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Banks Trade Below Liquidation Value With Smallest Gain


Two years after the collapse of Lehman Brothers Holdings Inc., investors still aren’t willing to pay more than liquidation value for banks in developed nations.

The KBW Bank Index trades at 95 percent of book value, a level never seen before 2008, while stocks of lenders in Europe and Japan are also lower than their assets minus liabilities. Financial firms in the Standard & Poor’s 500 Index rose 6 percent this quarter before today, the worst of any industry and about half the return for the gauge of American equity.

Bears say the combination of slowing economic growth, the weak U.S. housing market and increasing regulation mean bank profits will be limited and bad loans may increase. To Wells Capital Management, DuPont Capital Management Corp. and Security Global Investors, low valuations, the fastest projected profit growth of any industry in the S&P 500 and the first decline in loss reserves since 2006 show banks are too enticing to ignore.

“I don’t know that trading results will be great, and I don’t know that lending results will be great, but it’s not going to matter because credit is improving fast enough that banks are going to look good and their book value’s going to grow,” said Mark Bronzo, an Irvington, New York-based fund manager at Security Global Investors, which oversees $21 billion. “The sector’s going to do well.”

Bank Slump

Declines averaging more than 50 percent since 2007 have left bank indexes below book value, data compiled by Bloomberg show. The KBW gauge closed last week with a multiple of 0.95, less than half its average of 1.95 since 1993. Lenders in the Stoxx Europe 600 Index trade for 0.96 book value after averaging 1.59 since 2002 and the ratio for lenders in Japan’s Topix Index is 0.66, the lowest since at least 1993, data compiled by Bloomberg show.

The S&P 500 declined 0.6 percent to 1,142.16 at 4 p.m. in New York today. The Stoxx 600 lost 0.4 percent while the Topix climbed 1.3 percent.

Shares of JPMorgan Chase & Co., the second-biggest U.S. bank by assets, are at 97 percent of book value and UniCredit SpA, Italy’s largest financial company, trades for 57 percent, compared with an average of 171 percent over the past 10 years. New York-based JPMorgan closed at $39.75 last week, up from a six-year low of $15.90 on March 9, 2009, while UniCredit in Milan tripled to 1.89 euros over the period.

“Investors are still scared right now, scared that if you go into a double-dip or deflation then maybe the credit quality will worsen and that won’t be good for banks,” said Rafi Zaman, who helps oversee about $22.5 billion as managing director of global equities at DuPont Capital Management in Wilmington, Delaware. “But if we’re going to a slow-growth recovery, which is what our view is, then these banks should be a decent place to be invested.”

Historic Valuations

Financial companies are trading at a discount to historic valuations even as credit markets recover from the crisis that helped spur $1.8 trillion of global bank losses. Defaults on corporate bonds and loans in August decreased to a 20-month low of 5.1 percent in the U.S. and an 18-month low of 4.8 percent in Europe, according to Moody’s Investors Service. Companies have issued $124.3 billion in corporate bonds in the U.S. this month, poised to beat the high of $125.1 billion in September 2009, according to data compiled by Bloomberg.

At the same time credit markets are improving, banks aren’t lending. They pared commercial and industrial loans to $1.24 trillion in the week ended Sept. 8, 11.3 percent lower than a year earlier, Federal Reserve data show.

Loan Provisions

Provisions for loan losses at American lenders fell 40.5 percent to $40.3 billion in the second quarter from a year earlier, marking the first reduction in four years. Foreclosures as a percentage of total loans fell last quarter after four years of advances, according to data released by the Mortgage Bankers Association on Aug. 26.

“The vast majority of them have worked through a lot of their problems,” said James Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management, which manages $342 billion. “Charge-off rates are coming down, delinquency rates are coming down. You look at the fundamentals here, and they’re really very good.”

Most investors are avoiding banks. Money managers overseeing a combined $579 billion listed them as the biggest “underweight” among 11 industries in a Bank of America Corp. survey last week. Financials were the only group deemed both “undervalued” and rated “underweight” in the poll.

Slowing Recovery

The companies may remain cheap as economic reports suggest a rebound from the first global recession since World War II is faltering, according to Thomas Haerter, who helps manage $58 billion at Swisscanto in Zurich.

The Fed said last week sluggish growth and the risk of deflation may prompt further steps to ease monetary policy. U.S. central bankers indicated they’re ready to expand their balance sheet from $2.3 trillion by purchasing bonds, after reports on home sales and jobs signaled the economy’s rate of growth is decreasing. The Fed’s benchmark interest rate has been at a record low of near zero since 2008.

U.S. rules limiting Wall Street firms’ proprietary trading and hedge fund investments may mean banks have fewer tools to boost profits. Regulators from 27 nations more than doubled their capital requirements for banks on Sept. 12 as part of international efforts to prevent future financial crises.

“The sector has capital problems, and it is ranked No. 1 in the hate list of politicians and the electorate,” said Swisscanto’s Haerter. He’s “neutral” on banks though may consider adding to the holdings because of the low valuations. “There are still huge risks out there.”

Housing Starts

Fewer new U.S. homes than forecast were sold in August, signaling the housing market remains depressed even as mortgage rates dropped, figures from the Commerce Department showed Sept. 24. Purchases were unchanged at a 288,000 annual pace, matching July as the second-lowest in data going back to 1963.

“We can’t forget the housing market is still relatively weak,” said Howard Ward, fund manager at Gamco Investors Inc., which oversees $26 billion in Rye, New York. “If housing prices start to go down again, that’s going to raise questions about asset quality and capital sufficiency and the banks are going to find themselves against a wall once again.”

Equity Turnover

U.S. investment banks may be having the worst quarter for trading since the peak of the financial crisis. Equity investors have traded a daily average of 14.2 billion shares in the third quarter, according to Bloomberg data. That’s on track for the lowest level since the April-to-June period in 2008, and 24 percent less than the year-earlier average, the data show.

The average daily dollar amount of U.S. Treasuries traded since July 1 was down 6.4 percent from last quarter, according to data from ICAP Plc, the world’s largest inter-dealer broker.

Analysts at Deutsche Bank AG including Michael Carrier lowered their forecast for third-quarter earnings at New York- based Goldman Sachs Group Inc. and Morgan Stanley on Sept. 21, citing “weak capital market trends.” The brokerage reiterated a “buy” recommendation on both stocks, saying that “despite the challenging quarter, we continue to believe the headwinds are mostly priced into current valuations.”

Goldman Sachs, which closed last week at $147.28, trades for 1.19 times book value after rallying 12 percent from its 2010 low of $131.08. Morgan Stanley fetches 0.85 times assets minus liabilities, compared with an average of 2.10 since 1996, according to data compiled by Bloomberg. The stock closed at $25.15 last week, down 15 percent for the year.

JPMorgan is below book value even with last year’s 86 percent surge in per-share profit. Analysts estimate earnings will rise 42 percent this year and 28 percent in 2011, data compiled by Bloomberg show. The shares are trailing the S&P 500, with a 4.6 percent loss so far in 2010, compared with the index’s 3 percent increase.

UniCredit Valuation

UniCredit’s stock has lost 15 percent in 2010, compared with the Stoxx 600’s 4 percent gain. Profit for the bank is forecast to double next year and climb another 36 percent in 2011, according to data compiled by Bloomberg. Second-quarter earnings fell 81 percent as trading plunged and the company recorded a writedown to goodwill.

Fifth Third Bancorp, Ohio’s largest lender by deposits, boosted earnings after setting aside 69 percent less money for future loan losses in the second quarter. The Cincinnati-based company posted its first profit in a year last quarter, and analysts estimate earnings will more than double this year, and then triple in 2011. Fifth Third trades for 97 percent of book value, data compiled by Bloomberg show.

“As we see continued improvement even at the margin, that should help rebuild confidence and ultimately close the gap between the price and the value,” said Mary Chris Gay, a fund manager at Baltimore-based Legg Mason Inc., which oversees $645 billion. “Groups that do lead the market are historically very cheap at the low point of the cycle.”