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ANALYSIS-Funds fear regulatory cosh will hit bank earningsLONDON, Oct 17, 2008 (Reuters via COMTEX) -- Governments may have stepped in to recapitalise struggling banks, but asset managers are still struggling to see value in the hard-hit sector. Funds are fearful lower leverage and tough regulation will hit earnings growth over the next decade, meaning the sector's prospects are significantly less attractive than in the past. "Banks have been broadly viewed as growth stocks, but with government involvement they will look to control risk to a much greater degree," said Jeff Munroe, chief investment officer of Newton Investment Management. "And with interest rates so low, how will they get a big play on the yield curve to replenish their profitability?" he asked, referring to banks' ability to borrow cheap short-term funds and lend long-term at higher rates. The European bank sector has plummeted to its lowest level since 1997, having lost well over half its value since hitting a peak in the middle of last year, and has lagged European blue chips as a whole by 17 percent so far this year. Blue chip casualties are not hard to find -- UBS AG is down more than 80 percent. The sector is also underperforming traditional defensives. The MSCI World Banks Index is down 47.2 percent over 12 months while the MSCI World Healthcare Index is down only 25.4 percent. But some value managers -- the usual buyers of beaten up stocks -- are not persuaded this is a buying opportunity. Adam Steiner, head of research at SVG Investment Managers, said banks only look cheap if earnings rebound to pre-credit crunch levels -- a prospect which looks unlikely any time soon. TEN-YEAR BUBBLE Sceptics argue bank earnings have been artificially inflated during the 10-year bubble in credit. Klaus Wiener, head of research at Generali Investments, said the targeted 25 percent return on equity for banking was only possible due to cheap and ample liquidity. "Those targets need to be more sensible. If you only have nominal GDP of about 5 or 6 percent, how can you expect one sector to return 25 percent?" Credit Suisse analysts have cut 2009 EPS estimates for European banks by an average of about 20 percent and stress the need for more earnings visibility before they can turn positive. They say the European wholesale banking sector now trades on a ratio of 0.97 to tangible 2008 estimated net asset value, with Deutsche Bank on 0.80 and UBS on 1.19. "At these valuations, the market is implying a significantly lower structural ROE (return on equity) going forward, which we believe is correct," they said. Nigel Jenkins, senior strategist at Payden & Rygel, noted all the institutions in trouble were characterised by rapid growth on the back of leverage. And the expected crackdown from regulators on excessive leverage will make it harder for banks to generate the returns they made in the easy credit years. Banks are largely a play on the dynamism of the local economy, so in a recessionary environment the attractiveness of banks as an investment proposition falls, particularly if dividends are curtailed as looks likely in the UK. "We might see some sort of bounce in banks based on better optimism or Probably not. The best opportunities are likely to be in different areas," Munroe said. DEAD IN THE WATER Jeff Arricale, lead portfolio manager of the T Rowe Price Financial Services Strategy, predicts a return to making money from traditional services, reflecting a shift from risk-taking investment banks and brokers to straight-laced commercial banks. Others agree. "The investment bank model is dead in the water," said Joan Payden, president of U.S.-based asset manager Payden & Rygel, noting derivatives had allowed the fixed income market to swell to twice the size of the equities market globally. "But if you take liquidity out of this system, you're looking at a completely different structure," she said. While regulators focus on preventing further collapses, investors are wondering how the system may be overhauled. "The problem at the moment is that banks take more risk when markets rise, so there is an accelerator effect," said Schroders chief economist Keith Wade. "If capital requirements increase automatically in line with market increases, this won't happen." He added shareholders also need to do more. "We are seeing the first signs of that. The share prices of Goldman Sachs and Morgan Stanley fell sharply because shareholders were saying that that business model doesn't work any more." Robert Talbut, chief investment officer of Royal London Asset Management, believes banks will rely less on short-term financing and will seek the stability of deposit bases. "The successful banks will be the ones with a strong branch network and retail savings base, as wholesale funding will be harder to come by and more expensive." (Editing by Joel Dimmock and David Holmes) Keywords: FINANCIAL/BANKS VALUATION [email protected] cmr COPYRIGHT Copyright Thomson Financial News Limited 2008. All rights reserved. The copying, republication or redistribution of Thomson Financial News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Financial News. MMMM [ Back To TMCnet.com's Homepage ] |