The longest rally in southern Europe’s banking stocks since the sovereign debt crisis began may prove unsustainable as the region’s economies lag behind a recovery in Germany and France.
Economic woes in Italy and Spain persist, meaning banks will probably be forced to set aside more provisions as consumers and businesses fall into default. After a six-week increase in the shares of Italian banks, they are trading at 20.7 times projected earnings yesterday, up from 10.3 times profit a year ago, according to data compiled by Bloomberg.
“I don’t think that current values are sustainable in the short to medium term as the economic outlook in the peripheral countries is still weak,” said Stefano Girola, who helps manage 25 billion euros ($33 billion) at Banque Syz & Co. SA in Lugano, Switzerland. “In particular, Iberian and Italian banks will be hurt at least until next year from higher bad loans and lower margins.”
Anticipation of an economic recovery in southern Europe has helped power a surge in financial stocks such as Spain’s Banco Popular Espanol SA. (POP) The stock has dropped 2.8 percent in Madrid this week to 3.97 euros after a seven-week rally brought returns of 74 percent, the most among European lenders. Spanish, Italian and Portuguese banks made up nine of the top 10 gainers on Europe’s 47-member Stoxx 600 Banks Index, which climbed 14 percent in the period.
While Germany and France led the 17-nation euro area out of a record slump in the second quarter -- the region grew 0.3 percent from the previous three months -- a jump in Spanish bad loans to a record 11.6 percent of total lending in June underscored weakness in southern Europe’s economies. Non-performing loans in Italy stood at 138 billion euros in June, a record level, according to its central bank.
Loan defaults may exceed 14 percent by the end of 2013 and peak at 16 percent in the second half of next year because of weak economic activity and as lenders comply with a Bank of Spain order to re-examine how they classify restructured loans, Antonio Garcia Pascual, Barclays Plc (BARC)’s chief economist for southern Europe, said in a report this week.
The bad loan data from Spain, published by the Spanish central bank this week, gave investors a reason to look again at economic fundamentals, said Peter Braendle, who manages about 500 million Swiss francs ($540 million) at Swisscanto Asset Management AF in Zurich. Unemployment is also a concern, he said.
The jobless rate in Spain, which fell for the first time in two years in the second quarter to 26 percent, is expected to increase to 27 percent by year-end, according to the median estimate of 21 analysts surveyed by Bloomberg. Italian unemployment is expected at 12.1 percent this year, unchanged from the second quarter, estimates showed. In Portugal the rate is 16 percent.
Spain’s economy may shrink 1.5 percent this year, more than the 1.4 percent contraction of 2012, before growing 0.5 percent in 2014, according to the median estimate of 40 economists. Italy’s economy will probably shrink 1.8 percent this year.
Economic troubles are reflected in the capital adequacy ratios of the countries’ banks. Banco Santander SA (SAN), Spain’s biggest lender, has a Tier 1 ratio of 12 percent compared with a European average of 13.1 percent and 20.4 percent for Svenska Handelsbanken AB (SHBA) of Sweden, the most capitalized. Small and medium-sized banks in Spain, Italy and Portugal prop up the bottom of the list. Italy’s Banca Popolare di Sondrio Scarl has a ratio of 7.5 percent and Banco Espirito Santo SA of Portugal 10 percent.
Simon Maughan, head of research at Olivetree Financial Group in London, said the rally may have gone too far.
“It’s striking how stretched some of these names are with no real earnings momentum behind them,” Maughan said by telephone. “Until there are also signs of life in the banking sector in the south of Europe, the crisis hasn’t gone away.”
Spanish Economy Minister Luis de Guindos told lawmakers in Madrid last month that the country was leaving its recession behind as the government presses ahead with measures that will help avoid repeating the “false recovery” of 2010.
The recession in the Spanish economy has eased. It shrank 0.1 percent in the second quarter from the previous three-month period, when it contracted by 0.5 percent.
“We believe that Spain is slowly and painfully restructuring its economy -- it’s a difficult process but we think it’s heading in the right direction,” said Cato Stonex, a partner at Taube Hodson Stonex Partners LLP in London, which holds Santander and CaixaBank (CABK) SA shares as part of the $5 billion in equities managed by the firm. “We have been adding to our bank holdings in Spain, and we look forward to buying more shares in that sector.”
Italy’s economy is also contracting at a slower pace as the longest recession since World War II abates. It shrank 0.2 percent in the three months ending in June compared with the first quarter when it fell 0.6 percent, the country’s statistics office said this month.
The rally in Italian and Spanish banking stocks has extended to Portugal. Banco Espirito Santo SA, Portugal’s biggest publicly traded bank, jumped almost 50 percent between the end of June through last week.
Southern Europe’s banks may have some scope to keep rising as economies recover and financing costs ease, said Marc Renaud, who helps manage about 1.8 billion euros of European equities at Mandarine Gestion (MANDVAL) in Paris.
Italy’s Mediobanca SpA (MB) and Spain’s Bankia SA (BKIA) led declines on Europe’s Stoxx 600 index today, dropping 2.5 percent and 2 percent respectively by 11:41 a.m.
Renaud advised against buying companies that only do business in Spain. He said he’s taking a cautious approach by investing in Santander because it is making a profit in countries such as the U.K. and Brazil, which it uses to offset losses in its home market. Still, he has cut holdings of the bank to 3.9 percent of total investments from 4.5 percent because it no longer presents a “big bargain.”
“It’s too dangerous to invest in pure domestic Spanish banks because you just don’t know what is going to happen to the price of real estate,” Renaud said. “If you don’t know what’s going to happen to the non-performing loans, then you get scared.”
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