KAI PFAFFENBACH
As the euro zone teeters on the edge of a possible default by Greece, shares of European banks look extraordinarily cheap – and extraordinarily dangerous for investors tempted to take advantage of their low valuations.
BNP Paribas SA and Société Générale SA of France trade at less than four times earnings, far below the double-digit levels of Canadian banks, making them alluring targets for bargain hunters.
However, the low valuations reflect high risk. Shares of the two French institutions, as well as those of Deutsche Bank AG, the largest lender in Germany, have fallen more than 45 per cent this year on concerns about losses they may face if Greece, Ireland, Spain or Italy fail to repay debt.
French banks, led by BNP Paribas and Société Générale, are the top lenders to Greece among global financial institutions, according to a June report by the Zurich-based Bank for International Settlements. Their losses accelerated Monday after Bloomberg said that Moody's Investors Service could cut their credit ratings this week.
"The market has started to lose confidence in European banks," said Rob Wessel, managing partner of Hamilton Capital, a Toronto-based fund manager specializing in the financial services sector.
To be sure, some investors see current valuations as tempting. They recall the case of Citigroup Inc., which returned solid gains to investors who bought into a share sale in late 2009 and waited a few months. Low valuations can also attract takeover bids that drive up the stock price, as happened to U.K.-based Northern Rock PLC in October 2007.
What happens to stock prices this time depends on how Europe handles the crisis. Forced sales of new shares, state bailouts or nationalizations are among scenarios that could dilute existing shareholders. But with the right conditions and timing, investors could gain.
"The share prices of euro-zone banks are now very depressed," London-based Capital Economics Ltd. said in a report dated Tuesday. "And if Germany decides that recapitalizing her banks to the value of their exposure to the Greek government is a prudent alternative to bailouts, the share prices of banks in Germany (and in other stronger countries that followed such a path) could well get a boost."
BNP Paribas is a retail and investment bank with more than 200,000 employees in 80 countries worldwide, mostly in France and Europe. Like Société Générale, with about 150,000 employees, it's a "national champion" whose importance to the financial system and the economy make it too big to fail.
Deutsche Bank, which has more than 100,000 employees, is the world's largest currency trader. It, too, is regarded as essential to the global financial system.
But it is not clear what their future holds in the event of a Greek default that would wipe out part of the value of their bond holdings. Most money managers recommend that investors remain cautious.
"Given the divergent views and the uncertainties surrounding measures of financial fragility, equity investors would be prudent to continue to underweight exposures to the region and the most exposed institutions, even given the now-reduced valuations," CIBC World Markets Inc. said in a report last week. Even if governments came to the rescue with public funds, "shareholders still take a blow when that last resort bailout proves necessary."