THE WORD “digitalisation” appears in more and more investor reports and conversations across asset classes and regions — including as a driver of recent European bank results.
Digitalisation refers to the use of technology “to change a business model and provide new revenue and value-producing opportunities” according to researcher Gartner.
It’s distinct from “digitisation”, which simply means converting things such as bank accounts or books from analog to digital.
Our emerging markets portfolio managers have also written about its role in driving businesses such as food delivery and online games.
Digitalisation of the economy was underway well before Covid. But the pandemic has accelerated adoption and looks to have raised the benchmark.
The recent run of positive results among European banks is another demonstration of how the trend is helping the bottom line for financials.
People aren’t visiting bank branches liked they used to, often because they can’t. Instead, they’re banking online, and that has big benefits for lenders, who for decades have been trying to reduce their costly branch network.
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As people who bank online know, once you start, you seldom enter a branch.
“We’re seeing decent progress in the banks on the cost side, which has much to do with digitalisation,” says Paul Wild, a senior fund manager who focuses on global equities at Pendal Group’s UK-based business, J O Hambro Capital Management.
“They are going ahead with branch closures, given the Covid crisis has forced customers to move online and into mobile banking.”
European Central Bank data shows that last year the number of bank branches continued to decline across the region by an average of more than 8 per cent. The pandemic helped accelerate the trend. And the lower costs will fall to the bottom line.
Paul also points out that reduced provisioning among European banks has been a driver of performance this season — which indicates the European economy is recovering quickly.
“The key drivers continue to be much lower provisioning, because the economy has normalised much faster than expected,” Wild says.
“In some instances we are seeing write-backs for generic provisions. Given the economy is where it is, provisioning levels should stay low for the foreseeable future.
There also been much better fee income, he says. “Generally, for European banks fees are about one-third of total revenue and we’ve seen a very strong performance on that front,” Wild says.
Meanwhile, interest rates are starting to rise in Eastern Europe with Scandinavia set to follow.
Banks in Europe, like some of their peers in other parts of the world, are relatively cheap, says Paul.
“Against a market that is trading at the high end of historic valuations — and a market where again growth stocks have done surprisingly well at a time when bond yields and real interest rates are low but the economic outlook seems to be quite favourable — the banks stick out,” he says.
“At 0.75x tangible book value they are cheap on a historic basis with positive earnings momentum in the sector driving higher returns on equity, complemented by very high shareholder pay-outs to come.”
Investors should also keep an eye on September 30, when the European Central Bank will allow banks to pay dividends again, having asked them to suspend payouts during the COVID-19 crisis.
“We expect to see some very large distributions from European banks, including some very large share buybacks as well,” Wild says.
Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.
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