26 February 2011

European Banks: How Well Have They Served Investors?

One simple way to estimate a company’s and its share’s future performance is to look at its past performance. So we asked: “How well have the European banks served their investors so far?”

The analysis covered somewhat subjective selection of 17 largest and/or otherwise interesting European banks from different countries:
* Dexia from Belgium
* Danske from Denmark
* BNP Paribas and Société Générale from France
* Deutsche Bank and Commerzbank from Germany
* Allied Irish Banks (AIB) from Ireland
* UniCredit from Italy
* ING from The Netherlands
* Nordea and Swedbank from Sweden
* Royal Bank of Scotland (RBS), Barklays and HSBC from UK
* UBS and Credit Suisse from Switzerland
* DnB NOR from Norway
Share price data for the period January 2003 to February 2011 was extracted from Yahoo! Finance. We used close prices adjusted for dividends and splits. Balance sheet data (the latest available at 23 February 2011; mostly as at 31 December 2010) and numbers of shares were taken from banks’ financial statements and –websites.

Figure 1 depicts the average share price index of the above listed European banks. It’s not weighted with anything; it’s just based on simple average of individual banks’ share price growth rates. Anyway, what we see is that on average, over the last eight years, the banks have generated a growth close to zero (which is quite an opposite to what they aim). From 2003 to mid-2007 it was very nice though: more than three times growth. And then the party was over. Lucky one who was able to quite around April 2007, because what followed was an almost seven times drop in share prices – on average. And lucky one who invested in the bottom in February 2009: by July 2009 he/she had doubled the value of her/his investment. Since that, nothing has really happened – on average. Putting it otherwise, banking sector has not been able to generate value for a long term investor.

Of course, when we look into individual banks, we see much more diversified picture, both in terms of return and in terms of risk. Some banks such as Danske and DnB NOR have provided investors with nice returns (capital gains of almost seven and four times respectively). The others like AIB and RBS have turned out to be complete value destruction by falling more than 95% and 80% respectively. Also Dexia, UniCredit and somewhat surprisingly UBS cannot brag with their past performance: from January 2003 to February 2011 their investors have lost respectively 58%, 24% and 11%.

Figure 2 provides a graphical summary of risk and return combinations of all the selected 17 banks. Return is measured as average monthly share price growth rate (calculated as continuous rate of return). Risk is expressed via its standard deviation. Bubble size indicates Price-to-Book value of a given bank’s share. As we see, differently from what theory says, more risk doesn’t certainly mean higher return (at least as soon as a major downturn is included into the analysis). Not surprisingly, AIB and RBS have been nightmares in this regard. Besides, too many other banks in the middle have turned out to be pointless investments. In the better end of risk and return scale there are Danske, DnB NOR, HSBC, Credit Suisse, Nordea and BNP Paribas.

Better combination of risk and return also tends to mean higher relative price of a bank’s share when expressed as Price-to-Book ratio. In general, Nordic banks (except Danske) tend to be more expensive than the others by having this ratio clearly above one, i.e. they cost more than their book value would imply. The same is valid for HSBC and the two Swiss banks, Credit Suisse and UBS. Differently from the others, UBS case is difficult to explain with its past performance which may indicate that it is overbought and overpaid. In the other side of the scale are AIB that costs almost nothing (no wonder when considering its past performance), and Commerzbank, the second-largest bank in Germany with Price-to-Book ratio of 0.29. The reasons for the later are also not so obvious from the historical data.

Figure 3 below summarises relative prices of different bank shares and the risk/return combinations that these shares provide to investors. Based on this chart, Danske is clearly the winner: rather cheap and with past performance that is remarkably better compared to the others (although risky as we saw from Figure 2 above, returns so far seem to have justified risks taken). DnB NOR and HSBC occupy the second and the third place respectively. DnB NOR is a bank with second-highest returns and average risk level, while the share price of HSBC has displayed rather low volatility (again, compared to the other European banks, not in absolute terms) combined with moderate growth. The others that might be considered include Credit Suisse, Nordea and BNP Paribas. According to this cart we also see that besides AIB and RBS, Dexia, UniCredit and UBS cannot be thought as good investments.

Finally, it has to be said that the limitation of the analysis based on past data is just that – it is based on past data which may not provide good enough indication for future performance. Furthermore, it doesn’t take into account the strategic changes that several banks are doing right now, or their very current troubles. However, it provides a good basis for starting asking questions like: “Why Danske looks so good in terms of risk and return, and still is relatively cheap?” (its large exposure to PIIGS countries, notably Ireland, and weak capital position that now is being strengthened and mixes the numbers) or “Why UBS is that expensive given its poor past performance?” or “If things should get worse again, will Dexia be the next one of the large European banks who basically fails given that its performance indicators are not much better than these of RBS?” More generally, one might ask: “Who is benefiting from banking business if strategic owners and long-term shareholders don’t?”

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