Mirror, mirror on the wall, which is the ugliest European equity sector of them all? A wicked fairytale investor might well have asked the magic green phosphorescent flicker of his Bloomberg screen in the grim dog days of August 2019. The answer would have definitely been European banks, then trading down almost 45% on the Stoxx 600 bank index since January 2018 to levels we last saw at the bottom of the systemic Greek/Cyprus sovereign debt and banking crises in 2011 – 2012.
It did not help that the German Grossbanken, led by Deutsche Bank, triggered one of history’s most obscene spasms of shareholder wealth destruction in the past decade. Global fund managers have abandoned the permabear Ursa Maxima crown jewels of Old World banking and even ECB President Mario Draghi’s swan song was the need for even lower policy rates, a catastrophe for net interest margins in European banking.
Amid the carnage, I could only evoke about the ghost of another Frankfurt banker, a ghetto money changer from the late Napoleonic Wars era named Nathan Mayer Rothschild, whose courier pigeons and genius grasp of mass psychology and the human herd instinct enabled him to make a fortune on the stock exchange just after history’s verdict at battle of Waterloo reached London. “Buy when blood flows on the streets”, Lord Rothschild advised posterity. In the jargon of Wall Street, we call it the “capitulation moment”, the point of maximum pessimism for an asset.
So I nibbled at my old Quaker bank (Jes? Bob Diamond – Quaker?) Barclays ADR in New York, more as a proxy for my desire to accumulate sterling near 1.20 for a 1.30 target, a trade idea I published on this media platform. The trade was profitable but I was still uneasy as I wanted to escape the storm clouds of Brexit and the City of London malaise. I want to accumulate the real crown jewels of European banking, franchises that are too big to fail, national champions in a major EU market without any strategic schizophrenia issues (gender charges are never pretty in humans or banks, as post Absa, Barclays attests!) or Basel Tier One capital ratio deficiencies. Voila! This meant a short list of Old World banking colossi. Banco Santander in Madrid, BNP Paribas/Banque Rouge et Noir in Paris, ABN Amro/ING in Benelux and Nordea in Vikingistan.
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The role of Landesbank/Sparkassen make it impossible for me to invest in Germany and the populist Cinque Stelle – Liga coalition in Rome rules out La Bella Italia, the land of my admittedly beloved mamma, pasta and discoteca”! At a time when J.P Morgan trades at 1.6 times tangible book value, the Europe Stoxx 600 Bank Index was trading at 0.5 times tangible book value in early September just before the Powell Fed injected $400 billion in the money markets to unplug an ostensibly clogged repo drainage sink. Yet, to butcher Shakespeare’s immortal rose, QE by any other name smells just as sweet – and so the Stoxx 600 (but not the banks) trade at all-time highs as I write.
While I was happy to surf with 2019 Big Tech darlings like Microsoft (167 now – incredible!) and Disney, there is fire in my contrarian’s DNA. So I recommended a 40% rise in Pakistani stocks after having sold my entire Karachi exposure the day the Supreme Court (or the Rawalpindi GHQ, our beloved Assi-Tussi Desi-Prussia) sacked the elected Prime Minister Nawaz Sharif (Abu Mayfair). I recommended a short on the Uber IPO when the entire Gulf was going gaga on the Careem deal/ride hailing apps and accumulated the shares of an unknown Chinese coffee chain IPO named Luckin Coffee. My published target range for the Luckin Coffee IPO was $14 – 57 in May 2019 and, seven months later, we tripled our money in this puppy, now trading at $50.
I do not expect any swift, spectacular Luckin Coffee scale money making spree in European banking in 2020 – the path from deep value to value, Godawful to just plain awful, is long, erratic and unwise for those without abdominal fortitude or unawareness of option/debt market hedging strategies in real time.
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Negative interest rates force EU banks to pay an expensive subsidy to depositors while killing margins on corporate loans and home mortgages tied to floating rates (though not in Holland!). Bank mergers? When zombies mate with zombies, zero plus zero still equals zero, the message of the aborted Deutsche Bank – Commerzbank “fusion” to me or recent GCC bank mergers that must remain unnamed as I have too many friends in this sector, many I was delighted to meet at Alpen’s lovely annual music fest. Yet there is serious money to be made in the Darwinian shakeout in European banking.
Banco Santander SA, the flagship and legacy of Don Emilio Botin and his brilliant ex J.P. Morgan alumna Marquesa Ana Patricia Botin, is on sale on the NYSE at $4 or a market cap of a mere $65 billion. Ana, the fourth generation Botin to chair Spain’s banking colossus, has committed to make Santander carbon neutral after a trip to see Greenland’s melting ice glaciers and thus won my heart. The Andrea Orcel hiring debacle is long over. Property prices in Madrid, Barcelona, Valencia and Bilbao have been on a roll as Spain has the fastest GDP growth rate in the EU and the lower Euro has led to surge in exports. Santander has also embraced the digital revolution in retail banking with a vengeance.
At a 7.8 times forward earnings, 0.64 times tangible book value and a 7.20 dividend yield on the ADR, I love Ana Botin even more. If option volatility on Santander spikes to 30, I have no problem selling one year 0.7 delta puts in my latest “Viva España” trade in banking.
The Banco Popular takeover was a beauty since Santander increased his Spanish deposit market share to 20% while sold 51% of its toxic loan book to Blackstone. This will further increase its funding cost advantage over his peers in the EU. After all, Santander has 13000 branches in relatively uncorrelated economies like Spain, Brazil, Chile, Poland and the US. This gives the bank a global scale in retail/commercial banking exceeded only by HSBC, Stan Chart and Citi. My friends on Wall Street believe Ana will sell her high risk, deep subprime vehicle finance business in the US, which will ignite the stock. Technology also enables Santander to cross sell lending, saving and asset management products across a global client base and thus extract “a relationship dividend” on both the asset and liability side of the balance sheet.
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Don Emilio’s genius lay in the integration of acquired banks and the extraction of operational efficiencies and revenue/cost synergies from consolidated business models. Banco Popular will be no different and the €7 billion purchase was a steel, a banking takeover coup for the Botin clan akin to the Abbey acquisition in the sceptered isle. Santander also dominates oligopolistic banking markets like UK clearing, Spain, Brazil, Chile, Mexico and Poland. I love the fact that Santander’s CDS is only 60% of its EU peers, a testament to its low funding costs and less volatile cost of credit risk implicit in its retail SME business model.
Northern Rock, Continental Illinois and the GCC banking meltdown in 2008/09 taught me never to invest in banks dependent on fickle/wholesale funding markets. So I love the safe and even boring funding, liquidity, capital, loan book diversification model of Santander. Triple bagger? With the right luck, market intel and Chicago options strategies, creo que si, verdadmente. Yes I really believe so.
Banking turnarounds can be a license to print money, as I learnt from John Reed/Sandy Weill’s Citigroup in the 1990’s after a Saudi prince acted as the New York banks white knight in 1991, when I was at its archrival Chase Manhattan. Since 2009, we have seen Bank of America rise from $3 to 35 in the NYSE, J.P. Morgan (the House of Pierpont is now the House of Jamie!) rise from $15 to $140. Who says fairy tale investments exist only in Silicon Valley software/E-commerce shares? Mark Twain said history does not repeat itself but it surely rhymes. So will it rhyme in the European banking? This is my dream as I watch the captains and kings of global finance pontificate about climate change in Davos, having flown Zurich in their swanky carbon neutral private jets LOL!