Non-U.S. Banks Stock Update - July 2010 - Industry Outlook

The global banking industry has been recovering at a slower pace from the worst downturn since the Great Depression that started as a credit issue in the subprime segment of the U.S. mortgage market and ultimately spread to engulf almost the entire global financial services industry. Though the worst of the financial crisis is behind us, there remain major political challenges following the intervention of governments to rescue and stabilize the global banking system.

Although non-U.S. banks are still dealing with liquidity and confidence challenges, governments have taken several steps to alleviate the sector, as banks are the lifeblood of the economy. Consequently, the political interference in the sector has increased significantly over time. The politicization has added to the existing financial risks that banks face.

The political interference will continue to influence banks' lending decisions to until they repay government money. According to banking regulators, if governments withdraw their support from banks before giving them sufficient time to restore their financial strength, the sector will face another collapse.

Though the industry is in the process of adopting tougher measures to help prevent a recurrence of the global financial crisis and restore public confidence, there remain lingering concerns. However, we believe it would be a perfect time to get involved with non-U.S. bank stocks for long-term investments, as valuations are now comparatively cheaper.

Investors with short-term targets should not go for non-U.S. stocks at this point as the near-term fundamental outlook remains weak -- asset quality is expected to continue to deteriorate as individuals and companies default on loans, and revenue growth should remain stretched as loan growth falters and investment banking faces a dearth of new business despite the economic recovery.

Increasing unemployment and sluggish business conditions worldwide are expected to dampen demand for credit, though banks are now capable of lending more. Moreover, these factors will also hurt asset quality and increase losses on the existing "good" loan portfolios. Combined with top-line pressure due to a sluggish economic recovery, non-U.S. banks face a discouraging outlook in the near- to mid-term.

Although the upturn in the banking sector through the remainder of 2010 will vary from country to country, depending on industry circumstances, we believe that banks in stable emerging economies, such as Chile, Brazil or India, may be more attractive investments -- similar to what we expect for certain regional banks in the U.S.

However, the recent debt crisis has threatened the Greek economy and the stability of the European Union's monetary policies. Starting as a solvency crisis of a single country, the turmoil has threatened the entire Euro-zone. This could again create a new global financial crisis, challenging the world banking system. Though the European Union has been bailing out the country to assure creditors that it will not default on its debt, there is no guarantee that the country will be safe as affluent domestic and foreign investors will not stop withdrawing their money from Greek banks, from which they have already pulled out billions.

However, European Union authorities have taken the decision to put more banks through the public stress test in an attempt to reinstate the transparency and trustworthiness of the European banking system.