AXA, ING Alpha Bank among top UBS picks

During June, the unexpected rise in bond yields affected European Financials more than other interest rate-sensitive sectors. Despite a partial recovery in longdated bond yields, Financials continue to lag behind the market. UBS analysts view this is an overreaction to the ongoing deterioration in the US sub-prime mortgage market and believe these risks are contained and should not spill over to other asset classes. Therefore, UBS analysts reiterate the conviction that European Financials offer good value and should be more cushioned than their US counterparts to the US sub-prime credit risk downturn, according to the UBS Investor’s Guide report dated 6 July 2007.

The recent weakness of insurance stocks is exaggerated. Insurance companies tend to enhance their returns by investing part of their bond portfolios in lower-rated bonds, which in generates a higher yield. However the recent insurance sell-off is an overreaction to the pickup in high-yield spreads, as most investments are securitized products, which are usually highly rated. Banks have suffered recently as well. Since 2003, low interest rates have fuelled demand for mortgage loans in Europe. The Irish and Spanish mortgage markets have grown at double-digit rates.

Still, even if we assume that higher interest rates would reduce demand for mortgage loans, the magnitude of the expected interest rate increase can not justify the recent correction in bank stocks.

 

Stock ideas within Financials

AXA is UBS’s top pick in the Equity Top List Financials. AXA has very good earnings and growth power and a well-regarded management team. The company is well diversified in terms of segment and region and benefits from strong secular trends in asset

gathering and life insurance. Swiss Re, the largest reinsurer globally and a defensive play within the sector, is another choice among insurers.

ING and Allianz are two further European insurers with attractive valuations. ING is a globally diversified financial service company well positioned in the US pension business and in Asia; moreover it has a leading position in on-line banking through ING Direct. Allianz can benefit from further restructuring and cash generation, with the latter leading to higher dividends and share buybacks.

We expect Spanish and Irish banks to grow earnings above the average of European banks, note UBS analysts. “Although we anticipate a gradual correction in Spanish house prices, this should result in only a moderate earnings slowdown.”

Finally, Anglo Irish Bank is another bank stock that has corrected strongly and offers good value; the company focuses primarily on commercial real estate lending in Ireland and the UK, two markets that we expect to be resilient and retain attractive growth rates. UBS analysts currently rate all stocks mentioned above as (“Buy/Outperform”).