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What we can learn from strong European bank results

The enduring trend to digitalisation and a faster-than-expected economic recovery are two insights we can learn from strong results among European banks. Paul Wild explains

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.

We’ve noted the digitalisation trend recently in relation to Australian stocks such as Xero and PushPay.

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.

Pendal wins Fund Manager of the Year 2020

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.

Reduced provisioning suggests Europe is recovering quickly

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.

European bank stocks look good value

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.

About Paul Wild and Pendal global equities strategies

Paul Wild is senior fund manager with J O Hambro Capital Management, a London-based active investment manager which is part of Pendal Group.

Pendal offers a range of global equities strategies to Australian investors including:

Pendal is an independent, global investment management business focused on delivering superior investment returns for our clients through active management.

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This article has been prepared by Pendal Fund Services Limited (PFSL) ABN 13 161 249 332, AFSL No 431426 and the information contained within is current as at August 25, . It is not to be published, or otherwise made available to any person other than the party to whom it is provided.

This article is for general information purposes only, should not be considered as a comprehensive statement on any matter and should not be relied upon as such. It has been prepared without taking into account any recipient’s personal objectives, financial situation or needs. Because of this, recipients should, before acting on this information, consider its appropriateness having regard to their individual objectives, financial situation and needs. This information is not to be regarded as a securities recommendation.

The information in this article may contain material provided by third parties, is given in good faith and has been derived from sources believed to be accurate as at its issue date. While such material is published with necessary permission, and while all reasonable care has been taken to ensure that the information in this article is complete and correct, to the maximum extent permitted by law neither PFSL nor any company in the Pendal group accepts any responsibility or liability for the accuracy or completeness of this information.

Performance figures are calculated in accordance with the Financial Services Council (FSC) standards. Performance data (post-fee) assumes reinvestment of distributions and is calculated using exit prices, net of management costs. Performance data (pre-fee) is calculated by adding back management costs to the post-fee performance. Past performance is not a reliable indicator of future performance.

Any projections contained in this article are predictive and should not be relied upon when making an investment decision or recommendation. While we have used every effort to ensure that the assumptions on which the projections are based are reasonable, the projections may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. The actual results may differ materially from these projections.

The Target Market Determination (TMD) for the Fund is available at www.pendalgroup.com/ddo. You should obtain and consider the PDS and the TMD before deciding whether to acquire, continue to hold or dispose of units in the Fund.

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