US Banks Are Doing Badly, But What About Non-US Banks?

As in the US, non-US bank stocks continue on a downward trend this year due to the financial problems that began in the US subprime mortgage market and spread globally to engulf many major financial institutions in most countries. The median year-to-date stock price decline for non-US banks in the Zacks universe is 27.1%, compared to a loss of 21.1% for the S&P 500 (^GSPC). This includes median price declines for non-US banks in the Zacks universe of 47.6% in Europe, 29.7% in Asia, and 14.6% in Latin America.

In response to the global financial crisis, governments have taken dramatic action to forestall the possibility of global meltdown. These rescue efforts include:

• Australia - guarantee of all bank deposits for three years and will guarantee all wholesale funding to Australian banks for five years
• Brazil - reduction in reserve requirements for smaller banks, injection of R$160 billion into the banking sector, and aiding bigger banks to buy loan books of smaller banks
• France - EUR360 billion, including EUR320 billion bank lending guarantee for bank paper issued before December 31, 2009 and lasting up to five years and EUR40 billion to buy bank shares
• Germany - EUR500, including EUR80 billion for recapitalizations and EUR400 billion for bank guarantees that will run until December 31, 2009
• Hong Kong - blanket guarantee for customer deposit accounts in all HK financial institutions until year-end 2010
• India - reduction in banks’ capital reserve ratio, providing Rs250 billion to lending institutions as part of a farm-loan waiver plan, and easing of rules for some foreign borrowings
• Ireland - EUR400 billion guarantee of existing and new debt and deposits over the next two years and a EUR5.5 billion bank recapitalzation plan
• Japan - ¥2 trillion for recapitalizations and to broaden repo operations
• South Korea - US$130 billion in debt guarantees and capital injections into banks
• Spain - EUR30 billion fund to buy assets from Spanish banks to help stabilize the lending industry and unfreeze credit, guarantee issues of new bank debt until December 2009, and bank deposit guarantees up to EUR100,000
• Switzerland - SFr60 billion financial aid, primarily to UBS (UBS), for share purchases and loans, and bank deposit guarantees up to SFr100,00 until yearend 2010
• United Kingdom - £400 billion, including £37 billion to buy bank shares and £250 billion in debt guarantees for short- and medium-term borrowing by banks, and an additional £500 billion for its Asset Protection Scheme (APS), under which the government insures the bank against losses on its most toxic assets (e.g., mortgage-backed securities and property loans) in return for a small fee and an obligation by the bank to increase lending to consumers and businesses. The bank absorbs the first 10% of losses, with the government assuming responsibility for the remaining 90%.

Assuming global financial system stability is achieved, non-US banks still have several hurdles ahead. Asset quality should continue to trend down as the recession takes hold. Consumers and businesses are likely to have problems meeting financial obligations as economies weaken. Revenues will be hurt from several different quarters. Loan growth will decelerate, and could turn negative, and with it, net interest income. Moreover, for many of the larger banks, capital markets activities will reflect global economic weakness. In short, revenues will fall, while credit losses will rise, with a negative impact on the bottom line.

Going forward, we expect stock prices to continue to be volatile and susceptible to headline risk. Moreover, depreciation of many foreign currencies relative to the US$ is depressing US$ stock prices. Additionally, a number of companies have cut dividends to conserve capital, and this will likely continue in the future. Combined with the grim economic outlook for many economies ranging from outright recession in developed economies to slowing growth in emerging market economies, we expect share price performance to continue to weaken.

OPPORTUNITIES

At this time, we see no near-term opportunities in this space.

WEAKNESSES

Stocks that could prove especially problematical include banks that participate in government recapitalization programs, such as The Royal Bank of Scotland Bank plc (RBS) or Lloyds TSB Group plc (LYG). In return for the government capital, these banks must submit to other government intervention, including limits on dividend payouts and nomination of board members. This will limit their financial flexibility for a while, which could hurt stock performance.

In addition, other banks have been forced to strengthen capital through rights offerings or other forms of capital increase, such as Barclays PLC (BCS), HSBC Holdings plc (HBC) and Banco Santander Central Hispano, S.A. (STD), significantly diluting existing shareholder interests, also a negative for share prices.

Current Sells include Banco Bilbao Vizcaya Argentaria, S.A. (BBV) and Banco Santander Central Hispano, S.A. (STD).

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