-
Unlike the bargain-heavy aftermath of the crisis, acquisitions during the recovery have been hampered by high premiums and unsatisfactory returns.
January 4 -
The Federal Deposit Insurance Corp.'s third-quarter industry update pointed to signs of banks expanding their risk profiles despite slow revenue growth.
November 24 -
The regulators' annual Shared National Credits review found nearly 10% of large, syndicated credits demonstrated some form of weakness, most of which were leveraged loans. But renewed concerns about energy loans also cropped up.
November 5
The
The precipitous drop in bank share prices could be seen as surprising, since recent earnings announcements have been relatively uneventful. But the fall in the banking index is more understandable when one considers the impact of a changing
In the years following the crisis, banks – supported by an accommodative monetary policy – increased commitments to higher-risk asset categories, including real estate, corporate, energy and emerging markets. Low default rates, narrowing credit spreads and rising asset prices encouraged banks to loosen underwriting standards in search of revenues during the upswing in the credit cycle.
But potential credit problems began surfacing last year. These included a flattening yield curve, rising high yield credit spreads, increasing corporate leverage and falling secondary market loan prices. The federal bank regulators expressed concern in their
Bank financial results for the fourth quarter are largely silent on this concern. This is not surprising since opaque bank financial statements are lagging, rather than leading, indicators of asset quality issues. For example, only recently have banks started increasing energy loan reserves despite the secondary market prices for many of these credits falling below 50% of par, according to Thompson Reuters. Instead, institutions are engaging in "
To be fair, any direct asset problems have not shown up on bank balance sheets. But investors are displaying signs of doubt about institutions' stock price compared with their asset values. Return on equity at many banks continues to lag their cost of equity, and the problem will worsen as the credit cycle becomes more unfavorable. Share prices relative to book value, or the total nominal value of a bank's assets, are low at banks of different sizes. JPMorgan Chase's stock price is trading at an 8% discount relative to its book value. The ratio is flat at BB&T, but KeyCorp is trading at an 11% discount while Wintrust is trading at a 10% discount. The problem is worse at banks like Citigroup and Bank of America, which have discounts as high as 40%.
The low ratios indicate these banks lack franchise value let alone growth potential. Institutions might be gaining more value if they took a more conservative approach consistently applying credit underwriting standards based on a clearly articulated risk appetite and enhanced risk disclosures. But if banks have elevated charge-offs in their future, that won't help earnings. Absent actions that signal tangible value potential – such as increased cash dividends - we can expect shareholder activism to grow as activists seek to close the growing value gap.
Activist investors are typically drawn to institutions with low returns that demonstrate caution and therefore a potential to gain value by reinvesting earnings in underperforming activities. They are challenging the strategic direction of banks based on continued poor performance. Unfortunately, for some banks, curtailing growth or reducing dividends may not be enough; spinoffs, divestments and outright sales may be needed. The problem cannot be covered over by moving up the credit risk curve or making overpriced acquisitions.
As Warren Buffett says you can only tell who was swimming naked when the tide goes out. The tide in this case may be the worsening credit cycle.
J.V. Rizzi is a banking industry consultant and investor.
