How negative rates are affecting banks

Low and even negative interest rates are putting pressure on banks’ net interest margins, forcing institutions to adapt to a challenging revenue environment. Conor Muldoon, fundamental portfolio manager at Causeway Capital Management LLC in Los Angeles, Calif., says he’s looking for banks that are findings ways to offset the impact of low rates.

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To protect their net income, banks are implementing interest rate hedges, he said in a Sept. 16 interview.

“The headwind that this creates tends to manifest itself slowly over time — over a period of three to five years, as opposed to an immediate impact,” he said. “This time allows banks to focus on potential offsets, such as cutting costs or asset repricing.”

Muldoon’s firm is also focusing more on management, preferring teams that put less emphasis on top-line growth.

“What we tend to see are management teams that are focused on managing the cost base, de-risking the balance sheet and preparing for a tough revenue environment,” he said.

There’s also an overlooked benefit from low interest rates, he said, regarding banks’ cost of risk or the level of bad debt provisioning.

Two picks

One financial company that Muldoon said is prepared for a tougher revenue environment with Europe’s negative rates is Italian bank UniCredit, which has “transformed itself” since a new management team took over in late 2016.

“What their sole focus has been over the last two to three years has been de-risking the balance sheet, improving the capital base of the bank and, ultimately, reducing its cost base,” he said.

To de-risk, the bank is reducing its non-performing loans, which made up 15% of its balance sheet, Muldoon said, aiming to get that to close to zero by 2021.

UniCredit has also reduced its cost base from $12 billion euros to $10 billion euros.

“What we like about this bank is none of this is really reflected in the stock price currently,” he said.

UniCredit is trading at around 6.5 times earnings.

Muldoon said he also expects the bank to start returning “a significant amount of capital” back to shareholders through dividends and share buybacks.

Another “favourite” is U.K. bank Barclays, which has also undergone a transformation over the last few years, he said. The management team is similarly focused on restructuring the cost base, as well as reinvesting in its corporate investment bank franchise and improving the level of returns on tangible equity to 9% or 10% in 2019 and 2020, which they’re well on their way to doing, he said.

Barclays is trading around 7.9 times earnings, and Muldoon also expects it to return more capital to shareholders in the next two to three years.

“It’s got north of 13% core equity tier one, and is now very well placed to start buybacks and increase common shareholder dividends in the next 12 months,” he said.

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