Buying Into European Banks

 | Jul 23, 2013 | 3:00 PM EDT  | Comments
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Stock quotes in this article:

db

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rbs

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bcs

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ire

I have been stuck on the idea of Europe finally seeing an economic recovery for the past few days. The article in Barron's over the weekend made a strong case for conditions improving on the continent.

I am not much of a macro guy, and I certainly do not invest on my macro opinions.  But the backdrop seems favorable for searching for cheap stocks. Consumer confidence in improving in the old world as many austerity issues are being scaled bank and the European Central Bank seems willing to do whatever it takes.

I am not sure it will be an overnight recovery, but I do think the European economies will slowly, but surely, improve over the next few years. This is a pretty good environment for owning cheap stocks, especially bank stocks.

European bank stocks were devastated during the economic crisis and it really looked for a while like many would go under. A combination of government aid, asset sales and restructuring has helped many to survive. I expect them to thrive again before too many more years pass. Although their stock prices have improved, they are still very cheap on a price-to-book basis and could reward patient disciplined shareholders over the next five years with large gains.

Deutsche Bank (DB) is a great example of what has happened in the European banking sector. The bank was hit hard by the economic crisis and its shares fell by more than 80% from the 2007 highs. Since then, the bank has set up a non-core operations unit to dispose of some riskier assets. They have reorganized their operations and raised capital to get the balance sheet more in line with their peer group.

The bank has put together a growth plan that calls for a greater focus on the Asia pacific markets and worked to improve their asset management division brand. The stock price has improved form the lows, but still trades at just 90% of book value.

I have owned Royal Bank of Scotland (RBS) for some time now, and I expect to own it for much of the next decade. Conditions reached a point for this bank that the British government had to step in. The government still owns 82% of the company. Royal Bank has disposed of several divisions, including its commodity businesses, the Asian banking operations and a stake in the bank of China.

Royal Bank has achieved its targets for liquidity and leverage ratios and is now turning its attention to improving profitability. The stock still trades at just 40% of tangible book value. If the economic headwinds ever become tailwinds, the potential for these shares is enormous.

In addition to economic issues, Barclays PLC (BCS) managed to get caught up in major regulatory issues, including the LIBOR fixing scandal. The CEO was forced to resign and the bank now has an uphill battle to improve its image in the global marketplace.

Barclays is working on cost reduction efforts and is refocusing its business on the United States, on the United Kingdom and on Africa and away from mainland Europe and Asia. They are also disposing of riskier assets to bring their capital ratios in line with peers and Basel III requirements. The stock trades at 80% of tangible book value and about a third of the levels reached before the economic crisis.

I still own shares of Bank of Ireland (IRE) that I purchased when Wilbur Ross took his initial stake. I have a huge gain in the stock, but the shares are still cheap enough to consider buying with new money.

Ireland was the first to bite the austerity bullet and is likely to be the first to see its economy resume a growth trajectory. The bank has had to do the same deleveraging and asset sales as have other major banks have done in the wake of the economic difficulties. They are, however, way ahead of their peers. Credit conditions are improving slowly, but they are improving. The stock has improved dramatically but still trades at just 60% of tangible book value.

I have no idea when Europe will finally turn the corner and start a sustained recovery. I do know two things for a near certainty. It will eventually recover and the markets will be very volatile with many stops and starts. I would use the volatility and use the sharp decline in European markets to scale into some of the leading banks that will be best positioned to benefit from the recovery.

Investors willing to own these stocks for a very long time should end up making an enormous amount of money as a reward for their patience and discipline.

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