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Holly Cook: At the Morningstar Investment Conference I met up with Erin Davis, senior equity analyst covering banks for Morningstar, and we talked about what investors should do when the UK government eventually sells its stake in 
Lloyds (LLOY) and RBS (RBS). But first off, she started by answering my question about whether she believes the European banking sector rally will continue. Here’s her answer.
Erin Davis: I’ve been getting a lot of investor questions about European banks for exactly that reason, and I don’t think the rally is going to continue. In fact, I think it’s already losing a little bit of steam, and the reason that I think that is, I see European banks as fully valued right now. I don’t think that there is a lot of room for them to appreciate, and I don’t think that they are offering a really attractive risk/reward profile for investors right now.
Cook: So do you think then for your average investor that it’s still worth perhaps holding some of those banks, because they fill a specific role in a portfolio, or is it perhaps an area that they want to get out of?
Davis: Yeah, we do have most of the European banks rated at three-stars, with a few twos and fours, and those are generally considered to be hold. So I don’t think it’s an emergency to sell them right away. I just don’t think that it’s a good time to be piling in.
Cook: So two of the banks in particular that I wanted to ask you about, Lloyds Banking Group and Royal Bank of Scotland, are obviously – well, they are essentially owned by an awful lot of UK investors because they’re taxpayers. What should those investors – what should those potential investors be thinking of doing when the government decides to eventually its stakes in those banks? Are they still worthwhile holdings? Because, back in the day, five years ago, they were really, really popular companies here in the UK.
Davis: Yeah, and for good reason. Lloyds especially is a really good company, and I think that it will be again someday. Retail banking in the UK is a very good business. It’s very profitable. RBS still has a good retail banking operation. The problem with it isn’t investment. It’s a little bit harder to understand, because it’s a larger, more complex company, and because it has an investment bank and that’s always going to be a little bit of a black box. So what investors should do when the government does finally decide to sell its shares will depend, of course, in large part in what price that the shares are trading for right then, and it’s hard to know that. But I do think that both banks are well on the road to recovery, and if we saw a big dip in their share price perhaps as a result of a lot of liquidity, that could be something that would be very interesting to long-term investors.
Cook: So is it fair to say that those banks that you think have more interest to investors or more attractive to investors right now? Are those that tend to have operations outside of Europe?
Davis: I think that’s generally true. You are definitely going to see better growth out of banks like HSBC (HSBA) and Standard Chartered (STAN) that have a lot more operations in high growth markets, and we’re seeing some European banks that are more focused on Europe that are trying to grow in those regions and I worry that they’re going to be the last ones to the party and may end up making the worst loans. I prefer the companies that already have established moaty operations in different geographies.
Cook: Great. Erin, thanks very much for joining us.
Davis: It was good to be here. Thank you.
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