from $8 to $60
Bank of America (BAC) traded from $3 to $35
I wonder if owning a basket of these seven major European banks, all of which are among the world’s 50 biggest banks, could generate the greatest total returns over the next one to two years as a directional buy-and-hold strategy. Below are the names of seven banks and their current annual dividend yields.
Lloyds Banking Group PLC (LYG) – United Kingdom – Yield 3.34%
Royal Bank of Scotland Group PLC (RBS) – United Kingdom – 1.50%
Banco Santander S.A. (SAN) – Spain – Yield 7.21%
Unicredito SPA (IT:UCG) – Italy – Yield 8.22%
UBS AG (UBS) – Switzerland – Yield 5.51%
Deutsche Bank AG (DB) – Germany – Yield 0.00%
ING Group N.V. (ING) – Netherlands – Yield 6.37%
From a pure fundamental numbers standpoint, there is no hurry to buy these and other European bank stocks. From a “Hey Mikey! He likes it!” viewpoint, the recent move off of the lows for the sector has my full attention. If there was ever a more hated and washed out sector that is too big to fail, it’s the European banks. But if there is also the potential for a 3-5x move in the making over the next three to five years – then I want in.
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