World's Second-Largest Economy's Bad Debt Is an Investment Opportunity

 | Jul 06, 2017 | 8:00 AM EDT
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Finding out more about the eurozone's bad debts problem and banking union plans is definitely not the best way to spend a hot July day. And yet, investors should do just that next Monday, when the Eurogroup meeting of eurozone finance ministers will discuss the issue of bad debts in the single currency area's banking system and how to tackle them.

The eurozone is the world's second-largest economy, with GDP at $11.9 trillion last year, according to World Bank data. This is behind U.S. GDP of $18.6 trillion, but just ahead of China's $11.2 trillion.

Progress on the banking and capital markets union has been painfully slow because of diverging political interests among various eurozone members. But it looks like, although the U.K. is not a eurozone member, the country's vote to leave the wider European Union has given new impetus to efforts to continue integration in the euro area. The latest measures taken to recapitalize banks have made Jim Cramer very excited about the eurozone's future

The main issue on the Eurogroup's agenda will be that of nonperforming loans (NPLs), as the bad debts on the European banks' balance sheets are known. These debts, which turned sour as the financial crisis of 2007-09 hit, have weighed heavily on the euro area's recovery and have been one of the main reasons for investors' loss of confidence in eurozone securities.

A look at the figures shows how big the problem is. The latest data from the European Central Bank (ECB) show that at the end of the fourth quarter of last year, total nonperforming loans in the eurozone were $879.8 billion ($998.6 billion). This represents 6.17% of gross loans in the eurozone.

Looking at specific countries, the ratio of nonperforming loans to gross loans varies wildly, with NPL ratios as high as 45.9% in Greece, 37.8% in Cyprus, 19.5% in Portugal, 15.9% in Ireland, 15.4% in Slovenia and 15.2% in Italy and as low as 1.8% in Luxembourg and 2.4% in the Netherlands and Germany.

At Monday's meeting, the eurozone ministers will discuss the legal frameworks of insolvency in the single currency area, focusing on nonperforming loans. Last November, the European Commission (the executive arm of the EU) put forward a proposal to ease the restructuring of nonperforming debt and give entrepreneurs a second chance.

The proposal facilitates restructuring of bad corporate debt by giving "breathing space" to entrepreneurs to renegotiate and restructure their debt, and also by reducing the powers of dissenting minority creditors and shareholders.

Any progress in this area would be positive for the single currency area's banks, because it would indicate that their biggest problem -- that of NPLs -- is being addressed. An index of major eurozone banks created by FactSet is up almost 25% this year, having advanced by more than 80% over the past year.

Still, this index's price-to-earnings ratio is only around 11, which indicates that under the right conditions eurozone banks' stocks still have room to run. The main banks in this index are France's BNP Paribas (BNPQF) , Societe Generale (SCGLY) , Spain's Banco Santander (SAN) , Belgium's Dexia (DXBGY) , Germany's Deutsche Bank (DB) , Dutch bank ABN AMRO (ABMRF) and Austria's Erste Group (EBKDY) .

Our resident technical analyst Bruce Kamich published an article looking at Santander's chart, and believes investors may still have to be patient with this stock. 

For investors who do not want to bother researching these banks further, a simpler way to get exposure to the eurozone is the iShares MSCI Eurozone ETF (EZU) , which is a holding of the Action Alerts PLUS charity portfolio co-managed by Jim Cramer.

Of course, there are still many people out there who believe there is no point learning anything about the eurozone at all because it will end up in failure. Look, it may well happen. But you should also consider that the U.S. took 150 years to become an optimal currency area, at least according to a research paper by NBER Research Associate Hugh Rockoff.

In that scenario, the eurozone still has more than 130 years to prove itself. Can you afford to wait that long before investing in the world's second-largest economy?

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