The consensus last week was that if the eurozone banks did well in the European Central Bank's stress tests there would be a bounce in the stocks. As usual, however, the consensus was not quite correct as 80% of the region's banks passed, but the stocks' response was muted. Concerns about weak growth and high unemployment in Europe still dominate trade in the region and many of the banks were down despite easily passing the stress tests.
Italian banks took a big spill after performing poorly in the tests. Nine Italian banks failed the tests. Five of them have already raised the capital needed to pass, but four will have to raise some additional equity capital to be compliant.
Bank stocks across the region are cheap, so if you do not have a position in them it's probably a good time to start tip-toeing into European banks.
The stress tests assumed falling equity and housing prices coupled with rising interest rates and default rates and a badly deteriorating economy. The banks that passed the tests should be able to survive the period of time needed for Europe to get back on more stable footing. You'll need a very long time frame and a strong stomach, however, as it's going to take a while for things in Europe to improve. I suspect that it will still be a news- and fear-driven market for a period of time, which should provide an opportunity to build a position in small bites during future declines.
Deutsche Bank (DB) remains the largest of the eurozone banks and passed the tests handily. The bank started disposing of bad assets and raising capital earlier this year and appears to be in pretty good shape at the moment. It also started exiting some riskier businesses and just sold its energy and metals trading business to Citigroup (C). The stock has been hit pretty hard in 2014 and is down about 30% for the year. The shares, which currently trade at just 64% of book value, appear to have strong recovery potential over the next five years or so.
Tomorrow is Deutsche Bank's analyst conference call to discuss third-quarter results, so this should provide a better look at conditions at the bank after the stress tests and recent economic weakness.
The U.K. banks also did well in the stress tests, and I believe a few of them are cheap enough to consider as long-term investment candidates. I have owned shares of Royal Bank of Scotland (RBS) since 2008 and even though I have a double in the stock so far it is still very inexpensive at just 68% of book value.
Barclays (BCS), which has been de-risking its balance sheet and selling divisions, is also cheap, at 65% of book value. The bank is focusing on the U.S. and African markets and that should lead to more consistent growth once it is done cutting costs and reinforcing the balance sheet.
In Greece, three banks failed the tests, but have already raised most of the capital needed to meet the shortfalls. At the recent Robin Hood conference in New York, hedge fund manager David Einhorn suggested buying two Greek banks, Alpha Bank (ALBKY) and Piraeus Bank (BPIRY). He pointed out the Greek economy is turning positive and that growth should pick up next year. Alpha Bank passed the stress tests handily. Piraeus Bank failed, but announced restructuring plans will eliminate the shortfall.
I also like and own shares of Eurobank Ergasias (EGFEY), which failed the test but has already raised the bulk of the needed capital. In addition, to Einhorn, many smart long-term investors, including Wilbur Ross, Seth Klarman, Prem Watsa and others have invested large sums in the Greek banks. I am comfortable putting my money alongside theirs.
The European banks are likely to be one of those long-term situations that teaches me to appreciate volatility but also occasionally ponder the possibility that I have lost my mind. In addition to Royal Bank of Scotland, my positions include Commerzbank (CRZBY), Societe Generale (SCGLY), Alpha and Eurobank. I was hoping that Credit Agricole (CRARY) would pull back a bit during the stress tests, as I would like to add that French Bank to my mix.
Europe is a mess right now and that's going to make for some interesting trading in the short to intermediate term. However, I believe at some point over the next five to seven years the eurozone economy will get better and the share prices of the surviving banks will go a lot higher.