European banks remain compelling despite global uncertainty - August Trust Update

Market review

Equity markets saw further gains in August supported by Fed Chair Jerome Powell’s comments at Jackson Hole that suggested an interest rate cut in September was warranted due to rising risks in the US jobs market, notwithstanding concerns around inflation. This was in contrast to the UK, where the positive impact of a cut in interest rates by the Bank of England was offset by the slim majority of members of the monetary policy committee who remain concerned about inflationary data which has been exacerbated by government tax and minimum wage changes.

Against that background financials outperformed wider equity markets, with the Trust’s net asset value rising 0.6% against its benchmark, the MSCI All County World Financials Index, which returned 1.0% . This underperformance was largely due to the Trust’s underweight position in Japan and holdings in Beazley and Fidelity National Information dragging on performance.

Nu Holdings and Bank of Cyprus

Nu Holdings (Nu) and Bank of Cyprus were two of the strongest contributors to performance over the month. Nu is the number one Latin American FinTech company with significant market share in Brazil and now growing in Mexico and Colombia. Its share price rose 21.7% over the month on the back of results that illustrated continued strong growth in its business with customer numbers increasing to 123 million, up more than four million on the quarter; net income was up 11% versus the previous quarter and 42% over the year on a constant currency basis. Cost of servicing a customer remained steady at only $0.80 per month. The only negative was a small uptick in bad debts, which management put down to seasonality.

Bank of Cyprus, the largest bank in Cyprus, produced a solid set of results although profits only rose 2% on the previous quarter, reflecting the impact of lower interest rates on its net interest income. Nevertheless, the bank still produced a return on tangible equity of over 18.0% on a Common Equity Tier 1 (CET1) ratio of 20.6%, well above European banking peers and the key driver of the continued rerating of its shares, which rose 14% over the month. The Cypriot economy continues to perform well, with the country upgraded to A- by S&P Global in December 2024, reflecting its strong growth and debt-to-GDP ratio being on a par with Germany, a significant improvement on the CCC rating it was cut to during its financial crisis in 2012-13.

Beazley and Fidelity National Information

Beazley’s shares fell on the back of a more cautious outlook for growth which overshadowed a good set of earnings with a return on equity of 18% and a very strong solvency ratio. Its shares have performed very strongly over the past five years, raising equity capital to lean into the hard market in property and catastrophe reinsurance as well as cyber, where it has a market-leading position. With the market outlook for interest rates looking softer, we expect Beazley’s underwriting strength will continue to deliver attractive returns when looking at the diversification of its franchise and are reassured by the company’s discipline to slow growth when the risk/reward is less attractive. We remain very comfortable with the holding.

We remain constructive on European banks, including the UK, our largest overweight position

Fidelity National Information, a banking software and payments company, also saw its shares fall sharply on its results which were marginally better than expected and management increased guidance for the full year, the latter due to FX moves and recent acquisitions as opposed to stronger growth. The company also stated that third-quarter revenues could be weaker before rebounding. Furthermore, free cashflow generation was very weak. While management fairly pointed out that this was seasonal and the second half would be much stronger, the market was less forgiving and not willing to give the company the benefit of the doubt. We feel the shares remain undervalued relative to the cash generation capacity of the company, but reduced the holding as this was the second miscommunication by management.

UK banks

August saw the UK’s Supreme Court issue its much anticipated judgement on the Motor Finance appeals brought by Close Brothers Group and MotoNovo (owned by FirstRand Bank), following last October’s far-reaching Court of Appeal ruling in favour of consumers. Crucially, the Supreme Court ruled in favour of the banks on two of the three consumer claims, specifically those of fiduciary duty and bribery. The ruling held that car dealers, and by proxy the banks, do not owe a fiduciary duty (i.e. undivided loyalty) to customers when arranging finance and so commission payments do not constitute a bribe.

The one claim to be upheld in favour of consumers, however, related to an ‘unfair’ relationship between customer and lender, under section 140A of the Consumer Credit Act. This was driven principally by the size of the commission charged (55% of total interest) and a lack of clear and adequate disclosure about its existence. As a result, the Court deemed compensation to be necessary for such occurrences, with the FCA subsequently announcing its intention to launch a consultation by early October 2025 on an appropriate redress scheme. Against that background, UK banks rallied sharply on the news in the expectation that total compensation under the scheme would be substantially lower than previously expected, albeit there was selling pressure towards the end of the month as speculation resurfaced of further taxes on the sector.

Outlook

With the rally in financial markets, we have modestly reduced risk in anticipation that markets will be less forgiving in September and October and will provide an opportunity to take on more risk in the portfolio at lower levels. Nevertheless, we remain constructive on European banks, including the UK, our largest overweight position. In a note during the month, Morgan Stanley highlighted that the sector saw the largest increase of positive versus negative adjectives in its second-quarter results which will have helped share price performance, notwithstanding that it was most likely in part due to the about turn on tariffs which would have dominated first-quarter earnings calls. Despite their strong performance, they remain on a large discount to wider equity markets and other major banking markets with a price/earnings ratio on average of 9.1x for calendar year 2026. In comparison, the equivalent price earnings ratios for Australian, Indian, US and Japanese banks are 19.9x, 14.3x, 12.9x and 11.6x respectively. Only Chinese and Korean banks trade on lower multiples.