BLX Banco Latinoamericano de Comercio Exterior SA

The global banking industry is still a sorry sight, and its near term looks even worse with several negatives like asset-quality troubles, weak revenue growth, steeper costs and weak loan demand. But thanks to the worldwide regulatory reform, the sector has at least entered a transformation phase. Needless to mention, a change has yet to be felt.

Potential threats from a deeper European debt crisis and the uncertain outlook for the U.S. economy following the rating downgrades by Standard & Poor’s (S&P) were quite obvious and the sector entered the second half of 2011 with a lot less momentum than was anticipated.

Though the growth potential of some non-U.S. banks could be subdued due to higher reserve requirements, increased property taxes and strict lending limits as part of the regulatory overhaul, and greater transparency in regulations could strengthen the fundamentals of many banks. It is expected to create a less risky lane for the overall industry.

Moreover, as inter-country investment walls have fallen, some large non-U.S. banks are freely expanding beyond their domestic boundaries through mergers and acquisitions.

Since 2010, the banking sector has been recovering at a moderate pace from the latest financial crisis that started as a credit issue in the subprime enclave of the U.S. mortgage market in mid-2007 and spilled over the globe.

Though the malice spread by the financial crisis is behind us, banks are now dealing with regulatory pressure as they had to take resort to taxpayers' money and government intervention to remain afloat. Moreover, government efforts to alleviate industry concerns have significantly raised political hurdles in the sector over time.

Politics will continue to influence lending decisions of banks until they repay the government money in full. According to banking regulators, if governments withdraw their support from banks before giving them sufficient time to restore their financial strength, the sector could collapse again.

The industry has been adopting tougher regulatory measures to prevent the recurrence of a global financial crisis and restore public confidence. In June, the oversight body of the Basel Committee on Banking Supervision proposed new rules that would force the world's biggest banks to hold extra capital on their balance sheets as protection and prevention against any financial catastrophe. The targeted banks are those that could threaten global economy if they collapse.

This extra capital requirement is an addition to the set of minimum capital standards, known as Basel III, proposed by regulatory officials of more than two dozen countries in 2010.

With these regulatory measures, the individual capital structures of banks will remain under constant pressure. The resulting slowdown at some big banks could be seen as a blessing in disguise as it would eventually make their balance sheets more recession-proof.

Balance sheet repair and credit environment recovery will make the valuations of some non-U.S. banks attractive. Particularly, valuations of the mega banks, which could comfortably maintain the minimum capital norms mandated by the Basel Committee, will experience the fastest valuation upside. Consequently, we believe this would be the perfect time for mid- to long-term investors to consider non-U.S. bank stocks, as their valuations are now comparatively cheap.

Investors with short-term targets, however, should be very careful while choosing non-U.S. stocks at this point as near-term fundamentals remain weak. Asset quality lacks potential to rebound anytime soon as default rates for individuals and companies are not expected to materially subside; and revenue growth might remain weak with faltering loan growth.

The sector anticipates a turnaround in the first half of 2012. But this will vary from country to country, depending on industry circumstances. We believe that banks in emerging economies –– Chile, Brazil or India –– might make more attractive investments, akin to our expectations from certain regional banks in the U.S.

The same, however, cannot be said of European institutions. In early 2010, the debt crisis originating in the Greek economy shook the stability of the European Union's (EU) monetary policies. Starting as a solvency crisis in a single country, the turmoil spread over to the entire Euro-zone.

Greece adopted measures to minimize government spending, but there is no guarantee that the country is out of the woods as affluent domestic and foreign investors will not stop withdrawing their money from Greek banks anytime soon. Also, the rising inflation will force regulators to tighten their policies in the Euro-zone, making banks less flexible.

May 2011 saw the re-emergence of the Greek crisis, with refinancing of public debts. Political instability further compounded the problem. The Greek government quickly intervened; the European Union leaders lent financial assurance and the situation is now under control. In October 2011, European Union leaders agreed to prevent the collapse of member economies through a package of measures. This included a proposal to write off 50% of Greek debt and demand 9% capitalization by European banks. However, acceptance of the package became dicey following the Greek Prime Minister’s announcement of a referendum for the view of the Greek people.

Overall, the European Union is trying hard not just to restore investor confidence but also the health of the continent’s banking system, but the issue is far from fully addressed.

Coming to banks in emerging economies, they will obviously face asset quality issues. However, they are not plagued by other significant problems that many of the larger banks face in continental Europe and the United Kingdom, such as toxic securities and dilution from capital raising. Moreover, these emerging-market banks generally tend to be well capitalized, aren't as heavily exposed to property markets, and have significant and growing sources of non-interest income.

Overall, a key determinant for quick recovery will be the quality of risk analysis and risk-awareness in decision-making and incentive policies. So, we believe that accumulating larger capital buffers over the cycle and reducing pointless complexity in business will be crucial to banking performance.

Also, the primary attention of policymakers should be on determining how much longer the fiscal stimulus should continue, ensuring that it is not withdrawn before a clearer sign of economic recovery is visible.

OPPORTUNITIES

Among the non-U.S. banks, we recommend Grupo Financiero Galicia S.A. (GGAL) with a Zacks #1 Rank (Strong Buy). Banks that we also like with a Zacks #2 Rank (Buy) include Banco Latinoamericano de Comercio Exterior S.A. (BLX) and Credicorp Ltd. (BAP).  

We also like a few Zacks #3 Rank stocks including Banco Bradesco S.A. (BBD), BBVA Banco Frances S.A. (BFR), Itau Unibanco Holding S.A. (ITUB), Bancolombia S.A. (CIB), Banco Santander-Chile (SAN), Mitsubishi UFJ Financial Group Inc. (MTU), Mizuho Financial Group, Inc. (MFG), National Bank of Greece SA (NBG) and Sauer-Danfoss Inc. (SHS).

WEAKNESSES

We would suggest avoiding banks in Greece at this point. Also, it is better to steer clear of banks in Great Britain and Ireland, particularly those that have participated in government recapitalization programs and are yet to reimburse the money. In return for government capital and asset quality protection, these banks are facing regulatory intervention, like enforcing limits on dividend payouts and board member nominations.

Currently, banks that we dislike with a Zacks #5 Rank (Strong Sell) include Banco Macro S.A. (BMA), Banco Santander, S.A. (BTD), Barclays plc (BCS), Credit Suisse Group (CS) and HSBC Holdings plc (HBC).

We also dislike a few stocks in the non-U.S. bank universe with a Zacks #4 Rank (Sell), namely Banco de Chile (BCH), Bank of Montreal (BMO), The Bank Of Nova Scotia (BNS), Canadian Imperial Bank of Commerce (CM), Deutsche Bank AG (DB), HDFC Bank Ltd. (HDB), ICICI Bank Ltd. (IBN), KB Financial Group Inc. (KB), Royal Bank of Canada (RY) and The Toronto-Dominion Bank (TD).
 
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