The Fairytale Banks Of Paris And Vienna

European bank shares have been gutted in the past four years, as the sovereign debt crisis in Club Med has escalated into an existential crisis for the Euro. However, as Lord Rothschild advised posterity after he made a fortune in British gilts on the eve of the battle of Waterloo, “buy when blood runs in the street”. The point of maximum pessimism is often the point when bank shares trade as leprosy metrics on the stock exchange or an inordinate discount to book value. However, even the slightest transformation in a bank’s operating prospects, credit profile or balance sheet risk can mean a spectacular valuation rerating in a distressed bank’s share price. So Citicorp shares rose eightfold in the 1990s as the New York bank improved its problem real estate, leveraged buyout and Latin American loan book. Brazil’s Banco Itau rose ten fold after President Lula de Silva averted default on its external debt and engineered an epic fall in its sovereign risk. I am convinced a similar, long term opportunity exists in two of Europe’s preeminent banks whose shares could well double in 2013.

Take France’s BNP Paribas, the leading private bank in Western Europe. At 30 Euros, I believe BNP is grossly undervalued as investors simply do not appreciate the recent, spectacular transformation in its balance sheet. BNP Paribas shares are closely correlated to credit risk spreads in Club Med sovereign debt, which have fallen after Mario Draghi’s “do whatever it takes to save the Euro” speech. Sure, France is burdened with a Socialist President in the Elysee Palace and export exposure to Italy/Spain but BNP Paribas is a too big to fail global bank that has dramatically slashed its dependence on short term funding and reduced rollover risk in its asset/liabilities book.

In the past year alone, BNP’s capital ratio has risen by an incredible 180 basis points and the bank has halved its holdings in peripheral Europe government debt. BNP has hugely boosted client deposits and its long term funding base, slashed its footprint in dollar funding dependent cross border project/ trade finance and publicly announced its intention to reduce its loan/deposit ratio below 100 per cent. BNP’s Basel Tier Three capital ratio is nine per cent but it still trades at a rock bottom 0.5 times book value. A Waterloo metaphor is not really apt for a French bank but BNP truly meets Nathan Mayer Rothschild’s “blood on the street” doctrine. Will France go into recession? Yes. Does BNP own an Italian bank BNL? Yes. Does it have a huge London capital markets franchise? Yes. Is there integration risk in its takeover of the Belgian bank Fortis. Yes. This is the reason BNP trades at its Cinderella valuation at 0.5 times book value. This is also the reason why the shares could well double in Paris in 2013. Voila!

The Hapsburg Empire that once dominated Central Europe is long gone but its spirit survives in Vienna’s Erste Bank, Austria’s largest lender whose pedigree goes back after the Napoleonic wars and the Congress of Vienna. Erste Bank owns 30 per cent of the retail banking market in the Czech Republic and Slovakia, two of the most stable, liquid, low banking penetration markets in Europe, apart from its dominant franchise in Austria. The bank has restructured its Hungarian business after Viktor Orban’s government intervened in the mortgage financial market and has hedged its Romanian exposure. Its footprint in troubled Serbia and Ukraine is marginal while Croatia and Slovenia are classic growth markets. The 2008 financial crisis was traumatic for the bank. The Austrian state injected 1.2 billion Euros in capital. The bank shocked the markets with a $1.1 billion loss, its first since 2008, due to Hungarian write offs and CDS trading. However, the markets excessively price its exposure to tail risks in peripheral Europe and Hungary. The bank’s valuation multiple is at classic Cinderella levels at 0.5 times book value. The shares trade at 15 Euros in Vienna. I believe sheet-earning growth will mean they double in 2013 to 28 – 33 Euros.